Morning Briefing, 12/04/2002

[21st Century Alert]

Title: Morning Briefing, 12/04/2002

Click Here! WEDNESDAY a.m. December 4, 2002   Rough Patch by David Nichols It now looks clear -- at least somewhat clear! -- that the market is entering a corrective period. After 8 straight weeks of gains, the bullish forces have at last run out of steam. Yet technically the uptrend has still done "nothing wrong". It still looks healthy with an objective glance. Looking at a 60 minute chart, a pattern of higher highs and lower lows is still apparent -- and that's by definition bullish. The advance phases are outpacing the decline phases, and you can't ask for anything more than that from an uptrend. Another thing propping up the bullish case is the fact that bonds have not confirmed the latest move down. In fact, much to my surprise, bonds were down yesterday. If there's one thing we've learned over the past months, it's that you can't trust a move in stocks unless it's confirmed by bonds. Someday that relationship may peter out, but it's not reasonable to assume that the moment for this is right now. There are definitely a few worrying signs for the stock market. It looks like stocks may now hit the skids for a while, maybe a week or two. Sentiment is signaling a decline phase is imminent, as indicated by our sentiment dashboard (below). Once a decline phase starts, it's imprudent to pre-judge how far it's capable of going. There is always, always an element of surprise to how far a move can go, as news flow is always capable of adding potential energy to a trend. It also looks suspiciously like my "parabolic pattern" has triggered to the downside on the 60 minute chart of the OEX. This pattern holds that after a parabolic, "blow-off" top, the resulting counter-move triggers in three predictable moves. In this case, we should see a leg 1 down -- which is forming now -- then a counter leg 2 up, followed by a larger leg 3 down. Interestingly, this parabolic pattern can be seen in all charts in all timeframes, as it's a recurring output pattern in the chaotic, non-linear dynamic system that we call the stock market. In another incredibly complex chaotic, non-dynamic system -- the weather -- certain initial input parameters will trigger a very predictable output pattern. This is why the 3-day weather forecast is so often accurate these days. The markets are no different. In fact, I would argue -- vociferously -- that the markets are a natural phenomenon, every bit as much as the weather. They are a product of natural forces, which in this case happen to be the emotions and perceptions of tens of millions of human beings. Changes in human perception and emotion on a massive scale create price movement in just the same way changes in atmospheric pressure create wind and weather. It's just not as easy to quantify, as our data-gathering facilities for market sentiment aren't nearly as advanced as weather data. But this is going to change. Everybody thinks I'm crazy when I say that forecasting the market with an incredibly high degree of accuracy is not only possible, but inevitable. I'm obsessively working towards this goal every day. Remember when they used to make fun of weather people? And it's true: weather forecasting used to be pretty bad. But they're not making fun anymore. The 3 to 5 day forecasts are now incredibly accurate. What happened? Computer modeling and data collection got much more sophisticated, and in turn the accuracy of weather forecasting got much better. Weather is a chaotic, non-linear system that is highly dependent on initial conditions -- just like the markets. Once triggered, both these systems act in predictable ways. And just like weather, the shorter the forecast, the more accurate it is. There are so many potential inputs that can crop up later to affect a longer-term forecast. Okay, enough of these crazy ramblings. Let's get back to planet earth. The parabolic pattern is telling us that we should see a counter-move soon, pushing the markets back up. But it's likely to be a tepid move back up that won't exceed the earlier highs. This will be an excellent time to get out of bullish positions, and perhaps even take a few speculative bearish positions. I am looking to exit our bullish Rydex positions into this counter-move back up, to get us better exit prices. In my opinion, it's not time to go hog wild for the downside. This is likely just a correction in a much larger uptrend. My colleague Adam Oliensis did such a great job summing up the dashboard this morning, I'm going to include his comments below: SENTIMENT TANK: The tank has broken back above the key 54% level again and to a new local high. There is a real spark of fear in the stock market as measured by the increase in implied volatility in options and the demand for put options. MID-TERM: The mid-term gauge has flipped over into a very early downtrend at 6 on a scale of 0-100. It's very early and our Confidence Diffusion Index (CDI) reads 1 on a scale of 0-7 (7 is highest confidence). Now that the gauge has flipped into a downtrend our CDI number reflects our confidence in the new downtrend. Often once this gauge flips over there is a short-term bounce in Price. That bounce can provide an excellent entry point on short positions as the prior price high is tested. LONG-TERM: The weekly gauge remains in its uptrend but has regressed to 86 from 88. It's been flipping between those two numbers. Our CDI on this gauge has declined to 3 as acceleration continues to wane. It has not, though, flipped into a downtrend yet. NOTE: While Sentiment has entered into a Market Decline Phase neither the benchmark stock indices nor the bond market have confirmed. That's part of why our CDI number on the mid-term gauge is so low. If the stock market sets about moving lower and the bond market higher, we will see increased confidence numbers in the mid--term CDI. The long-term gauge will be slower to roll over into a decline phase. Should it do so that will provide still further confirmation on the mid-term gauge. Short positions entered at this point on the mid-term gauge are of the speculative variety.   Definitions   This Morning Briefing is brought to you by 21st Century Alert. Your 21st Century Alert subscription offers so much more. Click here to go to 21st Century Alert's Web site. You can find this article on the Web at: http://www.21stcenturyalert.com/page/tcx/morningbriefing/2002-12-04/ To remove yourself from our mailing list, or to get your username and password so that you can access the Morning Briefing archives on our Web site, click here.