David's Trade Journal

[david_3011]

David’s Weekly Market Chartmentary Sunday, May 22, 2005

SOMETHING ABOUT LAST WEEK'S RALLY

As I had expected in last Sunday's Chartmentary, the market had one of its best week since November last year. It would appear that this rally carries enough strength to continue, and I was about ready to go with the flow and turn in my new Chartmentary accordingly. But then, there's something that keeps bothering me.

This was the chart that made its début about a month ago. In my previous analysis I pointed out the inverse correlation between the market and the M2 minus M1. For new visitors, backing out M1 leaves M2 with just the savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds. This I believe is where a large portion of the money flows in and out of the market. I don't believe I've seen anyone using this indicator.

This chart below shows a reliable degree of inverse correlation. It would seem that money's leaving M2-exM1 for the stock market. While this indicates another upleg in the rally, the one-week lag time of the Fed's money stock report always put a little apprehension in my mind. In addition, the latest decline in M2-exM1, for the week ended 5/9/2005, was the slowest decline of the past two weekly declining cycles - the weeks ended 4/4/2005 & 4/25/2005.

That made me think twice about the real strength of this past week's rally.



Let me turn to another one of my favorite indicator for verification. As I've mentioned before, the breaks of the trendline signals a change of the market direction. Based on this indicator, our forecast had been right on the mark 2 weeks in a row. This 200-day Exponential Moving Average indicator seems to indicate the continuation of the rally as well.

This week, this 200-day EMA moved another notch higher. The tech sector was leading the charge. The Internet and the Computer Network sectors, in particular, looked unstoppable. And, Google started looking pretty good to me at this point. But, wait a minute! What's with that Consumer Non-Cyclical (bottom pane of the chart) also charging ahead of the market? It can not be.



This next chart shows that when the Non-Cyclicals running ahead of the market, the market tends to start reversing its uptrend. Intuitively, I believe that's when the investor's confidence starts to leave the market for the so-called "defensive" sector. Although other major indices demonstrate similar pattern, I used NASDAQ for comparison as this rally was led primarily by the tech sector. Were this investor's psychology to be repeated, then last week's surge of the Non-Cyclicals would mean that the market is due for a decline.

Fine. So, I noticed these little inconclusive negativities. So, what? No one's saying this is a strong market. There's going to be signs of weaknesses in this market. What's so unusual about that? I guess it's nothing unusual except that something just continues to bother me. It's never easy for me.



Something that Dr. Alexander Elder said about the volume that really bothers me - "Changes in volume provide clues as to whether trends are likely to continue or to reverse."

I went back to my 200-day EMA indicator and checked on the volume. As shown on the chart below, Friday's volume was 12% below the 2-week (10 trading days) exponential moving average. Now since Friday was a minor down day for the broad market, let's check on NASDAQ, which had an up day on Friday.



NASDAQ volume also showed a decline (9.76%). In addition, the Percentage Volume Oscillator (PVO) didn't break above the 0 line with all its strength last week. This is sign of a declining buying pressure.

"A breakout on low volume shows little emotional commitment to a new trend. It indicates that prices are likely to return into their trading range. Falling volume shows that the remaining bulls have a higher level of pain tolerance." --- Dr. Elder.



Volume as per Dr. Elder is the backbone of the market trend. This rally last week, while appeared bullish on surface, did not have the strong backbone to provide the necessary support for its continuation. Having recognized this landmine under the bullish surface, for an inquiring mind like mine, I needed another confirmation.

I'm not sure if the inverse correlation between the Dollar and the market is as a common sense amongst investors as I thought it should be. Without getting into all the fundamental details, this chart shows the technical inverse correlation between the two. Therefore, technically speaking, the rising Dollar is going to put pressure on the market. Dollar Index has been on a strong uptrend with approx. target of 90. This can not be good for the market.



Based on the above analysis, I'd stay away from long positions this week. It does NOT appear likely that last week's rally would carry on too much further.