Tech Talk

02/04/2005 12:00 am EST


John Murphy

Head Market Analyst,

In preparation for a speech at the professional 2005 Annual Forecast Meeting of the Market Technicians Association, technical expert John Murphy graciously shared some of his comments with readers. Here is an overview of his outlook for the coming year.

"This meeting of technical professionals will address such questions as ‘Where do we stand in the presidential cycle? Will 2005 be another bull year? Is there a secular bear market in force? Which sectors look most attractive?’ I thought this would be a good time to review some of them with my readers.


"The presidential cycle is broken down into four years. Usually, the worst of the four is the post-election year. That's this year. The first two years are weaker than the second two. The reason for that is because the government often takes harsh measures to get its economic house in order at the start of a new term. This year that could be in the form of a more aggressive tightening by the Fed - or a willingness to let the dollar continue to depreciate. Whatever form it takes, the presidential cycle works against the market this year and next. The market has a strong history of bottoming every four years - 1990, 1994, 1998, 2002, etc. Those bottoms occur midway through the presidential cycle. The next major bottom is due in the autumn of 2006. The period between now and then may not be that good.


"I doubt it. I believe that the ‘cyclical’ bull market that started in October 2002 is peaking. I can't rule out another retest of the old high (especially by the blue chip averages), but, in my opinion, that would be part of a topping process. After that, I think there's more risk than reward. The weekly bars...put the trend into better perspective for the S&P 500. I believe that the upleg that started last August is the last one in the cyclical bull market. I can't say for sure that it's over. But if it isn't, it's very close. When it is, the downside expectation would be a drop back down to the lows of last summer (1060). That would represent a 38% retracement of the entire cyclical bull market. From its December peak, that would be a 13% decline in the S&P. The downside target for the Nasdaq Composite is 1750, which would be a decline of 20% from its recent high. That would also be a 38% retracement of its cyclical bull market.


"In case you're not sure what that means, a chart of the S&P 500 since 1974 shows a rising trendline that started in 1982. That defined the secular bull market that lasted for nearly two decades. That long-term support line, however, has been broken. At the very least, that means that the secular bull market is over. At its current level, the S&P is 300 points (20%) beneath its year 2000 peak. If it starts to roll over in the first half of this year, that will be the first example of 'lower highs' in twenty years. The worst case scenario is another plunge beneath its 2002 lows. A more moderate scenario (which I lean toward) is a flatter trend between its 2000 highs and its 2002 lows. That latter scenario calls for alternating bull and bear cyclical markets through the balance of the decade. That means that the buy and hold style of investing that worked so well during the 1980s and 1990s probably won't work as well in this decade. One of the arguments against a full blown secular bear market at this time is the fact that the current cyclical bull market has taken place in five waves. In Elliott Waves, that calls for a serious retracement of the bull market, but not a move to new lows.


"My favorite sector play for this year is energy stocks, and oil service stocks in particular. Stocks tied to commodities should continue to do well, especially when the dollar starts to weaken again. I also favor defensive groups like consumer staples and healthcare. I believe that large-cap stocks should do better than small caps. I also favor large cap value over growth. Dividend-paying stocks should do relatively well. And, as I suggested earlier this month, rising short-term rates will make money market funds an increasingly attractive alternative to stocks."


Meanwhile, from his recent market reports to subscribers at, Murphy offers this advice: "Crude oil is rallying and appears to be resuming its recent uptrend. The Energy Select Sector SPDR (XLE AMEX) moving up as well. It's now trying to get above its late November peak. I think it will do it. The AMEX Oil Index ($US:XOI.X ) is an index of integrated oil companies. It broke out to a new record in the middle of last year and is still in a long-term uptrend. But it's not cheap. The Natural Gas Index ($US:XNG.X ) broke through its early 2001 peak at the end of last year. The more recent breakout looks more appealing My favorite, however, is the Oil Service Index ($US:OSX.X ), which hit a three-year high in the second half of last year. It's moving up to test the highs formed in 1997 and 2000. I still believe that oil service is the best energy value.

"Back in December, I wrote about how consumer staples were the next in line after energy to take over market leadership in the normal course of events. Since then, staples have been the top performers (with energy in second). If the sector rotations follow their normal historical pattern, utilities are next in line to start showing better relative strength. And, right on cue, utilities now rank third for the new year. The Utilities Select Sector SPDR (XLU AMEX) has been doing much better than the S&P 500. The Dow Utilities are currently breaking out to a new recovery high (actually a new three-year high). Its relative strength line has also broken out. In my sector rotation work, movement into utilities is just another sign that investors are showing a preference for more defensive stock groups. Utilities may also be benefiting from money flows into bond funds, which are closely tied to utilities.

"I've received a number of questions about buying a bear market fund to profit from a falling stock market. As the name implies, a bear market mutual fund - such as Rydex URSA (RYURX ) - does well in a bear market. It's designed to move in the exact opposite direction of the stock market. In a bull market, you want to own a bull market fund. In a bear market, you want to own a bear fund. Simple enough. The trick is deciding whether we're in a bull or a bear market. When analyzing a bear fund, we apply the exact same technical indicators that we do to the S&P 500. We just reverse them. In other words, a major ‘sell’ on the S&P 500 should coincide with a major ‘buy’ signal in a bear fund."

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