OCTOBER GETS OFF TO A BAD START -- MARKET INDEXES ARE TESTING 200-DAY AVERAGES -- WEEKLY MACD LINES HAVE TURNED BEARISH
DAILY CHARTS ... October is trying to live up to its reputation as one of the year's most dangerous months. All of the market averages fell sharply and on rising volume. That's a bad combination. Many of them undercut initial chart support at their August lows and are threatening their 200-day moving averages. Chart 1 shows the S&P 500 ending the week below that long-term support line. Most of the other market indexes,however, are still testing the 200-day line. Chart 2 shows the Nasdaq Composite bouncing off it on Friday. Unfortunately, Friday's market bounce came on the lowest volume of the week. That doesn't inspire a lot of confidence. Charts 3 and 4 show two other important indexes that are testing their 200-day lines -- 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 of this week's selloff was bigger losses in the Nasdaq market and small caps. Just the week before I had written that new signs of buying in both groups was encouraging. This week's heavier selling in both erased any positive interpretation coming from September's strong finish. Nasdaq and small cap leadership is essential for the market. That's another reason why they have to be watched especially closely as they test their 200-day averages.
Chart 1
Chart 2
Chart 3
Chart 4
WATCHING LONG-TERM INDICATORS ... At the end of the previous week, I wrote that the late-September bounce had kept long-term indicators from turning bearish. That's no longer the case. That's why it's especially important to keep an eye on the weekly and monthly indicators at this crucial point. What happens to them carries a lot more importance than what happens on the daily charts. Chart 5 shows a monthly bar chart of the Wilshire 5000 for the last seven years. [I'm using the Wilshire 5000 Index because it's the broadest market measure that we have]. I've super-imposed monthly Bollinger bands on the price bars. In my view, the most important line is the dashed middle line which is the 20-month moving average. The last two crossings of that line signaled the start of the bear market in 2000 (red circle) and the bull market in 2003 (green circle). A downside violation would carry long-term bearish implications. The 9-month RSI line at the top of the chart shows a "triple top" formation which suggests an overbought market with a major negative divergence (see blue arrows). That's a warning sign. I've shown two different versions of the monthly MACD lines. The one on the top shows the major sell signal in the middle of 2000 and the major buy signal in the spring of 2003 (see arrows). No signal has been given since then. But the two lines are coming dangerously close. The monthly histogram bars at the bottom of the chart show how close
Chart 5
MONTHLY HISTOGRAMS AT DANGEROUS POINT ... The MACD (green) histogram bars measure the difference between the two MACD lines. Major buy and sell signal are given when the histogram crosses above (buy) and below (sell) the zero line. Those signals coincide with the MACD line crossings as shown by the sell signal in the middle of 2000 (red arrow) and the buy signal in the spring of 2003 (green arrow). Notice, however, that the histogram starts moving toward the zero line long before an actual buy or sell is given. That means that the two MACD lines are converging. The rising histogram in the second half of 2002 (green trendline) was an early sign that the bear market was losing momentum. The MACD histogram has been dropping since the start of 2004 (red trendline). That's an early sign that the bull market is losing momentum. To give a major sell signal, the histogram has to fall below zero. It hasn't done that yet. But it's the closest to a major sell signal than it's been in two and half years. The weekly MACD lines have already turned bearish.
WEEKLY MACD LINES TURN BEARISH ... In case you're wondering why I rely so heavily on the MACD lines, it's because I have found it to be one of the most reliable of the all the technical indicators I use. That's especially true of long-term signal on the monthly and weekly charts. The signals are relatively infrequent and, although not infallible, are pretty reliable. Another thing I like about the MACD lines is that they combine two important aspects of trend analysis. The crossing of the two moving average lines gives precise (and generally reliable) trend signals. The MACD lines, however, also have some qualities of an oscillator in the sense that they provide positive and negative divergences. Both of those qualities are demonstrated in Chart 6. I've superimposed the MACD lines on the weekly bars for the Wilshire 5000 Index. The declining trendline shows a huge negative divergence between the MACD lines and the Wilshire at the start and end of 2005. [A negative divergence exists when prices hit new highs but the MACD lines don't]. To the far right, it can be seen that the weekly MACD lines (and the histogram) have turned bearish for second time this year. This is the third MACD sell signal since the start of 2004. I've mentioned before that the second or third signals are usually the most dangerous. The fact that this is the third MACD sell signal carries more weight than the previous two. [Weekly sell signals have also been given on the Dow Industrials, the Nasdaq Composite, and the S&P 500].
Chart 6
TIME TO BE VERY CAUTIOUS... Those of you who have been reading my messages for awhile know my views 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 written in the past that the most dangerous time for the market is the autumn of 2005 to the autumn of 2006. We're now in that dangerous time period. That's why this week's 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. A decisive violation of this past week's lows would call for a downright bearish stance.
