Financial Markets Forecast & Analysis

The Dow Jones Industrial Average fell 108.23 in line with our expectations as last week's ShorttermTII came in at negative (33.25). This indicator has been quite accurate since the first of the year, the week prior being the lone exception. That week's inaccuracy was due more to the truncated wave c of 2 up due to the extreme bearish intermediate-term environment taking control. After two huge news events this week, The Fed's decision to keep short-term interest rates artificially low and the 288,000 reported non-farm payroll jobs added in April, the markets chewed a bit, then spewed out their displeasure. Friday's sell-off was horribly Bearish and it is a miracle that prices in the DJIA and S&P 500 didn't plummet. The Transports plunged, Bonds got creamed, Gold was dumped, and the mining stocks resumed their crash. The word "crash" is looking more and more apropos and we will spend more ink on this topic this week.

Breadth was (pick an ominous adjective), with advances only 8 percent -that's right- of total NYSE issues traded. Volume was up Friday on market participants' abject rejection of Dubya's top sandbaggers, the Fed and the Labor Department, making it another "Distribution day" where the smart money got the heck out of Dodge while the "buy and hold" amateurs or "don't-give-a-hoot, just-pay-me-the commission" money managers bought in "cheaper."

This week the Short-term Technical Indicator Index comes in at negative (28.75). This indicator is a useful predictor of equity market moves over the next two weeks, both as to direction and to a lesser extent strength of move. For example, readings near zero indicate narrow sideways moves are probable. Readings closer to +/-100 indicate with a higher degree of confidence that an impulsive move up or down is likely over the short run. Market conditions can change on a dime, so it may be unwise to trade off this weeklymeasured indicator. Massive increases in M-3 have reduced the severity of this indicator. It appears the Intermediate reading is dominating the Short-term at this time - highly unusual.

The Intermediate-term Technical Indicator Index is useful for monitoring what's over the horizon- over the next twelve weeks. It serves as an early warning system for unforeseen trend changes of considerable magnitude. This week the Intermediate-term TII comes in at negative (47.75), warning that a significant decline may be imminent. Massive increases in M-3 have reduced the severity of this reading, and may serve to mitigate the damage or the timing of a precipitous fall.

We remain under a Dow Theory "sell signal" and should both the DJIA and the Trannies record new closing lows, below March 24th's 10,048 in the Industrials and below March 22nd's 2,750 in the Transports, the sell signal and downtrend will be confirmed. Most major indices have formed Bearish price patterns with many patterns completing and/or looking worse. Head & Shoulders Tops appear in the NASDAQ Composite ($COMPX), the NASDAQ 100 ($NDX), the Amex Gold Bugs ($HUI), the Philadelphia Gold & Silver Sector Index ($XAU), Philadelphia Semiconductors ($SOX), the Trannies ($TRAN), the Dow Jones Utilities ($UTIL), and the i shares Dow Jones US Financial Sector Index (IYF). A Double Top is seen in the Morgan Stanley Consumer Index ($CMR), Rounded Tops in the Dow Jones Industrial, S&P 500, and Amex Composite Indices, and Quadruple Tops in the Russell 2000 ($IUX) and the Wilshire 5000 ($TMW.X). The NASDAQ Composite, Trannies, and i shares broke below their 200 day moving averages on Friday and the Mining Stock Indices continued their decisive break below their 200 day MAs along their trek into the abyss.

Let's talk crash. The Dow Jones Industrial Average may be in the early stages of one. This week I'd like to examine the 52-week new highs versus 52-week new lows on the NYSE to see if they offer us a clue about crashes, their start and their finish.

There is a pattern of highs and lows that I believe does a pretty good job of warning when a major decline is about to occur, is upon us, or is about to bottom. Please refer to above chart for the 6 crashes that have already occurred since the Bear Market began in early 2000, and the 7th crash which may actually be happening right now.

The pattern goes something like this: Leading up to a top, the # of new highs far exceeds the # of new lows. This, of course, is common sense. Signs of trouble occur when the # of new highs becomes approximately equal to the # of 52 week new lows, with both figures above 90 issues.

This equality sometimes creates what my good friend Kennedy Gammage (The Richland Report, P.O. Box 222, La Jolla, CA 92038, Report # 04-9, April 30th, 2004, (858) 459-2611) has dubbed the "Hindenburg Omen." This indicator is a reliable "crash" predictor. It occurs when both New Highs and New Lows on the NYSE each exceed 2.4% of the issues traded that day, and the 50-day MA of the S&P 500 is still moving up, and the McClellan Oscillator is below zero. This crash indicator is the creation of Jim Miekka (The Sudbury Bull & Bear Report).

