McHugh's Thursday Market Briefing

This is one of those times when the Elliott Wave labeling suggests we are approaching a top for a correction in a new down-trend, however there was so much buying power generated in Thursday's rally in major equity markets that reliable "buy" signals were generated that normally indicate at least a 2 percent move is coming over several more days. These diverging indicators can be reconciled if the Sub-micro degree wave {c} up of Micro 2 up extends, and takes the Major averages up several more percentage points to a deep retrace of the Micro wave 1 down from early May. In the case of the Dow Industrials, new "buy" signals in our key trend-finder indicators could mean a Fibonacci .786 retrace is coming, to the 11,550ish area, about 300 points above Thursday's close. A .618 retrace would target 11,400ish, about 140 points from Thursday's close, but that seems shallow given we just got new "buy" signals. All this said, the percent of DJIA stocks above their 10 day average rose to 83.33, the level where multi-week significant declines begin. It is possible for this indicator to remain in overbought territory over the next week, while the rally that the "buy" signals suggest should occur, finishes - to be followed by the next significant decline.

Thursday saw a short-covering rally that our Plunge Protection Team Intervention Risk Indicator has been warning would be coming. This indicator not only warned that a short-covering rally would come, but that it would have some follow-through legs. The fact we had so many of our key indicators generate "buy" signals Thursday, suggests the PPT indicator will prove prescient, that we should see some decent upside follow-through from here. However, today's rally did spend quite a bit of short interest (which is the fuel for short-covering rallies), as the PPT indicator fell to + 9.11. What that may mean is that while we should see prices 2 or 3 percent higher from here, we should not get much more than that.

The Dow Industrials rose 91.97 points Thursday to close at 11,260.28. Volume was 96 percent of its 10 day average, with NYSE upside volume at a strong 84 percent, advancing issues a solid 78 percent, and S&P 500 upside points a buying panic (here's where we see the short-covering) 96 percent. Readings over 90 percent indicate a panic to buy - which is not what you see in intermediateterm, grass roots Bull market rallies. The out-of-the-blue mega rally is usually corrective within a Bear market. NYSE New 52 week Highs rose to 62, above New Lows at 44. The McClellan Oscillator rose to 127.47, the south side of overbought. It can go higher before a meaningful decline comes. The Summation Index is back above zero, at 127.55.

The percent of DJIA stocks above their 30 day moving average rose just a hair to 33.33 from 30.00, so the intermediate-term trend appears to have not gotten much of a boost from today's rally. That is consistent with our view that the Bear market resumed in early May, and that this rally is part of an {a}-up, {b}-down, {c}-up of 2 up correction. We believe the third of an eventual five-wave impulse of nano degree for {c} up of that correction - the last leg - started Thursday. It could/should last into at least the middle of next week, assuming this third wave will be the extended wave. The percent of DJIA stocks above their 10 day average - as mentioned before - has reached an overbought 83.33 reading. It can stay there for a week or so, but if you go to either last night's Midweek report, issue 341 in the archives at www.technicalindicatorindex.com, or last weekend's report, issue no. 339, on page 3 you will see that almost every single time the percent above 10 day reaches overbought levels, a significant multi-week decline follows within 1 to 5 days or so. That means the percent above 10 day is telling us not to get too excited chasing this rally - even if it has 2 percent or 3 percent more left in it - because it is a trap, a set-up to get rid of the huge volume of shorts before the next decline - which since it will be a Micro wave 3 down, should be a doozy, possibly 1,000 points. The percent above 5 day rose to 73.33, but is not overbought. This means more upside is likely over the very short-term, again, consistent with the EW labeling.

S&P 500 Demand Power rose 9 points to 407, while Supply Pressure fell 9 points to 418. There just weren't many sellers Thursday, as most of them were too busy buying to protect their open short positions. In fact, fund managers likely jumped in today as well, as our key trend-finder indicators suggest the buying was broad-based, more than just shorts. So let's get to the goodies.

Our Blue Chip key trend-finder indicators are now in agreement, both on a new "buy" signal Thursday as the historically reliable S&P 500/DJIA Purchasing Power Indicator triggered a new "buy" signal, its measure rising more than 6 points from its recent low to 86.60, up 3 points Thursday. This indicator has been exceptional at filtering out noise (short-term daily market swings that result in no clear trend), and has done a terrific job at pointing us to those times when a multi-week or significant (more than 2 percent ) move is about to unfold. So when we get a new signal from this indicator, we take it seriously. The DJIA 14 day Stochastic Fast measure rose to 56.67, remaining above the Slow at 36.67, and its "buy" from May 25th remains intact. This new jointly confirmed "buy" signal suggests to us the DJIA could be headed for 11,500ish before the next wave down begins. While no guarantee here, the odds favor this assessment. The Purchasing Power Indicator measures net Supply and Demand power, while the 14 day Stochastic measures breadth momentum. They are designed to identify multi-week or significant trends shortly after they start, soon enough for aggressive traders to take advantage of the new trend, and profit from it. These are entry signals, not exit. Exiting is in the eye of the beholder, based upon individual risk appetite, financial position, trading strategies, etc.. Always use stops when speculating, never speculate with more money than you can afford to lose, only speculate with a small percentage of your holdings if you must speculate, and understand the risks of the investment vehicles you choose to play. Playing countertrend moves is usually riskier, and less profitable than playing a short-term trend moving in the same direction as a major trend. That is because surprises usually short-circuit the short-term trend, and send markets in the direction of the larger trend. In the current case, the larger trend is down, the short-term trend is corrective and up, so surprises should occur to the downside, short-circuiting the projected 2 to 3 percent expected rally.

