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Today's WrapUp by Martin Goldberg 11.24.2003 Mon Tue Wed Thu Fri Archive |
"NASDAQ Showing Technical Weakness"
If you watch any of the financial cable TV shows that are aired during the Thanksgiving Day holiday, you are sure to be exposed to a healthy portion of bullish sentiment. The market is going to continue to go up and everyone knows it. There will be a host of reasons why the “new bull market” will continue that will be buttressed by various economic data. There will be Wall Street analysts with stock tips aplenty, including recommendations to buy retailers, homebuilders and of course, technology companies. I’m expecting a festive atmosphere; similar to Thanksgiving of 2000, when CNBC had a band in the studio playing, “I Got the World on a String, Sitting on a Rainbow”. This was CNBC’s follow-up to the hit TV commercial that featured the song, the distinctive blue CNBC ticker, and relaxed people watching the ticker as they lounged by a pool or played golf. The band played the day after Thanksgiving of 2000, when in one-half day of trading; the NASDAQ was up 150 points to close at 2,954. Then as now, stocks seemed cheap to a very optimistic, active, and vulnerable public.
The general sentiment is that we are in a new bull market. We are not. Last October’s “bottom” will continue to be referred to on TV as “the mother of all bottoms”. In truth, we have just experienced the mother of all secondary corrections. This too shall soon pass. There have been a host of clear technical and fundamental descriptions why this is a secondary correction and we are still in a primary bear market. They include overvaluation, overtrading, overconfidence, more Wall Street chicanery, lack of quality new stock market leadership, and an unsustainable economic recovery. Although practically all of us including me hope for an economic recovery, the overvaluation and excessive speculation in the stock market results in stock values that are actually disconnected from underlying business fundamentals. This is true with or without an economic recovery.
There are several technical indications that this rally has probably run its course. The most impressive leaders of this the market rally have indicated probable tops in their charts, which will probably hold. Some key groups that have clearly topped include the Internet stocks, and the Chinese Internet stocks. Two of the less liquid homebuilding stocks have also taken on water – MI Schottenstein Homes Inc (MHO), and Orleans Home (OHB), proving that as with Internet stocks, a rising tide no longer lifts all boats.
In this article, I will describe:
1. Technical evidence comparing the trading volume during and after the 1929 primary market top to that of the 2000 top. This analysis suggests that the current rally is not a “new bull market”, but rather “a mother of a secondary correction”.
2. A NASDAQ chart indicating that the secondary bull correction in a primary bear market has probably ended.
3. Application of Victor Sperandeo’s “4-day Rule” to the NASDAQ chart, also indicating that the secondary bull correction in a primary bear market has probably ended.
Our Bubble Compared to Our Grandparent’s Bubble
The two charts below include monthly price and volume of the 1929 and 2000-bubble stock markets. (Price is indicated by the dark blue line and the left-hand scale; trading volume is indicated by the violet line and the right-hand scale.) The first chart includes the NASDAQ of our grandfather’s (or great grandfather’s) day – the Dow Jones Industrial Average (DJIA). At the October 1929 market top, about 100 million shares per month traded. As you can see from the charts below, in 1929 a continual drop off in trading volume characterized bear market. Volume bottomed at about 20 million shares per month. This is known as “revulsion”. It signals the normal occurrence of people “giving up” on the market. A spike in volume and a continual increase in volume marked the end of the bear market as the new bull market began. A large spike in volume signaled the end of the bear market. This is also a normal occurrence when a new bull market begins.
The chart below shows similar data for the NASDAQ, 70 years later. Unlike 1929 the volume is still very close to where it was at the market top. There has been no “quit” in the wild speculation of the late 90s. This is in direct contrast to all other primary bear market bottoms, including the 1933 end to the bear market that began in October of 1929. In order to believe that we have seen the “mother of all bottoms”, we would have to believe that this bottom would have broken the mold of all other primary bear markets. And you would also have to believe that this would occur with stocks at valuations that resembled the October of 1929 top. This is exactly the heard mentality that will be pushed on cable TV throughout the holiday season. There will be a host of reasons to support such wild overvaluation of these businesses’ stocks. Are these reasons sound? Only if Buffalo Wild Wings can fly!
