Market Outlook Still Turbulent

The mainstream financial press never ceases to remind us that "our problems are behind us" in the way of the equities market. Gone, we are told, are the bearish elements that characterized the Dow and the NASDAQ from January through June. Gone are the wild trading sessions of extreme volatility and high turnover. Gone are the interminable trading sessions of lateral price movement for weeks on end. The summer is here, the rally has begun, and we are saved. So we are told.

Stock market analysts and observers have been framing their discussions of this present market environment in terms of volatility, or breadth, or confirmation, or cycles, all of which undoubtedly influence the market at this time. But it is our adamant claim that it is not within reference to these technical considerations that the present market must be judged; rather, it is within reference to volume and only volume that the market's pulse can be taken. The problem plaguing the market today is not one of technical deterioration, or lack of breadth or volatility or upside participation. The central problem of this marketplace-NASDAQ and NYSE alike-is a volume problem.

While the ratio of volume on both exchanges (upside versus downside volume) has been fairly healthy in recent weeks, and while there has been a palpable increase in volume since last week, especially on the NASDAQ, the fact still remains that daily average trading volume is well below that of the most dynamic phase of last year's runup in both major indices. And a market that cannot maintain its volume of trade is a market lacking strength and participation. True enough, the trading public are major participants in this current phase of the market, but the "smart money" insiders are clearly missing from the field. Their absence is made evident and conspicuous by the daily figures for trading volume on Wall Street. Our market, therefore, is a sick patient whose diagnosis is anemia. And just as the blood is the primary determinant of health and liveliness in human physiology, trading volume (i.e., liquidity) is the lifeblood of the financial system. Without healthy volume, the financial system contracts and eventually dies.

The stock bulls will undoubtedly point to the fact that volume on both exchanges has tended to diminish on declines-ordinarily a sign that the buyers are comfortable with their positions and are in no hurry to sell. But in this case an argument could be made that the declining volume on sell-offs is not bullish. That's because this volume rule only applies when the "smart money" insiders are net long in stocks. There is reason to believe they liquidated (to a large degere) their long positions months ago and are heavy in cash. If this assumption is correct, then it matters not that volume shrivels up on declines since this market is composed predominantly of the "dumb money" public, which never sells out anyway until after a long, drawn-out bear market.

Due to the enormous interest in the day-to-day state of affairs in the U.S. stock market, the technical indicators we have come to rely on in recent years have lost their efficacy. This is attributable to the phenomenon of everyone looking at the same measurement and attempting to make the same trading decisions based on them. For this reason, we have been forced to cast aside all use of the indicators for now. In place of these, we are relying on good old-fashioned tape reading, a skill which is of vital importance in market environments such as the present one (incidentally, you may want to learn this skill if you haven't already by reading our recent book, Tape Reading for the 21st Century, available from us, and later this year, from Traders Press). Indicators may lie, but the tape never does. What follows is our new approach to interpreting market action: a daily summary and dissection of the market looking only at the market itself, without the benefit of indicators, moving averages, etc., and sometimes even without the charts. Here is last week's market summary:

Monday, 7/10: NASDAQ off nearly 43 points on moderate volume, while the Dow closes down 10 points on very low volume-one of the lowest readings of the year. Since the close was a mid-range closing, this could be a turning point for the Dow (as mid-range closings so often are). Selling volume outpaces buying volume on both exchanges, but the sellers are clearly lacking in strength to swing things their way. More convincing evidence surfaces that a 3-4 month Wall Cycle has begun, which, if true, will likely take the indexes higher this month and possibly next, though probably not to all-time highs.

Tuesday, 7/11: Nice trading volume on the NASDAQ-over 1.6 billion shares traded today, the highest volume reading in several weeks, but still a long way from the high-volume days earlier this winter. While the official volume breakdown was 633 million advancing shares versus 966 declining-the sellers outnumbering the buyers-the buyers were out in enough force to lead one to believe the insiders are accumulating, at least on a near-term basis.

On a stock-by-stock basis, Microsoft [MSFT] still gives cause for skepticismtrading pattern isn't convincing enough to be bullish. JDS Uniphase[JDSU] looks positively bearish-the stock dropped several points onextremely high volume today and was preceded by a high-volume mid-range closing price yesterday, which typically precedes big sell-offs. Another favorite among the tech crowd-RF Microdevices [RFMD]-also looks bearish. While the index itself looks bullish, there are still many bearish-looking tech stocks on the NASDAQ: the recent run-up could be an engineered move designed to fool the weak-handed traders into going long while the insiders continue to sell.

The intraday chart for the NASDAQ looked like accumulation-rounding-bottom-type formation. The NYSE, meanwhile, still looks a bit sluggish. Volume is still low and the Dow can't seem to establish an upward trend, even though it has been rising of late. IBM-a Dow bellwether-is still in bearish hands and could trigger a Dow sell-off if the buyers don't soon enter to support it.