Sometimes "approximately equal # of new highs and lows above 2.4% of total issues traded" does not create a crash signal because either the S&P's 50-Day MA wasn't rising or the McClellan Oscillator was above zero - yet a crash comes anyway.

In fact, the six crashes identified in the prior chart each reached this greater than 90 new highs/ new lows approximate equality phenomenon, but not all registered Hindenburg Omens. If you get an Omen, it adds to the body of evidence supporting an imminent crash (within 30 days of the Omen), but crashes can occur without it.

Preceding crashes, the pattern of new highs and new lows proceeds from a point of near equality, above 90 each, to a point of reversal where the number of new lows begins to exceed the number of new 52- week highs in a day. The margin of difference usually jumps to a pretty wide number right from the get-go of this reversal. What makes this aspect of the pattern a pretty good clue of an impending crash is that when you think about it, the averages are already near their 52 week highs (since they recently topped), yet many stocks individually have experienced severe price deflation to quickly reach 52-week lows. This suggests serious deterioration in underlying market conditions, invisible to index watchers.

Continuing the crash high/low pattern development, as the freefall hits its stride, you typically see the number of new lows start to exceed the number of new highs by about 150 to 200 issues, with the number of new highs coming in below 50.

The bottom of the crash is near when the # of new lows exceeds 500 or so. The 1/14/2000 to 2/25/2000 crash took the DJIA from 11,722 to 9862, an 1860 decline over 28 trading days. The bottom, 9,862 was 100.8 % of the previous 52-weeks' closing low, and the crash ended with 354 new lows.

Crash # 2, from 3/8/01 to 3/22/01, from 10,858 to 9389, a relatively mild 1469 point crash over 10 trading days, ended with a mere 140 new lows. 9389 was 94.1 % of the closing low within the past 52 weeks.

Crash # 3 that started on 8/24/01 and lasted 15 trading days until 9/21/01 wiped out 2,187 points and ended with 23 new highs vs: 800 new lows. The bottom of this crash, DJIA 8235, was 87.7 percent of the prior 52 weeks' index low.

Crash # 4 started on 5/14/02, declining 2596 points (25.2%) over 48 trading days until hitting 7,702 on 7/23/02. New lows on the last day of the crash spiked to 728 from the prior day's 558 from 423 and 202 the two days before. This bottom, 7,702 was 93.5% of the prior 52 weeks' closing low.

Crash # 5 started on 9/10/02 and fell 1316 (15.3%) points over 21 trading days ending 10/9/02 with 608 new lows. The low in the index was 7,286, 94.5 % of the low in the index over the past 52 weeks. New lows the four days leading to the crash's last day were 375, 505, 498 and lastly 608. New highs each of those days were under 50.

Crash # 6 started on 1/14/03, the third year anniversary of the 1/14/00 all-time top, and lasted 38 trading days, falling 1,318 points (14.9%) to a 3/11/03 closing low of 7524. The # of new lows that day spiked to 285 from the prior two day's lows of 258 and 186. The small # of new lows at the crash's bottom is likely due to the fact that a lower Bear Market low had occurred within the past 52 weeks, 10/9/02's 7,286.

This was probably the toughest crash to call a bottom for because the number of new lows did not come close to exceeding 500. The ratio of the crash's low to the previous 52 week low was quite high, 103.3%. The Iraq War and massive amounts of liquidity likely served to cut this crash short.

Which most importantly brings us in long-winded fashion to crash # 7, the next one in this four year Bear market, which we believe could come in the next six weeks - and may already be underway. First of all, the DJIA closed at a recent high of 10,737 on 2/11/04, the top of a nearly year-long rally that took us to 91% of the all-time high. If the crash is underway, I would label its start from 4/6/04, at 10,570. Or, it could be labeled to start from 10,478 on 4/27/04, the top of Elliott Wave minute degree wave 2 up. Of course, maybe the crash has not started yet.

But consider this: The number of new lows moved to an approximate equal # of new highs, with both over 90, on 4/13/2004. A Hindenburg Omen was triggered on that day. Same for 4/22, 4/23, 4/26, and 4/27/2004 according to Kennedy Gammage. That is - count' em - five Hindenburg Omens in April. Since then, the number of new lows was running about 100 more than the # of new highs on average - until Friday May 7th. Friday saw 26 new highs and - are you sitting? - 709 new lows. This means the sweet spot for this crash - if it is one - is upon us. Since we finished a huge one-year rally, with prices reaching back up toward all time highs, I would expect the signal for the bottom of the next crash to be a very high # of new lows, over 1000, perhaps 1200 or more.

