Two-Tiered Market Continues, But Bulls Still in Control

The extraordinary two-tiered market we have witnessed for the past three months continues to astound market neophytes and long-time observers alike. We ourselves must confess we've never seen anything quite like this. On the NYSE, market internals look short-term bearish and some indicators are flat-out horrendous (namely the advance/decline line and the new high/new low index). On the white-hot NASDAQ, however, the astounding updraft continues with momentum and upside volume positively soaring to vertiginous heights. The incredible upward ascendance of the OTC sector has not yet seen its apogee, so don't sell short this sector yet.

Tuesday's huge sell-off on both the NYSE and NASDAQ was jolting for many investors, and we freely confess we did not foresee such a significant decline in such a short timeframe. However, this sort of behavior is by no means out of character for a market that is in the midst of its dynamic bull phase, as the NASDAQ certainly is. No less an authority than Edwards & Magee stated that swiftly moving bull markets are typically characterized by sharp, sudden pullbacks that are designed to shake out weak-handed players into selling their stocks to the more experienced (and moneyed) pros. Such is the nature of the current correction.

Indeed, the astounding momentum and upside volume that have carried the NASDAQ to vertiginous heights continues to be supportive of the bull market and Tuesday's big decline was likely nothing more than a much needed correction as well as an opportunity for the big players to profit at the expense of the little guys. Judging by the way Wall Street propaganda preceded this latest decline (a noted analyst proclaimed to much fanfare that the S&P would correct by 25% before resuming its upward move) it is obvious that the insiders desperately want to grab the shares out of the hands of the investing public for their own accounts.

About the only bearish aspect of this current market environment is the underlying "stealth" bear market that has been underway since 1997. This is reflected by the overwhelmingly bearish nature of the NYSE Advance/Decline Line (a measure of market breadth) and the new highs/new lows index. Both charts tell the tale of a market that is slowly deflating and will eventually implode. In fact, the A/D line illustrates better than any other indicator the current phase of the Kondratieff cycle, which K-Wave theorists call the "early runaway deflation" period. This phase typically precedes a market crash and economic recession, both of which are long overdue in the U.S. but likely will not occur until later this year. But we'll save that discussion for another time.

Once this latest correction ends, expect the NASDAQ to resume its remarkable rise toward the mythical 5000 level.

The outlook for the NYSE, however, is a lot trickier to interpret. The Dow Jones Industrials have sorely lagged the NASDAQ for several weeks now, and it is well known that market breadth has been diverging from the overall upward trend of the market for over two years now-a stunning divergence which indicates an underlying bearishness in the broad market. Indeed, a declining advance/decline line is reflective of the overall trend towards deflation that has been present in the market in varying degrees since 1997. This is what Kondratieff Wave Theorists call "early runaway deflation," the period that historically precedes stock market crashes and long-term bear markets and prolonged recessions. It cannot be denied that the U.S. is long overdue for such a cyclical downturn, and 2000 may well presage this reversal of fortune (albeit at a later point in the year). But we'll save that discussion for a later time.

Right now we must concern ourselves with the current message of the tape. And the tape we are examining is what tape readers call a "split tape."

Despite suffering a minor setback on Tuesday, the chart showing cumulative volume on the NASDAQ is still trending firmly and impressively higher. Until we see the unmistakable signs of a reversal of net upside volume we have no choice but to conclude that the trend is still up for the OTC stocks. The tape doesn't lie and the tape is telling a story of tremendous buying interest in OTC stocks, mainly for speculative purposes. But for now, that's good enough to ensure a continuation of the bull market.

The NYSE tape is less impressive and even a bit bearish on a near-term basis. The Cumulative Volume Index (CVI), which is a measure of advancing volume minus declining volume on the NYSE, while above the equilibrium (or zero) line, is still nowhere near its high point of last summer. The CVI has a lot of ground to cover before we can go full-scale bullish on NYSE stocks. NYSE 5-day advancing volume is declining in bearish fashion; however, NYSE 5-day declining volume is also falling-even more drastically. This means that while there is a lot of selling underway, there is very little interest in completely abandoning long positions. What is more likely is that specialists have engineered a short-term move designed to cause the public to give up their long positions so that Wall Street operators can lay claim to them.

What is particularly interesting to us is the nature of the current volume cycle. This extremely important cycle is illustrated in the charts in our newsletter which show NYSE volume momentum (10-day) and the closing ARMS index (daily). Both of these indicators serve as excellent proxies for significant market moves. In this case, we were warned in advance that a massive move was imminent by the huge drop-off in volume momentum; in fact, our volume momentum chart hit a one-year low just before Tuesday's sell-off, which warned of a sharp move to come. However, now that the sell-off has likely seen its worse, we expect an equally powerful snap-back over the course of the next few days.

Momentum on the NYSE is no longer supportive of a move higher (on a short-term basis). The chart showing 10-day NYSE momentum is fluctuating near the equilibrium line and is technically neutral-to-bearish. However, the more important 30-day momentum indicator has just flashed a bearish signal; thus, we can expect more bearishness on the NYSE through the remainder of January. We do not believe, however, that this is the beginning of a bear market; rather, it is only a temporary corrective phase that may last a few weeks before the upward trend resumes.

More convincing proof for our assertions lie in the charts of the leading market sectors. Our proprietary Internet index, for instance, is full-scale bullish, having just broken out from a months-long consolidation pattern on high volume. Relative strength for the Internet sector is also on the rise, which is quite bullish. The CBOE Internet index, which measures option bets on the Internet sector, recently hit an all-time high on strong volume. The uptrend in this security is still intact and the overall pattern is a bullish one.

Our own industrial indicator, a composite of the five leading industrial stocks, is still technically bullish. The chart for this index is showing a bullish pattern know as a "pennant." Price-to-volume configurations for stocks within this sector are also bullish. Higher prices are likely ahead in the near future for the industrial stocks.

Further bolstering our conviction that the trend remains up for the NYSE in the intermediate-term is the fact that the Dow Jones Utility index just registered a "head and shoulders" bottom, indicating that the trend is now toward higher prices for utility stocks. Utilities are a leading indicator not only for the Dow Jones Industrial Average but also for U.S. Treasuries. We believe the upward trend in Treasury yields has climaxed and that interest rates will now be heading lower from here.

We would reiterate our conviction that the gold mining sector is a buy in the intermediate term due to our reading of the chart for gold (see chart). Our proprietary chart is composed of the five leading gold mining stocks, and it portrays a distinctly bullish "falling wedge" pattern, as well as an upward-slanting trendline. We expect higher prices for gold stocks over the next few months.

The oil sector looks sloppy. In our view, the impressive rally in crude oil extending from the summer is over and distribution has evidently been underway for several weeks now. Avoid this sector, unless to go short.

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