The NYSE 10 day average Advance/Decline Line Indicator rose to positive 261.71, above the necessary positive 120.0 reading to generate a new "buy." This also suggests we have more upside coming.

The Russell 2000 rose 15.49 points to close at 736.50. Volume was 101 percent of its 10 day average, with upside volume at 85 percent and advancing issues at 87 percent. The Russell 2000 Purchasing Power Indicator whipsawed again, dealing with a highly volatile market, and generated a new "buy" signal Thursday, rising to 100.04, more than 6 points above its recent low. The RUT 10 day average Advance/Decline Line Indicator also generated a new "buy" signal, rising to positive +134.5, more than the positive +80.00 threshold. We should see more upside from the small caps in the days ahead.

The NASDAQ 100 had a good day, up 36.99 or over 2 percent, to close at 1,616.57. Volume was at its 10 day average, with upside volume at a strong 86 percent, advancing issues a buying panic 91 percent, and upside points also a buying panic 96 percent. Yes, shorts were buying until their fingers bled Thursday. But so were fund managers, thus the broad buying needed to generate a new "buy" signal in our key trend-finder indicators was present. Demand Power was up 8 points, the highest reading of 2006, to 407, while Supply Pressure fell 6 points to 420. The fact that Demand Power's rise exceeded Supply Pressure's decline suggests a rally with some legs is likely. The NASDAQ 100 Purchasing Power Indicator, which is the net of our Demand Power and Supply Pressure components, rose a huge 8 points to 97.12, triggering a new "buy" signal. This confirms the buy signal from May 25th in the NDX 14 day Stochastic. Its Fast rose to 68.00, above the Slow at 37.00. The NASDAQ has started its wave {c} up, the final leg - but maybe an extended one - for Micro degree wave 2 up. The NDX 10 day average Advance/Decline Line Indicator also generated a new "buy" signal Thursday, putting an exclamation point on the PPI and Stochastic new "buy." It rose to positive +6.9, above the positive +5.0 threshold necessary to trigger a new "buy."

The HUI Amex Gold Bugs Index fell 2.06 points to 331.75, following its path charted in Wednesday's Midweek, the last leg Minor degree wave c down of Intermediate degree 2 down. No surprise here. Volume was 91 percent of its 10 day average, with downside volume at 52 percent and breadth even at 50-50. Both key trend-finder indicators remain on a "sideways" signal as they differ with each other. The HUI Purchasing Power Indicator remains on its "buy" from May 25th, coming in at 195.25, close to its recent high. However, the HUI 30 day Stochastic remains on its "sell" from May 15th. Its Fast did move higher to 11.11, above the Slow at 2.47, but would need to rise more than 20 points above the Slow to generate a confirming "buy." Gold the metal fell 15.50 to 629.2, very likely completing the first wave {a}-down of an {a}-down, {b}-up, {c}-down of the Micro 2 down correction charted in Wednesday's issue at www.technicalindicatorindex.com . However, wave fives tend to extend in metals, so more downside could come before {a}'s bottom hits. Silver also fell, down 0.55 to 12.02, and may be starting its Minuette wave c down of 2 down. Oil fell a buck, while Bonds and the Dollar were flat.

Bottom Line: It looks as if this correction up in equities is going to be deeper than the first two waves {a}-up and {b}-down suggested. Wave {c} will likely extend. Then wave 3 down should catch a ton of folks off guard. This rally is a Bear trap. Any surprises over the next week should be to the downside, as that is where the major trend lies. Caution is warranted.

Tonight's newsletter is a market update to highlight today's market action in light of our full expanded analysis, published over the weekend, issue no. 339, available by clicking on the weekend button at our home page at www.technicalindicatorindex.com

June 2, 2006

Robert D. McHugh, Jr. Ph.D.
Main Line Investors, Inc.

Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania, and can be reached at www.technicalindicatorindex.com. The statements, opinions and analyses presented in this newsletter are provided as a general information and education service only. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this newsletter is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. Neither Main Line Investors, Inc. nor Robert D. McHugh, Jr., Ph.D. Editor shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.