We cannot be sure another crash has started, but if it has, the # of new lows should help us identify the bottom. We don't know how high or how long prices will rally from that bottom before another crash occurs, but the repeating high/low pattern we've just outlined can be a guide.

The Dow Jones Industrial Average has completed a Bearish Rounded Top, and appears to be rolling off the right side of the arc, preparing for a vertical decline. Friday's price action broke below the bottom line of its upward sloping trend-channel. Not good. Key support is at 10,048, the exact same point where the 200-day moving average and the prior low on March 24th sits. A break below support opens the door for an uninterrupted slide to the 9500 to 9700 area, possibly even lower.

Believe it or not, the DJIA 14-day Relative Strength Indicator is showing that the Industrials are not yet oversold. Worse, the Moving Average Convergence Divergence is declining although oversold.

The above chart (courtesy of www.stockcharts.com) shows the New York Stock Exchange index of Financial Stocks getting slaughtered. Here we see a classic Rounded Top pattern. If you want to know what happens after prices proceed to the right side of the top's arc, this picture shows it. Picture a globe. Once it hits due east, the only place for prices to go is due south. Financials lost 2.34 % on Friday, May 7th, a whopping 154 points, and violated its 200 day moving average. It is interest rate fears, the unwinding of the carry trade (fear they won't be able to borrow short at historic lows and invest out further along the yield curve at a positive spread). It's been easy money doing this for several years now. The market knows that earnings opportunities are about to go away. The market also senses with all the debt out there, should interest rates rise, two more bad things can happen to this group's earnings: first, financings and refinancings and the hefty volume of transaction and leveraged-deal fees will disappear. Second, those institutions holding direct paper with borrowers are likely to experience rising debt defaults and increasing charge offs. The plight of financials will trickle down to operating only companies as we have in effect, by Master Planner design, become a financial transaction nation, since manufacturing has been shipped overseas. The price action above is ominous.

The Economy

The Institute for Supply Management reported that its Index of Manufacturing Activity fell to 62.4 for April from 62.5 in March. The government reported that Factory Orders rose 4.3 percent in March. Based upon the ISM report, perhaps April will be weaker. The Commerce Department reported on Friday that Wholesale Inventories rose in March, up 0.6 percent. Commerce put a spin on this that because inventories fell short of March's 2.7 percent increase in wholesale sales, production will need to be increased. The problem is twofold. Perhaps inventories are down because businesses aren't optimistic about future sales. Even if businesses needed to boost inventories because future sales increase, it just means more Chinese imports. We can't even be happy when sales rise because our economy doesn't get to benefit from the manufacturing of those products being sold. What lunacy.

Construction Spending gained 1.5 percent in March, according to Commerce.

Thursday we were told that Initial Claims for Unemployment Insurance fell dramatically, down 25,000 to 315,000 for the week ended May 1st. The Labor Department also told us that the total number of good folks receiving unemployment checks fell 69,000 to 2.935 million from 3.004 million. Well, good. Folks are finding jobs. Great. Must have been that Dividend Exclusion tax break passed last summer.

Friday we received the April Unemployment figures. The Labor Department reported that Nonfarm Payrolls jumped a huge 288,000, topping the most optimistic of forecasts. This on the heels of all those temporary and part-time jobs we received in March. All right. Can't wait to read the breakdown of the quality of April's brand new jobs. Probably a lot of high-five, six figure jobs I would bet. Probably the sort of jobs you can support a family with, build a future on, sink your teeth into and look forward each morning to tackling.

The Federal Reserve made news this week, leaving short-term interest rates, specifically the targeted Federal Funds rate at a 46 year historic low of 1.00%. March's economic numbers were reported as strong. April's are coming out pretty strong as well. Gosh, employment isn't much of a problem anymore, Labor Secretary Chao effused after the release of the number, which included an upward revision to March's from 308,000 to 337,000. Inflation seems to be picking up according to recent government figures. So what's the problem? Why not bump interest rates from 1.00 percent to 1.25%? What's up with that?