Wednesday, 7/12: More signs that a massive distribution campaign may be under way. The Dow does not look good from our vantage point. Despite the impressive rally now underway in the NASDAQ, the Dow can't seem to keep up. This is the third consecutive day that a low-to-moderate volume mid-range closing has been posted. Failure to post a closing price near or at the day's high is a sign that a market is not in strong hands. The Dow Transportation Average looks good on a short-term basis, but a critical component-General Motors (GM)-does not. This is the third month that GM has failed to make a new high (instead, it continues to languish near its crash low of around $60/share). Under the venerable GM Rule, a failure for GM to make a new high within four months is a bearish indicator for the entire market. Oil prices, from a chart perspective, seem to have topped out, so this may explain why the Transportation index looks strong (oil, of course, being a critical component of transportation). Yet GM fails to rise. Why? Obviously, the insiders see something in the future that can only be bad for GM's business prospects, and if bad for GM then bad for America.

The big leaders of the NASDAQ's impressive 143-point rise on volume of 1.77 billion shares were Yahoo [YHOO], CMGI [CMGI], with America Online [AOL] and Paine Webber Group [PWJ] following suit. From a chart perspective, Paine Webber has probably registered today what is known in Japanese candlestick analysis as an "evening star." The price gapped open over 20 points at the start of trading, yet traded within a narrow band of only 3 points. Volume was extremely heavy. The closing price came in the middle of the day's range, giving us our reason for believing the top has been seen for this stock. Quite the opposite for Yahoo, which obviously had a day of big accumulation on Tuesday preceding today's stellar performance. Yahoo should see a nice rally this summer before fizzling out. AOL looks fairly strong, too, at least on a short-term basis. AOL, CMGI, et al, will likely serve as summer rally leaders to cover the insiders who continue to unload duringthe current markup phase.

Interesting to note that the QQQ, a tracking stock for the NASDAQ, and the Rydex Series OTC Fund [RYOCX], which measures institutional interest in the NASDAQ, both looked less-than-strong today. Despite a tremendous NASDAQ performance, the QQQ could only manage a rise of just over a point on average volume, while the RYOCX actually declined in value. The S&P Depository Receipts [SPY], a tracking stock for the S&P 500, meanwhile, also saw a mid-range closing on average volume. Ditto for the Dow Diamonds Trust [DIA], a Dow tracker. Could it be that the institutional traders and other "smart money" traders are not committed to this rally? Still, though, there is enough momentum behind this rally to last a little while, and that's probably what it amounts to: a nice mid-summer's rally.

Thursday, 7/13: Yet another high-volume mid-range closing for the Dow Industrials, which closed up only five points from its previous day's close. Volume on the NYSE was a little over a billion shares-about average, but still below what it was during the Dow's dynamic upside phase last year. The NYSE Composite closed down, but the NASDAQ Composite continued its upswing, gaining 75 points on high volume of 1.88 billion. Volume is continually increasing on the NASDAQ, obviously lulling the sidelines money out of the woodwork and back into the markets.

The Russell 2000 small-cap index continues to exhibit incredible strength, a testimony to the underlying bullish conditions among small-cap companies. We continue to ride the strength of the Russell 2000 with the Summit Apex Russell 2000 Small-Cap Index Fund [SARSX], which continues to make new highs.

Friday, 7/14: The ratio of upside-to-downside volume on the NASDAQ continues to expand in favor of the upside. Clearly, the NASDAQ has become a buyers market with the bulls now firmly in control. On a sector basis, the chart patterns of REIT stocks and other real-estate-related companies look bullish. This should at least at some fuel for the present summer rally, if nothing else. Intel [INTC] is hailed by the financial press as the savior of the techs, yet its leadership-like much of the rest of this market-is characterized by diminishing trading volume (relative to its six-month daily average). A tell-tale sign indeed.

GM continues to languish near its recent lows, albeit, on extremely low volume; it can't seem to find commitment in either direction. The S&P 500, along with its tracking stock the SPY, have already broken out of dome formations and are challenging all-time highs; however, the SPY is making its move on declining volume-a sign of diminishing institutional support. Can the S&P 500 truly be said to be in strong hands when its tracking stock is clearly not? The Diamonds [DIA] also exhibits this same declining volume phenomenon. Even the QQQ does! What can this possibly portend for the health of the broad market? There simply must be a substantial increase in volume if this current run-up is to be confirmed.

The all-important bank stocks are being supported. For instance, Fleet Boston [FBF], a major regional bank, while still trading within the confines of a five-year dome pattern, saw a high-volume price spike in June which obviously marked the entry of buyers into the market. Fleet is threatening to penetrate its dome pattern with an upside breakout, which would pave the way for a bank stock rally. Bank of American [BAC] looks bearish. It is conforming perfectly to the rim of a textbook dome pattern. A super-high volume sell-off in June only adds credence to the bearish case for BAC. Suntrust Banks [STI] shares much the same pattern and exhibits an even more pronounced selling volume pattern. The major regional bank stocks are under heavy selling pressure this summer and the rest of the market is masking this weakness from the public.

So what are the conclusions that may be drawn from this daily account of last week's trading sessions? Our primary observation is that this market lacks broad-based institutional support. There is a noticeable and increasing ebullience among the trading public for the technology stocks, with the financial press acting as cheerleaders every step of the way. But the commercials are clearly not buying it. Their presence will become known (if they every decide to join the parade) by a perspicuous increase in trading volume. Otherwise, the equities market is floating on air with nothing of substance to ensure its continued rise.