WILSHIRE 5000 HAS RETRACED 62% OF BEAR MARKET AND MAY BE AT OR NEAR MAJOR TOP

WILSHIRE 5000 HAS RETRACED 62% OF BEAR TREND... One of the problems with doing a chart analysis of the "market" is knowing which market index to use. No one stock index speaks for the entire market. There is one, however, that a number of readers have asked about -- and that's the Wilshire 5000 Index. As its name implies, it contains a lot more stocks than other popular averages. That may also make it a good barometer of the entire market. One of our readers pointed out yesterday that the WLSH had retraced 61.8% of its 2000-2002 bear market. That is correct. The horizontal bars in Chart 1 measure the percentage retracements of the decline from the early 2000 peak and the late 2002 trough. The top line is a 61.8% retracement of the previous decline, which is a significant resistance level in Elliott Wave analysis. Adding to the significance of that level is the fact that the 12000 level is close to the previous peak reached in the spring of 2001 (see arrow). I've once again imposed my five-wave analysis on the cyclical bull market that started in October 2002. That suggests that the Wilshire 5000 is in its fifth and final upwave, has retraced 62% of its previous bear market, and has reached its next resistance barrier at 12000. Now let's look at the indicators.

Chart 1

FIFTH WAVE DIVERGENCE? ... I've plotted a 9-month RSI oscillator on the monthly bars in Chart 1. The RSI turned up from under 30 at the end of 2002 (see green arrow) and correctly signaled the new uptrend. Right now, the two peaks in the RSI show a "negative divergence" (see blue arrows). In other words, the last upleg in the WLSH hasn't been confirmed by the oscillator line. [Oscillator divergences during a fifth wave advance take on more significance than at any other time]. It's important to note, however, that the monthly MACD lines are still in an uptrend. The two lines are converging (which is a sign of diminishing upside momentum). But no major sell signal takes place until the two lines cross. The two circles on the MACD lines show the last two major trend signals -- both of which worked out pretty well. The weight of the evidence, however, suggests that the cyclical bull market is at -- or very close to -- an important top. The big question now is whether or not the fifth and final upwave is complete.

FIVE WAVE ADVANCE MAY NOT BE COMPLETE ... Assuming I'm reading the waves correctly, the rally that began in August of last year should be the fifth and final upwave in the cyclical bull market. But that fifth wave has to also show five relatively clear waves before being complete. Which brings us to the current dilemma. Waves 1 and 2 are pretty clear in Chart 2. Wave 3 began in late October. There should be a short-term correction or consolidation to mark Wave 4 before the fifth and final upwave can be identified. Although there was some hesitation in late November/ early December, I'm not sure it qualifies as Wave 4. That raises the possibility that the recent peak may be the top of Wave 3. In other words, I can't say for sure if the recent peak is the top of Wave 3 or Wave 5. If it's the top of Wave 5, the rally should be over. If it's the top of Wave 3, the market can make one more attempt at a new high. In times of such indecision, it's usually best to fall back on more traditional market indicators like support and resistance levels, trendlines, and moving averages.

Chart 2

50-DAY AVERAGE STILL HOLDING ... Chart 2 shows that the WLSH is still above its (blue) 50-day moving average. That encourages the view that the WLSH may be forming a wave 4 correction. Even if another upwave ensues, the fact that small caps and the Nasdaq are already starting to underperform isn't a good sign. In my view, that would just create more "negative divergences" in another challenge of the old high. I suggested yesterday that I thought it was time to start raising some cash (preferably in a money market fund) -- just in case the market has already seen its high. Even if it hasn't and another rally ensues, I'd use that rally as another opportunity to do some selling. As an alternative to (or in addition to) a money market fund, I'd also consider switching some funds into more defensive sectors like consumer staples and healthcare. The point & figure chart of the WLSH in Chart 3 also presents some support and resistance levels to watch. So far, the p&f uptrend is still intact. The WLSH would have to drop to 11500 or 11450 to give a p&f sell signal. That would also put it well below its 50-day moving average.

Chart 3