Hmmm. A little footnote among the week's big news: The outplacement firm Challenger, Gray and Christmas Inc. said the number ofPlanned Job Cuts jumped in April as US employers announced plans to cut more than 72,000 jobs (reported Tuesday 5/4/04 onwww.cnnmoney.com).

Greenspan spoke on the evils of a rising US federal budget deficit and trade protectionism. He got into the inevitable slowing of China's economy and the likelihood that at some point foreign investors will "diversify" out of US assets (ergo Bonds, Stocks, and Real Estate). A, ahem, that's deflation. He will not speak the word, but I guarantee you he thinks the word. How do I know? The actions. The Fed Funds target. The Money Supply figures.

Money Supply, the Dollar & Gold

Let's start with Gold stocks and the metals. The Philadelphia Index of the Gold and Silver Sector stocks is in a crash )as we've been showing is also the case with the HUI). It's bad, its ugly, and it could get worse. The XAU is now down over 30 percent since January, and lost a huge 5.22 percent again Friday, May 7th. The problem here is this was one of the first indices to crash and when the major equity indices do likewise, their downdraft could pull these Gold and Silver stocks down even further. A very Bearish event occurred Friday as the 50 day moving average crossed below the 200 day moving average. I take this to mean this decline has further to go, in spite of its oversold levels.

The Fed not only allowed interest rates to remain at 46 year historic lows in the face of booming economic figures, but it turned up the spigots wide open, ripped open the pipes, and pumped out another $45.4 billion of M-3 in just one week! This is Banana Republic, third world, hyperinflation at its obscene finest as this annualizes to $2.4 trillion of additional fiat money, a doo doo doo doo 26% annualized rate of growth. Huh? And the US trade-weighted Dollar rises in the face of this? And precious metals come crashing down and the CRB drifts lower? What is going on?

My take: The Fed sees a stock market crash coming of historic proportion and is preemptively dumping liquidity it anticipates will be needed. Further, the Mining stock crash is telling us deflation is on its way - big time deflation. Deflation means Debt default and massive asset liquidations. In a deflationary environment, dollars will be hard to come by and critical to have. Thus it rises.

Bonds & Interest Rates

The Federal Reserve made its abdication announcement on Tuesday that short-term interest rates would remain the same. Given the economic statistics coming out, either the Fed doesn't believe them, doesn't believe that they matter, or is simply scared to death about the Debt deflation that will occur once rates rise. They may be trapped. Too much debt pegged to short-rate indices. If they dare raise rates, debt defaults will arise and massive asset liquidations will be forced upon America, driving real estate and financial assets and about everything else into the gutter. THEY CAN'T RAISE RATES! It's as simple as that. Many home equity and adjustable rate mortgages that folks just refinanced into are floating rate, tied to short-term interest rates. Monthly payments would rise and folks wouldn't be able to pay on time. The banks would be forced to take possession of properties. People would have to sell and attempt to downsize. This is the stuff Depressions are made of.

My take: An equity event will eradicate the rising interest rate threat. Should equities crash, look for long-term interest rates to decline and bond prices to rally hard. The above chart shows Bonds are oversold. The timing is interesting. Rising rates act as one of the catalysts to an equity event and that equity event acts as a catalyst for the Bond market to work off its oversold position. It fits.

I still don't like the looks of that Head and Shoulders monster in the US Bond. After all is said and done with the next equity crash, bonds could continue their slide. Why? There's just too many dollars and too much debt and too much government budget and trade deficit.

Bottom Line

The price action of stocks on Friday reminds me of the action in 1987 that eventually led to the Black Monday massacre. As I wrote a few weeks ago, the 1987 crash actually started 10 trading days before that infamous event. Black Monday represented capitulation, the final panic-selling wipeout where fear exhausted itself. Friday is a precursor to such capitulation. I expect a panic, fear-driven mass exodus during a day or two of selling some time over the next six weeks, and it wouldn't surprise me if it came sooner. June 15th is a major Fibonacci turn date, aligned with its phi mate, the October 9, 2002 low for this four year Bear market. If June 15th is a low, then it could be a deep low. I say that because it is still 26 trading days away. That's a lot of time for markets to fall with a major freefall at the end. Let's hope June 15th represents a high. The Fed is pumping money into the system as if a crash is underway or its start is a certainty. They spoke loudly this past week by doing nothing with short-term rates. We are always much wiser to watch a man's actions than to listen to his words. Defensive strategies are warranted

Note: VIX up, Gold and Silver plunge, Oil up almost to a new all-time high, M-3 UPPPPPP!!!