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01/06/2006 12:00 am EST
Even if one is bullish on the long-term outlook for the market and the economy, all investors are best served by understanding the arguments that go against that position. Here, Steven Hochberg, a leading expert on Elliott Wave analysis, explains his bearishness.
"The advance since October is the final bullish burst of this bear market rally. The Dow’s pattern since February 2004 is what we call a running triangle, which is a wave within the ‘Primary Wave’ rally that started in March 2003. The thrust is already well developed and many sentiment measures that have corresponded with market highs in the past are now at bullish extremes.
"The percentage of NYSE stocks trading above their 200-day moving average is making a series of lower highs since it peaked at 91% in January 2004. The same holds true for the ten-day average of NYSE 52-week highs minus the 52-week new lows. The move is very similar to the five-week rally that occurred in August-September 2000. At that time, the index pushed past the upper trendline of a similar diamond formation right before a steep decline.
"That Dow high of 11,401 on September 6, 2000 still stands. The market’s reticence to launch immediately into the next leg of the bear market from January 2000 is a disappointment, but the triangle pattern in the Dow makes the technical case for a top even stronger. The likelihood is very high that the peak posted at the end of the latest run in the Industrial average will last for years to come.
"Meanwhile, the NASDAQ Composite is tracing out the same ending diagonal as the S&P. The same technical weakness is displayed by the dramatic narrowing in the number of stocks participating in the NASDAQ’s advance since January 2004, the series of lower highs in the percentage of NASDAQ stocks above their 200-day moving average, and the fall-off in 10-day NASDAQ volume. The downward reversal after the completion of the pattern should be swift and powerful. The NASDAQ’s deteriorating technical health suggests that the index is fast approaching this turn.
"Many of the ‘market generals’ have abandoned the rally and it now appears that the troops are departing as well, as intermediate-term measures of market breadth are also deteriorating. The dwindling participation in each rally attempt is a telltale sign of upside exhaustion. The key to discerning the meaning of these indicators is the Elliott Wave pattern. The thrust out of the Dow’s running triangle and the ending diagonal in both the S&P and NASDAQ are unequivocally saying that the technical weakness is real and should be taken seriously.
"We also note that the only time that ‘Wall Street’ ever intersects with ‘Easy Street’ is near major peaks. A sign of such a crossing is a ‘hiring surge’ that has brokerage firm staffing back to levels not seen since before 2000. MBA enrollments are also rising again and the quick compus revival of get-rich-on-Wall Street ambitions demonstrates that the market is still a long way from its ultimate lows. A youthful enthusiasm for finance is what happens at the end of and not the beginning of a bull market.
"One of the most impressive pictures of the epic public faith in the rising trend is a look at personal savings rates over the last 40 years, which depicts a rising sense of fearlessness. The source of this emotion is clearly the bull market. The savings rate peaked in August 1982, the exact month of the low in stocks, and plunged with every major advance of the bull market.
"In 1999, when the monthly saving rate fell below zero for the first time, we noted that this willingness to bet on the future instead of conserving had been a forerunner to almost every important stock market high since 1970. Further, the main economic driver in the economy has been the housing and home equity lending booms. Now, the housing market is in the process of falling into an enormous crater.
"The extremes we are seeing in bullish sentiment in the absence of any corresponding all-time high in the Dow, NASDAQ, or S&P 500 are powerful evidence that the last three years of rising stock prices is a countertrend rally that will be completely retraced. The bear market rally in stock has pushed higher than anticipated, but not without tiring dramatically.
"Deteriorating stock market breadth, momentum, and volume measures signal that the countertrend rise is in its concluding days. At the same time, investor optimism is back near bullish extremes. Wave counts in all the major averages now support the case for a strong decline once the current thrust is over."
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