To all Bears: The Trend is now our Friend

For long-time bears, the U.S. stock market's long and arduous ride to historic highs has been nothing short of frustrating. Many a trader, no doubt, experienced the anguish many times over of being stopped out of a short sale over the past couple of years due to the market's seemingly unstoppable upward bias. Added to this frustration has been the ostracism associated with being bearish when bearish wasn't cool. But things are about to change in a big way. The bears among us who for so long have been made to feel uncomfortable and unwanted in a bullish environment will soon find the investing climate more suited to their taste—and the bulls will likewise soon find themselves freezing to death in the arctic frost accompanying this changing climate. And that change is already beginning.

The change of which we speak was manifested in every major stock index over the last week. Our primary index, the Dow Jones Industrial Average, fell over 500 points on an intra-day basis over a six-day period, briefly falling below 8850 before bouncing back to slightly above 9000 the next day. The Dow rests as of this writing (July 30) at 9026. The Dow's fall has been so far confirmed by the Transportation index, which fell last week to below 3250—a level not seen since January—in a continuation of its incipient bear market. This Dow Theory confirmation serves as our first indicator that the bear is among us.

The Dow Jones Utilities, meanwhile, have also fallen off from their impressive gains of recent weeks and have the look of a developing bear market, also. We expected this one to stay bullish a while longer, but it now appears that three downward Elliott Waves have developed in this index with the fourth in the process of forming. Admittedly, it is too early to pass judgement with certainty, but a fifth downward leg in this index would go a long way in confirming a bearish trend.

Returning to the Dow Jones Industrials, the sudden, sharp drop from above DJ 9350 to below 8850 has the appearance of a classic bear market turnaround—sharp and almost perfectly straight down—and is eerily reminiscent of the Dow's turn at exactly this same time a year ago. In last year's late July top, the Dow fell several hundred points before experiencing its famous mini-crash on Oct. 27.

Giving us further credence to this bearish outlook is the fact that several leading market timers—Bob Prechter, Cristopher Carolan, and Eric Hadik—all predicted a top in the Dow during the late July/early August time frame—right on target!

From a purely technical perspective, the Dow can be seen as having registered the first two of its five initial Elliott Waves downward. Given that the third wave of any Elliott Wave advance or decline tends to be the longest, it would not be surprising to see a steep sell-off within the next week or so (assuming that our wave count is correct). Otherwise, we have misinterpreted the wave count and another leg of the bull market can be expected.

From a Gann perspective, several key support and resistance areas are within close proximity to where the Dow now finds itself. Though by the time you read this it may be moot, the Dow faces strong resistance at 9050 and again at approximately 9180. This could well be the level to which the Dow retraces in registering its second "wave" before falling into wave three. Other support/resistance levels to watch include 8900, 8800, 8700 and 8600.Below 8600 it is all air until the next closest support level at approximately 7700. A break above resistance at 9180 would annul this forecast and in all likelihood signal the beginning of another leg of the bull market.

From a socio-political standpoint, the timing of the latest revelations in the ongoing President Clinton/Monica Lewinsky saga were my no means coincidental. The revelations mark an important turning point in social mood and should be seen as confirming trend in the developing equities bear market. It has long been observed that a strong positive correlation exists between a president's popularity poll and the direction of the stock market. Clinton's popularity rating chart has thus far followed exactly the trend in the Dow Jones Industrial average, and we expect this time to be no different. In fact, a recent Wall Street Journal/NBC News poll found that already Americans are beginning to take a less benevolent view of the commander-in-chief.

Though we would never argue that the president's scandal caused the stock market to sag; rather, the timing of the scandal itself is consistent with the rapid change in social mood/investor psychology. Bill Clinton, who won the 1992 and 1996 presidential elections as an "economy" president, will likewise lose the presidency (or at least his support) on the economy when the economy turns bad. Recent statistics indicate the economy is already slowing down while the nation's major stock indices deteriorate. Thus, the recent news that Clinton will be forced to testify before prosecutor Kenneth Starr cannot be seen as anything but a manifestation of the developing bear market.