Newsletter

March 4, 2006

Resolution

Market & Sector Review
When will we know?

Largest Changes This Week

This Week's Economic Reports

Member Update: Sector Charts now contain on the daily chart the Advance/Decline line for that particular sector. The weekly Sector chart shows the % of stocks in that sector trading above their respective 40-week (200-day) moving average. If you reference the Microsoft Excel charts in last week's newsletter 2/25 Newsletter most of the indicators shown plus a few more will eventually become part of these charts. It should, as we did with the DOW last week help you determine what exactly is going on; sector by sector.
Resolution
By:Vic Johnson

“Resolution is the directing and impelling force in individual progress. Without it no substantial work can be accomplished.” – Above Life's Turmoil

The esteemed philosopher Goethe wrote, "Until one is committed, there is hesitancy, the chance to draw back, always ineffectiveness." There are so many opportunities that could make our lives better if we’d only make the decision (resolution) to pursue them. Whether it’s fear, doubt or some other insecurity that holds us back, these missed opportunities keep us from living the life of our dreams.

In 711 a North African warrior, whose army was backed up to the Mediterranean Sea, gave the unthinkable order to his men to "burn your boats," thus taking away his army’s only means of escape. Faced with certain death unless they were victorious, his army routed their opponents even though they were outnumbered five to one. When we are likewise resolved, we too can conquer all the obstacles in our path.

Don't worry about "how-to-do-it." One of my early mistakes was trying to figure out how I was going to do something before I'd get committed to do it. Now I think about all of the great inventions of our time, and I wonder if we’d have any of them if the inventor had waited to make his commitment until he knew how he was going to do it. Making the decision (the resolution) to do it is the most important part of any undertaking. As W.H. Murray wrote, “Whatever you can do or dream you can, begin it. Boldness has genius, power and magic in it!”

If you don’t feel like you have enough information to make a decision, then by all means, get the information. But don’t put off getting the information as a means to put off making the decision. And don’t think you have to have ALL the information that’s available --- you only need ENOUGH to fully evaluate and decide. “Paralysis by analysis” has killed many a dream.

Any decision is almost always better than no decision as it puts into play some powerful forces. As Goethe also told us, “Concerning all acts of initiative (and creation), there is one elementary truth that ignorance of which kills countless ideas and splendid plans: that the moment one definitely commits oneself, then Providence moves too. All sorts of things occur to help one that would never otherwise have occurred. A whole stream of events issues from the decision, raising in one's favor all manner of unforeseen incidents and meetings and material assistance, which no man could have dreamed would have come his way.”

For those of you interested in motivational and psychological information in both written and audio form Vic Johnson's site has a plethora of wonderful stuff, just click on his name above.
Market & Sector Review
When will we know?

In last week's letter I stated that time permitting we might take a look at how to recognize when the anticipated down trend has begun, and I also stated it will not be within a percent or two of "the top". Time did not permit so we will look this week at a few points worthy of consideration. Allow me to preface this discussion by stating that I am personally not a short term trader but more interested in the intermediate to longer term trend. This is not to slight those that are short term oriented, we just share different styles. My tendency is to look at the big picture first, then come down to the daily fluctuations which are often just noise within the larger time frame. Always remembering we can never know exactly what will happen tomorrow, it hasn't arrived yet

Now that you know where I am coming from let's take a look at what has happened and what needs to happen in the future to convince me that the 4-year cycle high is in place. For the most part the entire bull market's leadership has come from the small and mid-cap issues. Rather than look at a few leadership high flyers such as Google or Apple let's take a look at broad based indices representing the small and mid-cap sectors, I'll use the proxy ETF's IJR - S&P small cap 600 and MDY -Spiders Mid-Cap Trust against the broad based New York Stock Exchange Index for the beginning of this exercise. Before we look at the charts a brief review of relative strength is in order. Relative strength is nothing more than division, your security price divided by the price of the Index you are making the comparison to. Relative strength over a period of time is merely a rate of change, the relative strength today compared to the relative strength reading 3, 6, or even 12 months ago. I have personally found this rate of change over a period of 6 months to be a very effective and useful tool (now included on the sector chart postings). I believe we all need to understand how to use our favorite indicators within the context of the overall big picture. Once you learn to apply your indicators within that context you will come to appreciate another market maxim; in a bull market you buy your sell signals and in a bear market you sell your buy signals. That in effect is how many indicators we use act. Now on to the charts:

