MARKET TESTING TOP OF 2005 TRADING RANGE - ANOTHER LOOK AT ELLIOTT WAVES -- DIVIDEND PAYING ETF HITS NEW HIGH

MARKET IS STILL IN A TRADING RANGE ... In a number of this year's market messages I've described the stock market as being in a trading range. [A "trading range" is a sideways market]. I have allowed for the possibility of "marginal" new highs in the broader market averages. But my longer-range view remains that the market is in the final stage of a cyclical bull market that started in the spring of 2003. That means that the market could retest (or even exceed) its 2005 highs during the summer. But I don't expect much on the upside after that. A headline that I posted on June 16 sums up my views: "Firmer technology sector could extend summer rally - Energy breakouts, however, should cap summer gains". June 16, 2005.

Chart 1

Chart 2

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WHICH INDEX TO USE... Part of the problem in giving a clear overview of the market is determining how to measure it. The three market indexes plotted above show very different pictures. The Russell 2000 Small Cap Index has already reached a new high for the year. The S&P 500 Large Cap Index is nearing a test of its 2005 high. The Dow Industrials are closer to their 2005 low. Which one do we use to determine what the "market" is doing? In order to keep things relatively simple, I'm going to use the S&P 500 in this analysis. Not because it's the best of the major averages, but because it's generally viewed as the main market benchmark. Chart 2 shows the S&P 500 moving up toward its March high at 1229. That will represent another test of the top of the 2005 trading range. It may even exceed that chart barrier. But probably not by too much.

ELLIOTT WAVES REVISITED ... Awhile back I published some Elliott Wave analysis to make the point that the S&P appeared to be in the fifth and final upwave in its cyclical bull market. [Elliott Wave holds that bull markets form five waves before ending]. The weekly bars in Chart 4 show why I believe that the fifth upwave started in the middle of last year (point 4). My longer-term view on that hasn't changed since the last time I wrote on the subject. What has changed is my wave count for the period since last summer. As I've explained before, the fifth wave that started last summer should also divide into five waves. Which brings us back to our 2005 trading range.

Chart 4

ELLIOTT RECOUNTS... The daily bars in Chart 5 show my revised interpretation of the Elliott Waves from the bottom last August. The key is to find a clear five-wave advance. Earlier this year I took the view that the early March high was a wave 5 (first 5). I no longer believe that to be the case. The reason has to do with the fact that the March/April decline retraced exactly 50% of its previous advance before turning higher. That's a normal retracement in an ongoing uptrend. The more important point about the April low is that it stopped right at the early October peak (near 1140). In Elliott work, a wave 4 pullback usually stops at the top of wave 1. As a result, I concluded that the April low was more likely a wave 4. That meant another upleg to come. If a fifth wave advance started in April (at point 4), then a retest of the old high is likely. It also leaves open the possibility of a move into new highs. But, as you may know, a fifth wave move into news is usually the end of an upmove -- not the beginning. The revised interpretation is a bit more bullish short-term, but still negative long-term.

Chart 5

THERE ARE ALSO CALENDAR FORCES AT WORK ... My cautiousness on the market after the summer (and into next year) isn't just based on Elliott Waves. It's also based on the normal life-span for cyclical bull markets, which has been exceeded. It's also based on negative seasonal patterns that begin in the autumn. [Remember that most of the summer rally is usually concentrated in July]. On a longer-term basis, the market is in the third year of the four-year presidential cycle. The first two years (2003 and 2004) are usually the best two. The two last years (2005 and 2006) are usually the weakest. Since the next major four-year bottom is due in the autumn of 2006, the time between now and then could be a lot tougher for the market once the summer rally has ended.

DIVIDEND PAYING ETF HITS NEW HIGH... There's at least one way to participate in the market's current strength and still maintain a somewhat defensive posture. That's with large-cap dividend paying stocks. High dividends cushion any potential price drop. Dividend yields are also an attractive alternative to low-yielding Treasury bonds. Chart 6 shows the Dow Jones Select Dividend iShares (DVY) moving to a new 52-week high. Upside volume has been noticeably heavy. The relative strength ratio on top of the chart has been moving up since January and is nearing a new high as well. As far as recent sector rotations are concerned, upside breakouts in retailers and semiconductors (and brokers) could extend the life of the cyclical bull market. But it's unlikely that a major new upleg is beginning as long as energy prices (and stocks) keep rising.

Chart 6