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Upside Resistance Will Be Breached

(March 13, 2003) - Two Days After the End of the Three-year Old Cyclical Bear Market

I have absolutely no idea why there was a big rally today.  It may be just a bounce from an oversold condition or it may be a significant bear market rally in the making.  Anyone who tells you that he knows doesn’t know what he is talking about.  The great Dow Theorist, Robert Rhea, once said that he is unsure of the direction of the markets 90% of the time.  Anyone who claims a better record is most probably an amateur.  This is similar to the high school student with a 4.0 GPA who thinks he is the smartest person alive.  The more you know, the more you realize that you don’t really know a lot. 

Anyway, let’s review the chart of the Nasdaq, since this is the market I am mainly interested in:

Heavy Resistance for the Nasdaq

As you can see from the daily chart, we are now at very heavy resistance.  The black line I have drawn above represents approximately the neckline of the H&S top in the Nasdaq.  The blue line represents the 50 DMA and the red the 200 DMA.  They are now very close together.

Let’s face it: no one could have seen today coming.  Monday was a 90% downside day but in terms of points on the Dow Industrials and the Nasdaq today, it just blew Monday apart.  I anticipated a bounce, but not this much!  Breadth and volume was actually okay too.  Even crap like VXGN managed to rally nearly 50% today.  Today was a very powerful upside day.  Was it a temporary bottom?  I have no idea, but today was definitely pretty convincing – especially since we are coming out of a very heavily oversold condition per the statistics from Lowry’s.

My Beliefs

However, we are also now running into some heavy resistance, namely, the neckline of the H&S top, the 50 DMA and the 200 DMA on the Nasdaq.

But I now believe that the H&S top is NOW INVALID.  In retrospect, I should have seen this coming (isn’t this always the case?).  Volume during recent declines have been very small – especially during the penetration of the neckline and during subsequent declines.  The volume on the 90% downside day (Monday) was very, very low.  I have not seen this before – 90% downside days are usually panic days but no one was panicking on Monday!

The H&S top neckline of SMH (a widely-traded ETF for semiconductors – similar to the QQQ for the Nasdaq) was also broken (on the upside) today.  The SMH is very important since the semiconductor stocks have been the most popular stocks (besides the biotech stocks) traded on the Nasdaq for the last six or seven years.  (See below chart).  Note that the neckline has also been drawn so as to allow for some pretty big leeway.

Head and Shoulder top neckline of SMH broken

The H&S top target on the Dow Jones Industrials has also been reached.  That level was around 7,500.  The Dow may have also bottomed there.

Similarly, gold-mining stocks had a pretty healthy reversal today, despite the “crash” in gold prices.  It is the belief of the great Dow Theorists that gold-mining stocks usually make the most progress during a bear market rally.  If it has bottomed today (or will bottom in the next few trading days) then the market will have made a temporary bottom as well.  I believe that this is now very likely.

Because of the above factors and the fact that today’s rally was somewhat convincing, I now believe that the heavy resistance in the Nasdaq will be breached – we will know in the next few trading days.  Unless we start going down big on early next week (or even tomorrow), I will continue to hold that belief. 

Target Levels

I still believe we are in a secular bear market.  Valuations and fundamentals are still rotten.  Also note that the rallies are big and swift and declines are small and slow during a bear market.  This is what we have been and are still witnessing.  We are also still witnessing consistent mutual fund redemptions.  The latest numbers from AMG were just released and the week ending Wednesday was another net redemption week (see www.amgdata.com). Moreover, in terms of points lost in recent months, the Nasdaq has not declined very far and thus, I don’t think it will bounce very high.  Therefore, I do not believe this current rally would last very long or go very far [July 2004 Editor’s note: I was incorrect on this statement – I should not have let my opinions affected my analysis at that point in time – although it was obvious soon after].

So what is the likely top for the Nasdaq?  If one draws a trend line (green line on the Nasdaq chart on page one) downwards from the most recent tops in December and January, then one has a target level just slightly south of Nasdaq 1,400 (approximately 1,390 or so).  This is not very far away from current levels and I believe can be accomplished very quickly.  So would it be a short at that level?  I honestly don’t know.  We will reevaluate as each day goes by but for now, I anticipate the next decline to be a long and drawn-out affair.  Any shorting from that level would require a lot of patience and confidence.  If one were to short with puts, then I would recommend September puts or even December puts.  If the 1,400 level is breached, however, one definitely does not want to be short.

Disclosure

I have covered all my (substantial) short positions.  I am currently on the sidelines – sitting on 100% cash.  I also do not want to be long the Nasdaq at these levels since I currently don’t believe the bounce will go very far.  The risk-reward ratio just isn’t there.  I believe the best strategy right now is to sit and wait, and if we get another impressive rally in the next few trading days, then go long the major gold-mining stocks.  I have on my mind NEM, GG, GLG, and KGC.  They have been hammered quite a bit lately and I believe buying them now would present very good risk/reward opportunities.  I also believe on the next rally, both the XAU and the HUI would convincingly surpass the 90, and the 160 levels, respectively [July 2004 Editor’s note: These two indices proceeded to double in nine months – far outperforming the DJIA, S&P 500, and the Nasdaq].

Henry To

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