NASDAQ Showing Weakness – Fan Rule Suggests Trend is Now Down
Unlike the folks on cable, charts don’t lie. The daily NASDAQ chart appears to have traced a “Fan Pattern”, suggesting that the intermediate bull correction in the primary bear market is over. I’ll describe the pattern exactly as in Technical Analysis of Stock Trends, 8th Edition (page 271), by Edwards and Magee, Edited and Co-Authored by W.H.C. Bassett, except that I will word it for a bull correction in a primary bear. (It’s worded the other way around in the book. However the authors note that the pattern applies equally to both bull and bear intermediate moves against the primary trend.)
It starts with a sharp reaction which proceeds for several days – perhaps for as much as 2 weeks – producing a steep Minor Trend line. This line is broken downside by a quick Minor downtrend, after which prices rally again in a duller and less precipitate trend. A second Minor Trend line may now be drawn from the original low point across the Bottom of the down thrust that broke the first trend. This second trend line is broken by another partial recovery thrust, and a third and still duller and flatter rally ensues. The third trend line can now be drawn from the original low across the Bottom of the second down thrust. The whole move, by this time, has taken roughly and irregularly a “Saucering-out” form. The three trend lines drawn from the original Reversal points from which the Corrective Rally started, each at a flatter angle than its predecessor, are known as Fan Lines. And the rule is that when the third Fan line is broken downside, the high of the Intermediate Correction has been seen.
The authors further state:
“…Note, however, that the Fan Principle is normally applied only to corrective moves, i.e., to determine the end of Intermediate Reactions in a Bull Market and of Intermediate Recoveries in a Bear Market.”
The chart below presents the NASDAQ composite daily chart from late February to the present. I have indicated the chart characteristics forming the basis of the fan pattern, and the violation of the third trend line that signals that the secondary correction is likely over.
The “fan pattern” described above only applies to determining the reversal of intermediate patterns that are against the primary trend. In this case, the breaking of the third trend line in the fan pattern signals the end of the bull correction in the primary bear market. As you can see in the NASDAQ daily chart above, the technical pattern indicated formation of the fan pattern with the third trend line being clearly broken last Monday. I would not be surprised to see a low volume before and day-after-Thanksgiving rally, but I think, the intermediate trend of the NASDAQ has turned from Up to Down. Application of this technical pattern would suggest shorting the NASDAQ on weak rallies, with a stop loss at its recent highs of about 2,010. (Rallies on high volume would indicate that all bets are off though.)
Victor Sperandeo’s “Four Day Rule” Says NASDAQ Rally is Probably Over
Victor Sperandeo is a fundamental and technical analyst and author that had his peak popularity in the early 90s. His two books were recognized as among the best of that era. In Trader Vic II – Principles of Professional Speculation (page 160), he describes what he considers an “excellent indicator” of a change in the intermediate trend, known as the “Four Day Rule”:
“When the market has a reversal, in the form of a 4-day up or down sequence from a high or a low, after an intermediate move has taken place, the odds of the trend having changed is very high.”
The daily chart of the NASDAQ below indicates 4-straight down days, which began on 13 November through 18 November 2003.
Sperandeo noted that within the date range he researched (1926 to 1985), 25% of the intermediate highs or lows were immediately followed by a 4-day sequence in the direction of the new trend, 41% were followed by a 4-day sequence within 6-days, and 75% had a 4-day sequence within the first 24 days. Only 10% of the intermediate moves did not contain a 4-day sequence in the direction of the trend. In the case of the current NASDAQ, the 4-day sequence occurred 3 days from the suspected NASDAQ intermediate top. Use of the “Four Day Rule” suggests that the intermediate up trend of the NASDAQ is probably over. As with the “Fan Rule” if the NASDAQ were to rally to over about 2,010, the 4-day Rule would be refuted and traders should cover short positions.
