Bull Market Becomes Selective

The bull market continues to rage ahead in the OTC market, but is by no means broad-based. This market has become extremely narrow and the leaders are few. Most stocks remained mired at lower levels, but for short-term trading purposes we can still take advantage of the opportunities afforded by the NASDAQ bull.

While the NASDAQ remains in a white hot melt-up by reason of the overwhelming amount of upside volume, the Dow Jones Industrials, as well as the DJ Transports and Utilities, remain mired at levels seen last summer (in the case of the Dow Industrials) and at levels unseen since 1998 (in the case of the Utilities)! While many analysts have interpreted this as a "bearish divergence," we see it as more a consequence of the public's tremendous appetite for more speculative issues of the type featured primarily in the NASDAQ Composite index. If anything, the Dow indexes are the victims of a lack of widespread interest in blue chip industrial-based stocks (talk of a "New Economy" abounds, with the Dow relegated to the status of "Old Economy"). As well, the Dow indexes (particularly the Transportations and the Utilities) appear to be suffering over the upward trend in interest rates and especially the continued bull market in crude oil and its derivatives. Since transportation is highly dependent on oil, any increase in oil and gas prices is certain to dampen the outlook for transport, as well as for oil and gas-dependent utilities.

The overriding question, then, becomes one of "what in the world is going on here?" We've addressed this oil and interest rate conundrum question several times in the past few months, but we feel it necessary to emphasize it once again: the crude oil market is apparently proactively responding to the threat of Y2K-related problems that will likely plague the U.S. economy in the early weeks/months of 2000. While we do not foresee a total shutdown of U.S. commerce, there will apparently be sufficient problems to slow things down for a while (as reflected in the Utility outlook). In this case, oil and the Dow Jones Utilities are anticipating, not an inflation, but a problem or series of problems that will likely arise over the next several weeks.

How should the prudent investor respond to this potentiality? We advise limiting exposure to stocks, bonds and currencies as we head closer to the New Year. We are not calling for a market crash (at least not yet); however, there is simply too much risk to have too much money tied up in a financial system that may well suffer from the effects of a widespread malfunction. Keep a certain amount of your investment capital in only the most liquid stocks and funds; the rest store safely in the confines of a money market account (and some of it in your own home) until Jan.1 passes. We can safely ascertain the outlook from there.

Talk of a market crash occurring in the next few weeks abounds among the circles of bearish analysts. But a crash, by its nature, is an implosion which implies a vacuum or hollow quality to the market. Currently, there is no air pocket in U.S. stock market as it is chock full of liquidity, most of it upside volume. As long as upside volume is predominate, the trend cannot but remain up. Only when the massive trading volume we are witnessing in the OTC stocks becomes net downside volume-or when volume (i.e., money flow) slows down-will there be a reversal of trend. Until then, the odds of a crash are remote.

In fact, the U.S. and world economic system is practically bursting at seams with liquidity, so much so that a crash in almost any of the major global stock market indices is all but impossible right now. World money supply is growing, and almost all of that money growth is being funneled into the markets, particularly the U.S. market. The best analogy to describe what is presently going on is gasoline in the tank of an automobile. As long as the tank (market) is full of gasoline (volume or liquidity), and as long as there exists plenty of momentum to propel the vehicle, it will keep right on running. Such is the case with the global economy at the moment.

While the tremendous upside volume and momentum are sufficient to propel the market to higher levels, there must be a correction at some point along the way. Every significant run-up in price must witness a corresponding downturn as a way of "purging" the excesses of the run-up. Just as a man given to appetite cannot continually feed himself without purgation (and probably a bout of sickness) at some point, so the market cannot continue to move ever and anon higher without either a consolidation or correction. So we must definitely expect at least a minor downturn at some point in the near future.