If you recall the markets bottomed in October of 2002, experienced a substantial rally then fell back into the March of 2003 lows, coinciding nicely with the four year cycle low due in that time frame. Notice the 6 month rate of change in relative strength for both these indices, increasing on the decline in price. The relative strength rate of change calculations continued to make higher highs and lower lows; a classical bull market setup for these sectors. Did this tell you to buy right then, in and of itself, no. What it did tell you, simply things are changing and we should be aware the leadership of a new bull might be right here. Let's move on to the present (Chart as of Wednesday 3/1 close):

Notice not only the exact reverse of the first chart but also note that both made their respective highs in relative strength last August and we are making lower highs and lower lows in relative strength rate-of-change as the price moves higher. A sell signal, no, but changes are taking place, the previous leaders are losing steam relative to the overall market. OK so if the previous leadership is losing steam something must be picking up the slack to keep the averages going, right? In a sense yes the strongest sectors right now are: METALS & MINING; ELECTRONICS; & TRANSPORTATION to name a few.

What is being suggested; simply that changes are occurring within the context of the four to four and a half year cycle I have been discussing for weeks. Enough changes to conclude a top is in place? Not necessarily, tops can, and often do take a long time to form. Averages contain a variety of sectors and we often experience rotation of sectors within those averages. In the late stages fewer and fewer stocks participate and it is when we reach that magic number of stocks unable to carry the indices higher, that they begin to fall of their own weight. Trying to pick that number or the exact top I have often found to be an exercise in futility, especially when looking at broad based averages. Now lets take a look at the average traders seem to favor the S&P 500, first the weekly chart.

Notice a couple of things, first the 55 week exponential moving average has provided good support throughout this bull phase, there is no reason, at this time, to think it will not again. In fact had you waited for the 55 EMA to turn positive before entry, you would be long the S&P-500 at approximately 945; and be sitting on a 36% gain, not too bad?

Next notice 3 Raff regression channels outlining 3 distinct trends over the last 3 years, 2 up trends and one minor down trend. Both the latest Raff channel and the 55 week EMA are close together in the low to mid 1200's, as of this writing I must assume these two will provide good support. Finally, take note of the Prudent Trader Momentum (on a weekly, not daily) calculation, this very briefly rolled over in mid 2004 but quickly enough moved back to bullish mode. If we put these 3 indications within the context of looking for a four year cycle high, I would personally like to see first the bottom of the Raff Channel not provide support; the 55 week EMA not hold, even roll over; and finally the PT-Momentum (weekly calculation) roll over. It is at this time that I will personally turn aggressively bearish and be looking to short rallies basis the S&P 500, but probably not till then.

Let's now, for fun, look at what is possible on the up side. I would not put a high probability on this happening but it is certainly a possibility. Remember the old Hewlett Packard commercial "We always ask what if?" Well what if this market decides to blow off on the upside prior to any serious down leg? Can we come up with some reasonable targets? I think so!

The S&P high in the spring of 2000 was approximately 1550, the October 2002 low 769, a decline of 781 points. Utilizing some Fibonacci ratio's; 61.8% = 1251; 78.6% = 1382. The 1251 level was briefly breached in the November/December period and then again in February but so far only by a few percentage points. The 78.6% level would then be the next target should current levels hold.

Applying Fibonacci extensions to last falls decline note how the 1.618 has so far held the S&P in check. The next levels (not shown on chart) would be 2 times that leg or 1312; next 2.382 = 1351; and next 2.618 = 1372 (pretty darn close to the 1382 or 78.6% retracement of the bear market decline).

While this is a somewhat subjective and perhaps narrowly focused analysis lets turn our attention to perhaps the single most important part of trading; risk/reward. Basis the S&P-500's close 1287: 1312 is an advance of 1.9%; and the extreme projection of 1382 is an advance of 7.38%. Very quickly assessing risk from an intermediate term perspective: minimum 1246 to 1253 (August highs, last intermediate low); maximum 1168 (October lows). Our reward to risk ratios therefore looks as such: If you bought the S&P at 1287 your potential gains at the objectives outlined would be 1.9 and 7.4%; at 1246 your risk is 3% and at 1186 it is 7.8%. Best possible scenario a 7.8% gain against a 3% risk, a reward to risk ratio of 2.6:1. I usually look for a minimum of 3:1, don't you? And that's in my humble opinion a best case scenario. If however, you are a short term oriented trader you may be able to pick off a few points here and there and still keep your reward to risk ratio in line.
Largest Changes This Week

This Week's Economic Reports

Have A Great Week!

Bill

Disclaimer: Trading in securities, of any type, may not be suitable for all individuals. The contents of this newsletter are not a solicitation to buy or sell securities. The opinions expressed are solely that of the author. You must do your own research, contact your own financial advisor for suitability of any investments. Data gathered is from sources believed to be reliable, but NO guarantee as to their accuracy is made.