Markets Continue Peculiar Sideways Pattern, Direction Uncertain at this Point

The U.S. stock market continued once again to display a surprising lack of decisive directional thrust last week for the sixth consecutive week. This phenomenon is reflective of widespread investor indecision, and these types of consolidations inevitably work themselves out into powerful impulsive moves in one direction or another upon resolution. Due to the extreme volatility and compactness of the Dow consolidation, we expect this resolution to be met very shortly. The only question that remains unanswered is which direction prices will take upon resolving.

From a technical standpoint, a case could be made either way. The stock market bears—with whom we have been fellow members with for some time, but only recently have turned (temporarily) bullish—continue to argue passionately their conviction that this market is nearly spent and a massive downside correction is imminent. While we do not deny the veracity of their arguments (at least superficially), we still favor the near-term bullish argument until we see further evidence in support of the "bear market now" position. Technical and fundamental measures notwithstanding, there is still too much liquidity in this market, too much money on the sidelines awaiting a profitable entry point, and far too many bears for market sentiment to favor a major correction anytime soon.

It cannot be denied that this market is old and tattered and on its last legs. Every technical indicator points to that. Yet we still see some room to the upside before the market completely exhausts itself. One highly quoted statistic recently among stock market bears has been the latest figures from Investor's Intelligence, which shows a perilously high amount of bullish advisors (over 60%), the highest since August 1987.

This is often touted as a reason the market must decline at any moment. But what most advisors fail to realize, as market analyst Bert Dohmen has pointed out, is that the percentage of bearish advisors has been equally high—26%. As Dohmen points out, "Normally, we don't see a market top until the percent of bears is below 20%. In fact …in January 1978, the percent of bears was below 4%." Thus, a tremendous amount of room for a decrease in bearishness still remains.

Looking at the charts, we see the aforementioned lateral movement within a narrow trading range of 300 Dow points (with support at 9100 and resistance at 9400). This range forms a chart pattern known as a "rectangle." An argument could be made that, under the venerable Rule of Five (wherein prices are expected to alternately touch the upper and lower boundaries of a trading range a total of five times before breaking out decisively), prices have already fulfilled the basic requirements for a breakout to the downside. This view will be validated if prices break below 9100 support by at least 3%. As we have emphasized over the past two months, DJ 9100 is the critical support in this market for the intermediate term, a level that has been tested several times in the past few weeks. However, this support has proven exceptionally strong and has acted to contain prices every time so far. Until it fails to hold, we do not feel justified in turning full-scale bearish.

Conversely, if overhead resistance at the 9400 level is decisively penetrated by 3% or more, it should carry with it enough momentum to test and perhaps overcome the previous all-time high near the 9700. So this will definitely be a level to keep an eye on.

The Dow Jones Transportation index, which had managed to impressively rally above its overhead resistance at 3200, deteriorated last week and closed the week slightly below critical support at 3100. Prices must stay above 3100 to ensure a continuation of a bullish trend. Next week will be critical for the Transports. However, nothing much has changed yet. The Utilities, however, are starting to break down. Prices have fallen out of a five month price range in this index and finished the week at 286, 14 points below critical support at 300. The last time this level was seen was in September of last year. We're not sure what the underlying fundamental reason behind this development is. Perhaps it has something to do with mounting Y2K compliance costs on the part of U.S. utility companies. One thing is certain, however, as Nancy Morrison pointed out in a recent issue of her Critical Factors newsletter "Money is moving from traditionally conservative vehicles into speculative ones." This point was further emphasized by Alan Newman, in a recent issue of Crosscurrents , as he wrote, "…action has narrowed so pathetically to only a few stocks, typically the largest issues, the most visible high-techs, and the big-name internet issues. And the circle continues to narrow…" Newman further pointed out that a "stealth bear market" has been in place since October 1997, with daily cumulative breadth on both the NASDAQ and NYSE contracting in inverse correlation to the price gains in the Dow and Nasdaq indices. "Only 15 stocks in the S&P 500 accounted for 50% of that index's gains in 1998 and 55% of all NYSE issues were down for the year," wrote Newman. "The simple truth has been that most stocks are not in bull mode."

Due to the difficulty of interpreting the increasingly muddled charts of late, we have been forced to resort to an old tactic favored by the more seasoned technical analysts—tape reading. This lost art is wonderfully helpful when it comes to gaining a clear picture of the underlying supply and demand of a market, and often serves to filter out the excess "noise" created by the charts at times. When we look at the Dow's "tape," what do we see? This is where we gain some support for our bullish near term stance. Our tape reading shows that volume has been contracting for the most part on the down days, and expanding on the up days. This is the stuff that continued bull markets are made of.

What the tape shows is that, while there may not be enough selling to force the market downward, there isn't yet enough buying to force it decisively upward, either. However, it is beginning to look more and more like an accumulation—a highly selective accumulation, but an accumulation nonetheless—is underway. If true, this should be enough to at least power the Dow towards its previous all-time high in the coming days. If we are wrong, you will know by the cited 9100 support failing to hold.

So what's our recommended tactic for preserving capital and profiting from this latest market move? Quite simply, we can only offer our advice to stay neutral until a clear signal is given by the Dow of its near term intent. Once again, this will come with either an upward penetration of 9400 with a closing of at least 3% above this level (at which time money should be placed to follow this move), or a 3% closing below 9100 (which will signal a downtrend with short selling opportunities coming on reactions along the way). The best approach is clearly to avoid anticipating the Dow's next movement in this highly volatile market and to let the Dow itself tell us of its plans.