FSU Editorial: "DOCTOR: And How Are You? MARKET: Exhausted Beyond Belief!" by James West 05/14/2006

DOCTOR: AND HOW ARE YOU? MARKET: EXHAUSTED BEYOND BELIEF!
by James West
buythebottom.com
forever a student of the markets
May 14, 2006

Before we begin, if you are not familiar with the Commitments of Traders (COT) report, please visit my two pervious articles. There you will learn some of the basics about the COT report, which will not be covered in this article right now. Here are the links:

COMMITMENTS OF TRADERS REPORT: THE 1987 CRASH
http://www.financialsense.com/fsu/editorials/west/2006/0506.html

STUDY: INVESTORS WHO DO NOT SMOKE CRACK - LOSE ON STOCK
http://www.financialsense.com/fsu/editorials/west/2006/0429.html

JAMES! You got the goods??? I SURE DO!

“If a picture is worth a thousand words, these charts, are worth several pictures.”

S&P 500 (2004 – present)

Commercials (yellow line) are selling out of the S&P 500, while large traders (blue line) are buying in. Until this trend is reversed, I am very bearish on the broad markets. And this trend will probably not reverse until we see the markets decline. Whether the market goes down 5%, 10%, 50% or more, is the million dollar question.

RUSSELL 2000 (2004 – present)

The Russell 2000 is displaying the clearest chart in my opinion. It shows a near perfect mirror image between the commercials and large traders. You could clearly see that from early 2004 to mid 2005 commercials were buyers and large traders were sellers in this market; a bullish sign. Not coincidentally, the Russell 2000 rallied and made consecutive new all time highs since then. From the second half of 2005 to present day, commercials are getting out (selling) while the large traders are buying into this market. Once again, the market is setup here to decline. The only unknown variables are WHEN EXACTLY will the market decline and to what EXTENT?
If you look at the black squares, you will see that when commercials were buyers in the market from April through August of 2004, the Russell 2000 index was in a downtrend. This example goes to show you that markets are setup by the commercials, so just because they are buyers today does not necessarily mean the market is going to rally tomorrow. In fact it may not be ready to move for several months, even years! Patience is a virtue.

DOW JONES INDUSTRIAL AVERAGE (2004 – present)

The Dow Jones has an interesting chart. The commercials (yellow line) have been sellers here since mid December of 2005, while large traders (blue line) have been buyers since mid November of 2005.
Please note that commercials were big sellers in this market in February of 2005 and June of 2005; after both instances the market declined. The concerning difference now is that from mid December of 2005, commercials are net-sellers for a MUCH longer period of time (red rectangle) when compared to the two spikes (red squares) in February and June of 2005. Could this mean a significant decline is approaching?

NASDAQ 100 (2004 – present)

The NASDAQ 100 is another interesting chart. Commercials are sellers, but there was a notable spike in buying activity in March of 2006. I do not want to speculate if this commercial buying is just a spark in the pan, or something more, instead I will wait until next week’s COT report and go from there.

The Good, the Bad and the Ugly

The good thing is: we know that the broad markets are setup to decline. That means exercise extreme caution when buying equities, hedge your long positions, bet small, limit your exposure to the upside, etc.

The bad thing is: we do not know when the decline is going to happen. In every chart, I placed a label that reads: “TOP?!” Reason being, there is a decent probability that we will see new all-time highs on the Dow Jones and Russell 2000 before it is all said and done. So is all of this going to result in a quick correction, before the markets continue to rise…which may eventually lead to a very big decline? Or is this right now, the beginning of that ‘very big decline’? Nobody knows for certain, but I will tell you this, the markets at this very moment, are setup to decline, and it may very well happen sooner than later.

The ugly thing is: we do not know the potential extent of the decline. Like I asked, is this going to be a quick correction? Maybe a market crash? Or perhaps the start (or continuation depending on who you ask) of a secular bear market? I do not know, nobody does; but one thing is for certain, the market is setup right now, to move down. So once again, utilize extreme caution. A market crash is not out of the question, and as you may already know, we have a confirmed Hindenburg Omen which appeared before all major market crashes in the past.

Quick note on OIL

Next week I will post an oil chart, but in summary, commercials are aggressive sellers of light sweet crude while large traders are aggressive buyers. I believe we will have a strong rally in the summer, but before that, look out for oil prices to potentially decline or at least stay in a trading range in the immediate future. However, an oil spike is not out of the question; in today’s world, nothing is really out of the question.

Now go outside and get some fresh air,

Until next week,

James

PS. I got a new website going, www.buythebottom.com; check it out, all the articles will be posted there plus other material down the road. Let me know what you think about the site, I encourage you to share any suggestions & ideas for improvement that you may have. Thanks!

CONTACT INFORMATION
James West
www.buythebottom.com
Toronto, Ontario, Canada
Email: westjam @ gmail.com (Remove the space before and after @ when sending your email)

The opinions of FSU contributors do not necessarily reflect those of Financial Sense