Markets Continue to Break Down but the Bear is not Here Yet

After almost two tumultuous weeks of trading, the U.S. equities outlook has now definitely established at least a short-term downtrend. Several critical near-term support levels and minor and/or intermediate-term trendlines were broken last week in several of the major stocks and indexes. This portends a continuation of the recent bearish trend in the days immediately ahead; however, the amplitude of a decline can never be known with assurance so it behooves us to continue to tread lightly upon this market rather than going full-scale bearish as we did last summer. Although there are some parallels from last year's decline in this latest market decline, there are still some indications that this may be nothing more than a bull market correction and that a re-test of the previous highs is forthcoming. The days ahead will tell us much.

The big story for the past month has been the total lack of trading volume, regardless of which direction the market has pursued. Beginning at the end of June (when several major stocks and indices saw huge spikes in volume on price runups) volume has continually slackened and has been consistently low during consolidations and even declines. The bears contend the June 30 across-the-board volume spike was a sign of a "blowoff" top, which occurs at or near the end of a major bull market when price and volume simultaneously experience massive and unsustainable increases before collapsing. That may be the case but we will have to wait and see. We doubt this was a case of blowoff volume, however, since the big increase in volume occurred before the final price high was established in the Dow Jones Industrials and was actually less than the volume spike a few months earlier that established an all-time record. Besides, several stocks and indices experienced this same volume increase well off their major highs and in some cases coming off of intermediate lows. Once again, we are faced with a situation in which considerable leeway for interpretation exists, and it is still too early to be dogmatic one way or the other.

Notwithstanding the low volume in the market volume has gradually been increasing in just the last few trading days and it appears to be expanding on the downside-a bearish sign. Furthermore, our charts showing upside and downside volume momentum as well as cumulative volume momentum, have been slowly picking up steam which means that volume can be expected to rise in the days ahead. Our volume indicators themselves have been anything but bullish of late. The chart showing NYSE advancing volume is still in a downtrend, the worst in over a year. NYSE declining volume has been coiling on the chart in a net sideways pattern. However, its chart shows a contracting triangle pattern which portends a forceful breakout in one just broken slightly above the upper part of the triangle which points to a marked increase in declining volume in the days ahead-a sign of continued bearishness in the markets.

Cumulative volume as measured by the CVI is still performing bearishly and is threatening to break down completely, which would be extremely bearish for the market. If, however, the CVI index can hold up over the next few days it will be a strong indication that perhaps the market has stabilized and that prices will resume their previous upward trend.

Market momentum (as measured by our 10-day and 30-day Rate of Change (ROC) oscillators) continues to break down in a way unseen in a long time. The chart showing 10-day momentum looks downright horrible. The chart showing 30-day momentum, while not nearly as bad, is starting to pick up steam to the downside and has also registered a bearish signal. Until these indicators bottom and show signs of reversing it is not safe to be on the long side of the market in any shape or form. We recommend that you either stay on the sidelines or selectively enter short positions (though we do not yet advocate a net short position in your portfolio). The bottom line is that while bearish signs are increasing the signal for an all-out bear market has not yet been registered and until it is the prudent course dictates that we treat this as a potential bull market correction and remain safely on the sidelines. We must let the market be our guide in this case and not our emotions or "gut instincts."

One of the analysts we highly respect is Stan Weinstein, editor of The Professional Tape Reader. Writes Weinsten: "We believe this market should still be given the longer-term bullish benefit of the doubt, even though we're starting to see signs of shorter term trouble. First of all, it's a continuing long-term favorable indication that the Dow, the S&P 500 Index, and the Nasdaq Composite all recently hit new highs. Furthermore, it's also positive that all three are still in powerful uptrends, as they remain comfortably above their rising 30-week moving averages. Until this situation changes, the overall market should not become a problem." We echo those sentiments entirely and our technical work corroborates very closely with Weinstein's right now.

Our Internet Index, a composite of the five leading Internet issues, is in a technically near-term bearish position and appears to be tracing out a massive head and shoulders pattern. But appearances can be deceiving. The important thing to look at is how volume corresponds to a given chart pattern. When we do that with our Internet Index we find that volume does not at all correspond to a classic H&S pattern, in which volume should be diminishing throughout the pattern. Instead, we find extremely high volume on what looks like the right "shoulder" of the pattern. Since this most of this volume occurred on the uptick and since prices were coming off intermediate lows we would not be justified in calling it "blowoff volume," at least not until further market action provides justification for this. It may very well be that this tremendous buying interest that occurred in late June was the precursor for yet another run to new all-time highs in the Internet sector as well as several other sectors of the broad market. The bottom line is that it is still too early to write this market's obituary and we should refrain from doing so until the market gives us sufficient evidence.