A Tough Market to Call

Every now and then a market comes along which presents so few clues as to its preferred trend that it becomes almost impossible interpret until a decisive breakout occurs. The present market is just such an example.

The Dow Jones Industrials and the S&P 500 continue to trade within a five-month trading range and continue to make little headway in one direction or another. Simply put, it is a pitched battle between the buyers and the sellers with neither side possessing a firm advantage. Ordinarily, such a battle would be attended by heavy volume. Such is not the case this time around which makes for an even more clouded view of where this market is headed. While trading volume on the NYSE has picked up the last few trading sessions, overall low volume continues to characterize this summer market.

Adding even more confusion to our analysis is the fact that the NASDAQ Composite index gave a technical buy signal last week, even as the Dow and S&P continued to trade neutral. The NASDAQ moved higher to register a new all-time high, and is now trading above its rising 30-day moving average. Confirming this pattern is the fact that the chart for the Rydex OTC Fund (RYOCX:NYSE) shows the exact same pattern and became a technical buy late last week. (Rydex funds are heavily utilized by institutions and therefore serve as reliable proxies of market trends).

In "normal" times, a bullish NASDAQ would serve as a leading indicator for the Dow, with the Industrials sure to follow the NASDAQ's lead. But such an assumption is not warranted this time. The Dow's internal indicators are still neutral-to-bearish and until we see significant improvement it would be rash to assume the Dow and S&P are headed higher along with NASDAQ.

In fact, the new record high in the NASDAQ may only be a fake-out rally to shake out the last of the shorts and trap the bulls into going heavily long just in time to witness a huge downside reversal. In market parlance, this is what is known as "painting the tape." So until we see some improvement in the NYSE internals we should view this latest NASDAQ rally as extremely suspect.

The Dow Transports have come very close to signaling a classic Dow Theory sell signal. The Transportation index is testing support and hasn't had a meaningful rally in months. Worse yet, the "Tranies" failed to confirm the Dow's last move to new highs in late August. The Dow Utilities aren't much better, as this index has been particularly weak of late, even on days in which the Dow Industrials looked strong. Both of these indices are sending out a bearish divergence signal, and the message should be heeded.

One further point that needs to be made before we give you the impression we have gone full-scale bearish on the Dow. A stock that we consider to be a leading indicator for the Dow, if only because it seems to be the bluest of blue chips (hence its nickname, "Big Blue"), is IBM. The chart for IBM is quite bullish and appears on the verge of making a new all-time high. We believe this would be very positive for the Dow. Currently, IBM is coming out of a rounding-bottom-type chart pattern and is trading above its rising 30-day moving average. Its MACD is coming off of an oversold reading is moving up nicely, having just registered a bullish crossover. Money Flow and RSI are both positive for IBM. As long as IBM looks good, the Dow cannot be said to be on a weak footing. So until IBM turns bearish, we refuse to turn full-scale bearish on the Dow.

Volume indicators are most bearish, but not exceedingly so. The 5-day NYSE advancing volume chart is still in a downtrend, having broken a long-term upward trendline and is now trading within the confines of a downward parallel channel. The 5-day NYSE declining volume chart, while much less bearish than advancing volume, is nevertheless sending out a warning signal. Last week, the 10-day moving average for this chart crossed above the 30-day moving average-a bearish crossover. We should definitely heed its warning and shy away from going long most NYSE stocks right now, though things have not yet progressed to the point where we would advise going net short.

The chart showing Cumulative Volume (CVI), meanwhile, is also bearish. This indicator is our favorite one for telling us where the Dow is headed. It presently indicates net distribution and has traced out a bearish head-and-shoulders-type pattern which is forecasting a big downside move based on the "swing rule." Confirming the CVI's weakness is the fact that its falling 30-day moving average has crossed above its falling 10-day moving average, which is a bearish signal. What's more, the CVI has penetrated a long-standing trendline and is now trending within a downward parallel channel. However, there is some near-term support for the CVI, so it may remain near its present level for awhile before heading lower.

Market momentum has thrown us a curveball of sorts. While momentum is by no means supportive of a major upswing, it is starting to show signs of improvement. The 30-day Rate of Change (ROC) oscillator, especially, is slowly (although barely) starting to improve. While it is still hugging the zero line, thereby indicating an equilibrium of buying and selling forces, its 30-day and 10-day moving averages are starting to turn up. The very fact that the Dow and S&P are holding firm in the face of bearish technicals-even if they are not making headway-is a show of strength, at least in the near-term. So based on our interpretation of short-term momentum the Dow may attempt a further rally, though it is likely to be anemic and probably won't make a new high.

Looking at the various market sectors presents a mixed picture, but the overall outlook remains bearish. Indeed, most market sectors are looking weak and are flashing sell signals, especially consumer, retail, brokerage, banking, cosmetics, food and agriculture, and housing sectors. This does not portend a positive outlook for the economy in general as we close out the year. But once again, the market has thrown us a curve. Despite the bearish pallor of most market segments, there are a handful of sectors that are looking quite bullish at the moment, including the high tech, biotech, chemical, and petroleum sectors. In fact, notwithstanding the bearish outlook for precious metals, even some leading mining stocks are looking decent right now. So once again, it is a very weak-looking and selective market but by no means a categorically bearish one.

The Internet sector continues weak. Our proprietary Internet Index is still meandering along near its crash low and is having problems mustering a serious rally. Even worse, relative strength for this index looks extremely weak and is by no means supportive of a sustained upmove anytime soon. This sector remains bearish. However, there are some buys among the Net stocks that must not be ignored. Yahoo is starting to look stronger and has successfully completed a fan line retracement. Harmonic Lightwaves has a fantastic-looking, but is probably overbought and nearing a correction. Zomax Optical Media also looks positive, as does RF Micro Devices.