Tech Talk: "Time for Caution"

10/14/2005 12:00 am EST

Focus:

John Murphy

Head Market Analyst, Stockcharts.com

When it comes to applying technical skills to an assessment of the market environment, few advisors can match John Murphy, head market analyst at Stockcharts.com. Here, he offers his guidance in a clear overview well-suited to technicians and non-technicians alike.

"October is trying to live up to its reputation as one of the year's most dangerous months, as all the market averages fell sharply on rising volume. That's a bad combination. Many undercut initial chart support at their August lows and are threatening their 200-day moving averages. The S&P 500 is below that long-term support line and most other indexes are testing the 200-day line. Further, the latest bounce came on low volume, which doesn't inspire a lot of confidence.

"Two other important indexes that are testing their 200-day lines are the Russell 2000 Small Cap Index and the Wilshire 5000. Unfortunately, both have fallen beneath their August lows, which may act as new resistance barriers on any rally attempt. Another disturbing element in this recent selloff was bigger losses in the NASDAQ market and small caps. This heavier selling in both erased any positive interpretation coming from September's strong finish. Small cap leadership is essential for the market.

"It's especially important to keep an eye on the weekly Wilshire 5000 Index because it's the broadest market measure that we have. The last two crossings of its 20-month moving average signaled the start of the bear market in 2000 and the bull market in 2003. A downside violation would carry long-term bearish implications. Meanwhile, the nine-month relative strength indicator line shows a ‘triple top’ formation which suggests an overbought market with a major negative divergence. That's a warning sign. No signal has been given yet, but it is getting dangerously close.

"Overall, this is a time to be very cautious. My forecast for a while has been that the cyclical bull market that started in the spring of 2003 is just about over. I've based that on Elliott Wave analysis, cyclical analysis of the four-year presidential cycle, seasonal trends, analysis of weekly and monthly charts, sector rotations, and intermarket factors like rising inflation and interest rates. 

"I've also been forecasting that the most dangerous time for the market is the autumn of 2005 to the autumn of 2006. We're now in that period. That's why this recent downturn carries such dangerous implications. I can't say for sure that a major downturn is in the offing. But I can say with some confidence that market risk is at the highest point in nearly three years. That calls for a defensive market posture."

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