Watch out for the "Eleventh Hour" Manipulators

It's the proverbial "eleventh hour" in this 17-year-old bull market and the manipulators are out in force. The ubiquitous yet furtive manipulators to which we refer are nothing more than corporate insiders, large speculators and commercial traders who have the ability to alter the course of individual stocks—and even the averages themselves—by "swinging their lines" of shares (which usually number in the thousands or even hundreds of thousands).

This game of manipulaton (which neophyte investors look upon as the paranoid figment of the overactive imaginations of the more experienced investor) is what makes the stock market tick. After all, the big, moneyed interests have to have someone to "play" against in order to augment their capital and their targets are the "dumb money" investing public. Manipulation is especially pronounced toward the end of great bull runs and just before the onset of bear markets because the manipulators realize that the technical traders are on their toes and the investing public itself becomes more leery of what may happen next. So in order to maintain their continual flow of profits they must send out false and misleading signals—both technical and fundamental in nature—in order to catch as many outside traders as they possibly can off guard and make money at their expense. It is during this final stage of the bull market that technical analysts especially are made to look foolish because the insiders take to manipulating the averages in such a way that false chart patterns are formed and misleading technical signals are sent. This is the situation in which we find ourselves in today.

The manipulators' most recent game of "fool the chartists" took place yesterday (July 20) when the Dow Jones Industrial index and the NASDAQ Composite both fell precipitously out of bullish chart formations and into dangerous territory. As we write this, the Dow was hanging precariously over its critical 11,000 support and the NASDAQ had fallen even further below its previous all-time high (by over three percent). Judging by the reaction of most chartists, many of them were taken in by what we believe was nothing more than an engineered "shake-out" designed to kill the longs and whipsaw inexperienced traders. This was done so the insiders could enjoy one last climb to new highs without the "uninvited guests" (i.e., the technical traders and dumb money investing public) tagging along before the real bear market gets underway. At the same time—assuming our theory is correct—it will serve to instill a false sense of confidence in the investing public so that when the real collapse begins everyone will assume it is just a "correction" and will see no need to exit long positions or go short.

And just what is our evidence in support of this assertion? As any good technical analyst knows, the "tape tells all," and the tape has not yet sent warning signals that the bear has begun. Most of the recent volume of the past few weeks has been upside volume, with very little downside volume (hence, no distribution…yet) so Tuesday's decline could not have been the beginning of a bear market. Trading volume on the NYSE and NASDAQ was not abnormally large for such a prodigious decline; in fact, volume could only be considered light-to-moderate. Classical technical analysis tells us that volume must always expand in the direction of the trend in order to confirm it. Until volume begins expanding to the downside the bull trend is still intact.

Undoubtedly, many chart analysts were taken in by what appeared to be a breakdown of a textbook-perfect bullish "flag" pattern in the Dow's chart. Based on the minimum measuring implications of this pattern, a Dow of approximately 12,000 was expected before the trend exhausted itself. Tuesday's big decline appeared to have invalidated that pattern. But not so fast! Upon closer inspection of the pattern, a small but distinctive "ascending triangle" could be seen. And according to Edwards & Magee (the "bible" of technical analysis) triangles can sometimes witness false moves to the downside before reversing higher. The clue that a triangle may have registered a false move is that volume doesn't expand to the downside when the false move occurs. And Tuesday's downside breakout from the triangle occurred on relatively low volume. So unless we see a resumption of the downward trend on expanding volume, the Dow is still pointing higher in the near term.

Further clues that Tuesday's decline was not the start of something bigger can be found by examining both the Dow Transportation and the Dow Utility averages. Neither of them were particularly effected by the DJI's fall and both basically held firm in the face of the declining Dow. Also, most leading NYSE and NASDAQ stocks (with the exceptions of IBM and Microsoft) were unhurt by Tuesday's decline and only witnessed marginal point declines on low volume. We'll need to see more before we can call this the beginning of the bear market.

In the event we are wrong and the bear trend really has gotten underway, you'll know it when certain key support levels in the Dow are violated on high volume. Among them: 10,900-11,000 and 10,400-10,500. We should also witness a corresponding breakdown in the Transportations and Utilities. Most importantly, NYSE volume should expand in the direction of the downward trend. If this does not happen, it will signal that not enough selling pressure exists to propel the markets lower.

What should an analyst keep his attention focused on in the days and weeks immediately ahead for clues that the trend is truly about to change? Again, it is important that you keep your eyes rivited on trading volume. A 10-day moving average of NYSE and NASDAQ advancing volume works well. Any violation of the upward trendline will likely signal a trend reversal is about to take place. Another good volume indicator is the Cumulative Volume Index (CVI) which is basically a running total of advancing minus declining volume. As long as the CVI is rising (as it has been for the better part of this year) the bull market is still intact. When it breaks down, however, a trend reversal will have been signaled.

Equally important, watch the interplay between price and volume—not only in the major stock averages but in the individual stocks themselves. This is what the old-timers called "tape reading." [For those of you who would like to know more about this lost art, send us an e-mail and we'll send you details on how you can obtain the classic book, "Studies in Tape Reading."] This is where so many technical analysts have lost their way and why so few of them can consistently call market turns—because they have disregarded volume in their analysis. Keep your eye on such leaders as IBM, Microsoft, AOL, Yahoo, Citigroup, J.P. Morgan, Chase Manhattan, and Merrill Lynch in the days/weeks ahead for any changes that may occur in price-to-volume behavior.

A good analyst watches the day-to-day fluctuations of the averages the and individual components of those averages for clues as to what is happening in the market. At any given time either accumulation or distribution is taking place, and reading the tape and scanning the charts will give you a good idea which of these two actions is taking place. But an analyst should also keep in mind the pattern of the bigger picture. And while it is not yet time for the bull market to end in the immediate term, the signs and tokens of distribution are everywhere apparent in the bigger picture. The interest rate outlook is changing from bullish to bearish, as the 30-year T-bond yield has broken a long-standing downtrend and is now trending higher in the intermediate term. Most leading stocks are tracing out a bearish distribution pattern known as the "head and shoulders" pattern in their charts. And upside volume has been gradually waning for a number of leading stocks. So we definitely know the end of this bull market is near.

While we won't venture any guesses as to when this bull market will come crashing down, we will offer a basic timeframe of when we expect it to end—no later than the fall of this year. The charts and the tape should guide us along the way and let us know when this bull will finally cease charging and when the bear will emerge from his long hibernation.