Another cause for concern for many investors has been the cumulative advance/decline line, which represents market breadth. This line has been falling for the better part of the last two years now, and even as we write is in decline mode. However, this is not necessarily an indication of danger on the immediate horizon. As we wrote in a recent commentary: "What matters most is not whether the majority of stocks on the NYSE or NASDAQ are falling in share price. What matters even more is the force by which they are falling: Is there a high-volume liquidation of these holdings or is it a mere case of a low-volume decline that could be nothing more than a healthy correction? That's why one should never put too much faith in the A/D Line alone without first looking at the cumulative volume situation." In the long-term picture, however, the falling A/D Line does have significance.

The immediate-term outlook for NYSE-based stocks is neutral-to-bearish. The NYSE 5-day advancing volume chart has now turned short-term bearish and is falling, which implies a further pullback in the Dow averages. In contrast to this, however, the 10-day and 30-day momentum oscillators for the NYSE are quite bullish. The cumulative volume outlook for NYSE stocks, however, is still mostly bullish; thus, the overall outlook remains positive. The most interest of our volume-based indicators is the chart showing NYSE volume momentum. The chart has plunged beneath the equilibrium ("zero") line and is at its lowest point of the entire year! This means low trading volume should continue to characterize the NYSE over the next couple of weeks. (Translation: all the trading interest is being funneled directly into NASDAQ stocks.)

The 30-day momentum indicator is actually in the most bullish position it has been in since last spring. This tells us momentum should be sufficient to carry the Dow at least slightly higher between now and year-end, even if it doesn't make a new record high. At the worst, the Dow will at leastremain stuck around the 11,000 level.

Upside volume on the NASDAQ is a completely different story. We counted almost three consecutive weeks of continuously rising upside volume on the NASDAQ before the first "correction" took place. This is one of the most bullish volume performances we've ever seen in this sector. Quite simply, all the trading interest on the OTC is on the upside. Momentum also remains firmly in favor of an upside continuation of NASDAQ prices.

The Internet outlook remains positive. Our benchmark CBOE Internet Index is on the verge of testing its previous all-time high of April of this year, and is moving with great momentum. We will need to monitor this index closely as it approaches the previous high to see how it reacts. Watch especially how trading volume behaves. The only worry we have right now is that open interest on this security is lagging considerably from where it was last spring. Open interest must pick up in order to ensure a continuation of the upmove.

The leading Internet stocks are in mostly bullish positions and are among the leading sectors in the NASDAQ bull market. However, a majority of Net stocks are not participating in this rally; the rally apparently is relegated to a handful of Internet blue chips, such as Yahoo!, Amazon.com, BroadVision, etc. It is still safe, however, to remain long the Internet Fund [WWIFX], which we recommended several weeks ago and has performed nicely since then.

The only major thorn in the side of the equities outlook is the banking sector. We pointed out a few weeks ago that the leading bank stocks, including major money center banks such as J.P. Morgan and Chase Manhattan, appeared to be under distribution. In fact, one major bank stock-Banc One-experienced a crash of sorts earlier in November and has not yet recovered. Is this a harbinger of what is to come to the broader bank sector? And does this relate in any way to Y2K? We have constructed a "Wyckoff Wave" composite bar chart of the five leading U.S. bank stocks in order to gain better insight into the bank situation (a method we discuss in our most recent book, Elliott Wave Simplified, and what we discovered was a source of amazement. The chart of this index has traced out a textbook "broadening top" formation, which normally implies a significant downturn in share price. The volume pattern corresponds perfectly to the way a broadening top (also known as a "megaphone" pattern because of its shape, see Technical Analysis Simplified) should look, so we know this is not just the silhouette of one. It will be very interesting to see how this pattern turns out.

In conclusion, we urge traders and investors to play it safe in the closing weeks of 1999. While the outlook for the first quarter of 2000 remains bullish from a stock market perspective, we cannot rule out the possibility of significant problems arising from the Y2K problem. This possibility, as we have mentioned above, seems to be reflected in the price trends for crude oil, interest rates and bank stocks, among other things.

There will be plenty of time for making money once the problems have cleared away. For now, however, we advise limiting exposure to equities until this problem blows over.