I previously noted Sperandeo’s “Four Day Corollary” a couple of months ago. This is a more aggressive rule that did not “work” in September, when the NASDAQ had 7 straight days in the direction of the up trend. The Four Day Corollary states that the end of an intermediate trend is signaled with four or more days in the direction of the trend, and that the first day against the intermediate trend is the end of the intermediate trend. Using this “corollary” would have stopped out aggressive traders. Those who applied this rule over the long term would have seen the NASDAD return to a little bit above where it was at the beginning of the signal. The corollary is based on an overheating of the intermediate trend, whereas the 4-day rule depends on confirmation of the change of trend. Accordingly, the recently signaled “Four Day Rule” is probably more reliable, but less aggressive than the corollary.
Summary/Conclusions
Volume comparisons between the 1929 and 2000 stock market aftermaths indicate that we have not yet seen a bear market bottom. The more likely nature of the recent market rally is a secondary bull move in a primary bear market that has not ended. There have been two technical signals that indicate that the rally has ended and the NASDAQ will continue to its primary (down) trend.
Today’s Market
A phone call from a friend late this afternoon: “Hey Marty, ya’ don’t know what you’re talking about! The NASDAQ was up over 50 today!”
OK, OK…. It was a sunny day in Manhattan today. The NASDAQ was up 2.8%, the Russell 2000 was up 2.8%, the S&P 500 was up 1.6%, and the Dow was up 1.24%. A good amount of the heavy lifting was done by the “Never Land Ranch” NASDAQ stocks, and other speculative favorites. Examples: Biotechnology – Protein Design up 7.3%, Vertex Pharma up 3.8%, Human Genome up 5%, Genzyme General up 6%, Gilead Sciences up 4.4%. Others - PF Chang’s China Bistro up 5%, Tractor Supply up 4%. Several homebuilders have penetrated their 52-week highs today. Internet Stocks – Ask Jeeves, Amazon, Yahoo and Ebay all up between 5 and 6%. What’s the news that would cause such panic buying? “Anticipation of good economic data, and a traditionally good week for the stock market.” The surge by these pure speculation plays, and the underperformance of the Dow (especially with tech not included) and S&P (especially with tech not included) tells me that today’s rally was not about improved economic conditions.
In spite of the 2.8 percent gains on the NASDAQ, volume came in at only average.
What does this all mean? I think that the fan analysis above would suggest a good entry point for shorting the NASDAQ with a stop loss at 2,010. The rally today, impressive as it was in price action, did not penetrate the L-3 trend line. This would indicate a good risk/reward ratio for bear positions. Long-term just-in-the-money puts is a way to play the overall long-term downtrend, and the eminent end to the mother of all secondary corrections. It’s also less scary too! I think when the NASDAQ finally caves, it’s going to cave big and fast. Why? Have you met even one person who is now long in the NASDAQ stocks for the long term? I don’t either! I think that everyone is singing the same Doors tune.
“When the music’s over, turn out the lights.”
The 10-year bond was down 17/32. Gold was down $4.50 to close at $391.50 per ounce. Investor optimism reached a multi-year high today. A sign of a top? The Ask Jeeves CEO is to open the NASDAQ market tomorrow. Also in attendance will be the “famous” Jeeves butler character. A sign of a top? Maybe.
Have a great evening and a happy Thanksgiving!
Martin
A Special Note From Martin:
I will be on Radio 580 CFRA Ottawa, Canada on November 28th (the day after Thanksgiving). It will be an interview to give my "technical take on the markets." You may listen on the Internet some time after 2:15 pm EST via the "Listen Live" button on the linked website: www.cfra.com/headlines/index.asp. ~ MG
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Copyright © 2003 All rights reserved. Martin F. Goldberg, MS, P.E. |
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