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"Another Buying Opportunity?"

Since January, the McClellan Oscillator has been in the -200 area six times, yet the equity markets are below their January, February, and March highs. The reason for the market's inability to embark on a sustainable rally can be found in the persistent weak internals which were in full display last week in terms of breadth and up/down volume. People fail to realize that "deeply oversold" conditions are responsible for igniting rallies; improving internals are responsible for sustaining the rally, because they provide the fuel that the rally consumes in order to keep on going. If your vehicle is running out of gas and it stalls, you can get it started by using a starter fluid, but unless you get some gas in the tank, the starter fluid won't get you where you need to go.

We have received lately many inquiries with regard to whether the market is approaching another important  intermediate term "buying" opportunity. Thus, I would like to address this issue before I talk about my  expectations for this week. Since January, breadth has been constantly deteriorating, new lows have been expanding, volume has been contracting on up days, and expanding on down days. Under these circumstances, rallies can't last regardless of how oversold the markets get. Thus, no intermediate term "buying opportunity" can be expected to be found in this type of market environment.

Moreover, given all the cross-currents that are currently exerting pressure on the markets from opposite ends, good earnings, improving economy, geopolitical uncertainty, political uncertainty, rising interest rates, rising oil prices, etc., it is an exercise in futility to attempt to determine in advance--with any degree of reasonable certainty--when the prevailing market conditions will change. Instead, by focusing on identifying the conditions that are currently in play, we can then determine with a high degree of certainty what can be expected of the markets right now, and what we ought to be doing accordingly. For example, we can determine with a high degree of certainty, that as long as breadth continues to deteriorate, new lows continue to expand, and volume continues to contract on up days/ expand on down days, it will be very difficult--if not impossible--for the markets to make any progress, and for investors to earn a return that adequately compensates them for the market risk they're taking.

To make the point even more clear, we shall take a look at the A/D and Volume McClellan Oscillators and Summation Indexes for the NYSE.

The Oscillators are in oversold territory, which means a bounce from an oversold condition, is to be expected. However, notice that all four of these important indicators are below zero and declining, which leaves no doubt that the current breadth and volume attributes of the NYSE are NOT supportive of higher prices. Given all the cross-currents that are exerting impact on the market at the present time, it is rather impossible to determine with any degree of certainty whether the Summation Indexes will bottom at -500 or -1000. However, as long as all four remain below zero and continue to decline, we can determine with a high degree of certainty that the path of least resistance is down, and thus it is premature to be looking for an intermediate term buying opportunity. 

In order to be successful in the market, investors/traders do not need to determine in advance when the market environment will change; what they need to do is to have a plan with regard to what they'll do when the environment does change, and when it does, they need to recognize the change and immediately act upon it by implementing their plan. Another example of what we are talking about can be seen in the A/D charts for the NYSE and NASDAQ. The two charts on the top show the current A/D line.

Notice the difference in the formation between now and March-April of 2003. Even a novice can tell that last year the A/D had formed a bottom, and it was moving up. In that type of environment it made sense to be a buyer because most stocks were appreciating. However, over the past 3 months the A/D line has formed a clear top and it is declining. In this current type of environment it makes sense to be a seller, because most stocks are  depreciating. The two charts on the bottom show the change that investors would want to see, in order to become buyers again.

When the A/D lines stop to decline, and they begin to form, once again, patterns that are usually associated with "bottom formations," then we can conclude with a reasonable degree of certainty that a positive change in the market environment has taken place, and thus, we should be buyers. Right now the A/D and Cumulative Volume lines for all major U.S. Indices are in a free fall, thus, it is premature to be looking for intermediate term buying opportunities. In fact, judging from the current chart pattern, investors ought to be concerned with whether the markets are in the process of completing intermediate term tops.

With regard to this week and perhaps the week after the next, the market action more likely will be impacted by two developments which took place last week. Last week the Thrust Oscillators and Buy/Sell Equilibrium Indexes turned up, while the Quantifiers and McClellan Summations Indexes continued lower. This twin action means the following: the McClellan Summation Index and the Quantifier are telling us that the markets internally are too weak to embark on a multi-week advance, but the positive divergences exhibited by the T.O. and BSE are suggesting that we are pretty close to another short term bottom just like the one we had in March. Notice that the set-up then was identical to the present one, advancing BSE and T.O./declining Summation Index and Quantifier. Consequently, we got to be alert for another fast and furious rally coming. The markets can rally this week, and then turn down next week going into options expiration, OR, we could see price weakness until about the middle of the week, and then a rally that will carry us into options expiration the following week on 5-21-04.

In addition, the RYDEX data show an increase in bearishness which also supports a short term wonder rally to delight the bulls and shock the bears out of their shorts. Notice that the assets in the bear funds have approached $2b. For the past 16 months, every time the assets in the RYDEX bear funds came close to the $2b level, the markets have staged a strong rally with the latest one taking place in March.

In summary, the deterioration in the market internals indicates that the overall environment continues to be negative, and in fact, last week it was the worst we have seen since the October lows of 2002. The charts, as well as the quantitative data, suggest that the current market environment is one in which most stocks decline, therefore it makes sense to be a seller instead of a buyer. The potential returns offered by the market, do not adequately compensate investors for the market risk they are taking. Although we have no signs suggesting that a change in the market environment is to be expected, we do have indications suggesting that a short term rally, similar to what we had in March but of lesser magnitude, should erupt in the next 1-2 trading days, providing short-term traders with a trading opportunity.

INTEREST RATES: The yield on the 10-Year Note, has broken marginally above resistance, and it is targeting the 55-56 level. At the same time, the 30-Year US Bond has yet to make contact with its long-term channel support, currently at 100. In other words, both these charts are telling us that interest rates can go higher before we see any pullback. In that case, they may drag down the equity markets for the next few days, but we should expect a pull-back in yields--higher bond prices--once they achieve their near term upside target which will allow the equity markets to rally.

SPECIAL NOTE ON GOLD STOCKS

Gold stocks are not yet in the "BUY" zone. We want to see the gold/xau ratio between 5.5 and 6.5.

Ike Iossif

All charts are property of Aegean Capital Group, Inc. All Rights Reserved, Reproduction without written permission, is strictly prohibited.

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