The Dow Report: The Stock Market Conundrum Continues
By Tim W Wood CPA, March 4, 2005
The word conundrum seems to be in vogue since Greenspan's recent testimony before the Senate Banking Committee. According to the dictionary, a conundrum is a riddle in which a fanciful question is answered by a pun or a paradoxical, insoluble, or difficult problem. Another dictionary defines the word as being a dilemma, a question or problem having only a conjectural answer or an intricate and difficult problem. Honestly, I can’tthink of a better word to describe the overall state of affairs and problems that the US economy faces. Not only is there a conundrum with interest rates, but also with the housing bubble; yes, the one that doesn't exist. But what about personal debt, corporate debt, personal savings, inflation vs. deflation, the stock market and even with the average person's view on the stock market?
Today, I want to look at a small piece of this giant multifaceted conundrum as it relates to the current issue of non-confirmations in the stock market. Below is the long-term chart of the Industrials and the Transports that was shown last week. This is the highest level or Grand Daddy of all non-confirmations and a tremendous negative that continues to plague the stock market, according to Dow theory.
But, at a lower level we do have the Transports confirming the move above the December high in the Industrials. From a Dow theory perspective this is positive on a secondary basis and should not be taken lightly.
In the next chart below we have the Dow Jones Select Top Ten Index. This index is an equal-weighted index of the top 10 dividend-yielding stocks in the Dow Jones Industrial Average. When this index diverges and fails to confirm the Industrials it has typically been followed by a downside break in the Industrials.
Next we have the Nasdaq 100, currently lagging the Industrials. When non-confirmations between these two indexes occur, it also serves as another sign of trouble for the overall market.
The non-confirmer I have next is the Retail Holders. This index is an excellent indication of trouble for the overall market when it fails to confirm the Industrials.
These charts are showing us that the recent rally in the Industrials is not a broad based rally, and this is a problem for the market as a whole. There is little doubt that the indexes are screaming "be careful." All the while, we have the general public that refuses to believe that we remain in a bear market. In fact, as of this writing, on the night of March 3, 2005, the Commitment of Trade data for the Nasdaq shows that last week the small speculator, the not so smart money, is at all time long levels. In fact, the small speculator is 45% above any previous long levels. Furthermore, we have begun the third year of more bulls than bears, according to Investor�s Intelligence. This has never occurred before. Most of the entire world is now convinced that the stock market is going up and that we have entered a bull market period of endless prosperity and perpetual motion finance that will go on for ever and ever, Amen. Yet, the smart money commercials have been distributing stock to the small speculator.
What people do not understand, or maybe I should say refuse to hear, is that we do remain in a secular bear market much like the period between 1966 and 1974. 1966 marked the top of the great bull market, which began in 1942. During the bear market period between 1966 and 1974 there were two good rallies, one of which even took the Industrials above the 1966 high. Those who truly understood the Dow theory knew that these rallies were counter trend suck-in-the-gullible-greedy-masses rallies.
I often receive e-mails from people asking how I can maintain that we are in a bear market when the market keeps pushing higher. I understand why this is a hard concept to grasp. Let me try to answer it this way. Dow theory allows us to define secular bull and bear markets, and when I say that we are in a bear market, I'm talking about a secular bear market just like the period between 1966 and 1974. From the 1966 top, the initial decline took the market down some 25%. From that low the market rallied for over two years into the 1968 top and in the process recovered nearly the entire loss from the 1966 top. This was a cyclical bull market within the overall secular bear market and can be better seen in the close up chart below.
Once this rally sucked the gullible greedy masses back into the market, it declined again into the next phase of the bear market. Those who understood Dow theory knew that this was coming, but I suspect that just as now, very, very few were willing to listen. This time the bear took the market down 32% and in the process he destroyed those in his path. But, the bear likes to play with his victims, so he then allowed the market to rally yet again. From the 1970 low the bear let the market rally 58% which actually carried the market to a new high. Because of that rally the gullible greedy masses were sucked right back in again. After all, they had to recoup their losses, right? But, the Dow theorist knew that it was a trap, a sick bear trick, and the bear once again fleeced the public, and this time he took the market down 45% to mark the bear market bottom. See, the bear does have a sense of humor and he is currently toying with the masses, just as he did in these counter trend rallies between 1966 and 1974. Those who understood the Dow theory knew that the 1974 low marked the bear market low and that stocks were then selling for great values. But guess what. The bear had broken the gullible greedy masses and they didn't want any part of the stock market. They let their greed and lack of understanding of the market allow the bear to beat them.
I wrote an article that was published in the October 2002 issue of Technical Analysis of Stocks and Commodities Magazine explaining that the rally out of the 4-year cycle low would convince everyone that the bull market was back. The bear has pretty much accomplished this mission and the current 4-year cycle advance, which constitutes the current cyclical bull market within the ongoing secular bear market, is getting mature to say the least. The gullible greedy masses are currently beyond convinced that a new bull market is underway, as is evident by the sentiment and COT data. People are telling me that the Dow theory is no longer valid because of some reason that makes "this time different." I will admit that this time is different in one respect, being that this time is worse. This time dwarfs the past and this time will result in a nasty decline into the Phase II low of the ongoing secular bear market and the gullible greedy masses will once again fall victim to the bear.
We have seen the market go through a number of setups in which the bear had the opportunity to take the market down, but he didn't. In the process this cyclical bull market has gone much further and lasted much longer than I or most any other bear has expected. This has served to make the bears look like the little boy that cried wolf. No, the bear not only toys with the bulls, he makes it very difficult for the bears as well. At one of these setups the bear will strike. That I can almost assure you. If you choose to ignore the warnings, then be prepared for the conundrum that you will find yourself in when the bear does strike. You have been warned, Again!
I would like point out a very informative article in the February 28th issue of Barron's. This article is titled the Prince of Tides, by Walter Deemer and begins on page 28. Walter is an old timer that has studied the markets for 40 years. He sees what is coming and is confirming my analysis and expected outcome for the markets.
Tim W. Wood
© 2005 Tim Wood