NYSE BULLISH PERCENT INDEX TESTS IMPORTANT SUPPORT -- S&P 500 IS TESTING 80-WEEK AVERAGE WHICH IS STILL HOLDING -- WHY BEAR FUNDS SHOULDN'T BE USED AS A LONG-TERM INVESTMENT

NYSE BULLISH PERCENT INDEX AT CRITICAL SUPPORT... I've been asked to update my views on the NYSE Bullish Percent Index (BPNYA). The BPNYA is the percent of stocks in the NYSE Index that are on point & figure buy signals. On September 26 I reported that the BPNYA had suffered a downside three-box reversal from above the 70 level which raised the risk level in the market. I cautioned, however, that an outright sell signal required that the last o column fall below a previous o column. That hasn't happened yet, but it's dangerously close to doing so. Chart 1 shows that the BPNYA falling back to 54 and testing the bottom of two previous o columns going back to the beginning of 2004. A drop to 52 would trigger a market sell signal. That puts the market at a critical support point.

Chart 1

S&P 500 STILL HOLDING 80 WEEK AVERAGE ... A reader asked about the status of the 80-week moving average. On August 25 I wrote that I believed the 80-week moving average to be more reliable for the S&P 500 than the traditional 40-week line. Chart 4 shows both moving average lines applied to a weekly chart of the S&P. The red line is the traditional 40-week average. If you scan back over the last ten years, you can see that it's been penetrated several times in uptrends after which the market turned back up again. In other words, it hasn't been that reliable as an indicator of major trend reversals. The blue 80-week average, however, has done much better. It was not penetrated once (on a closing basis) during the bull move from 1996 to 2000. A downside violation in 2000 (down arrow) marked the end of the bull market and the start of a major bear. The upside penetration in 2003 (up arrow) marked the start of the last bull market. That means there have only been two weekly crossings of that line in the last ten years -- and both signaled major trend reversals.

Chart 2

Chart 3

THE 80-WEEK AVERAGE IS STILL HOLDING... Chart 3 gives a closer look at the two moving average lines since the 2003 buy signal. As is always the case with moving averages, a crossing of the shorter (red) line always occurs first. In the spring of 2003, an upside crossing of the red 40-week average gave an earlier signal than the upside crossing of the blue 80-week line. From the middle of 2004 to the middle of 2005, however, the red line was broken three times (see red circles). In all three instances, the market turned back up again. The blue line, however, was not broken at any point. Over the last week, the red 40-week line has been broken again. That raises a caution flag. But the S&P needs a weekly close beneath the blue 80-week line (currently at 1165) to signal a major downside crossing. As was the case in Chart 1, that also puts the market at a crucial testing point.

WHY BEAR FUNDS ARE TRADING VEHICLES ... My Wednesday message on bear funds wrote that they should be used as trading vehicles and not as a long-term investment. One of our readers asked why. That's because the market has a history of rising more often that it falls. To hold a bear fund in a rising market ensures unnecessary market losses. Since the start of 2003, for example, the bear fund would have lost 28% while the S&P 500 gained 34%. In other words, a bear fund would have been a bad holding over the last three years. The picture is even worse the further back we look. Chart 4 compares the S&P 500 monthly bars to the Rydex Ursa bear fund (red line) for the last ten years. The bear fund is designed to move in the opposite direction of the S&P 500. The bear fund fell from 1995 to 2000 as the market rose. After rallying from 2000 to 2002, it fell again from 2002 to 2005. That means that the bear fund fell for seven out of the last ten years and three out of the last five. It would have done a little better than the S&P 500 since 2000. But it would have lost a lot in the three years since 2002 and a lot more over the entire ten-year period. That's why it shouldn't be used as a long-term investment. A bear fund can and should be used, however, when the market looks like it may be turning down -- as it is now. In my view, that makes bear funds trading vehicles and not long-term investments.

Chart 4