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Have the bears capitulated yet?

(March 10, 2002)

Since our last update, the Dow has gained a meager 1.8 points. During Friday's session, the Dow gained 47 points.

It is interesting to note that during the morning, the Dow was up by more than 130 points on better-than-expected unemployment numbers (a decline to 5.5% in February from 5.6% in January-mind you, the non seasonally-adjusted rate was 6.1%) and a subsequent call that the recession was over. Towards late afternoon, however, the Dow embarked on a steady decline as GE declined by over $1.00 during that period (on the release of its 10-K and the disclosure that GE has over $40 billion assets in off-balance sheet financial arrangements).

Take note that IBM's 10-K will also be released shortly. The earnings warnings will also start flowing during the upcoming few weeks. Is this a recipe for a continuation of the rally or a decline? We will let our readers decide. Let's take a look at the chart first:

DJIA Price and NYSE Volume Information (November 1, 2001 to March 8, 2002)

If the last few days were really a consolidation phase, then volume would need to increase again from here for a continuation of the rally. Something in the order of over 1.6 billion shares per trading day. Since the end of September, however, these heavy-volume days have been rare, with two days in early October, none in November, two in December, two in January, and one in February. In the last three instances, those have been all down days-indicating heavy selling pressure.

We believe that the short-covering is nearly over, and once the volume from that is gone, this latest blowoff rally would have reached exhaustion. Some indicators that we are nearing that point:

The McClellan Oscillator reached an extremely overbought level of +170 on Wednesday and is now trending down closing at +140 on Friday indicating that the momentum is now on the downside. The majority of stocks won't decline, however, until this indicator is below 0 and these may take days or even weeks. Nonetheless this indicator has generated a sell signal.

The Commitment of Traders Report (one of the most reliable contrarian indicators we have seen) as of last Tuesday signaled a record imbalance of net long and short positions among the small speculators and the commercials in the S&P 500 futures.

The net long position for small speculators are 100,770 contracts. The two previous peaks since June 1999 were on March 6, 2001 (net long 91,122 contracts) and on September 10, 2001 (net long 87,410 contracts). And we all know what happened afterwards.

The net short position for commercials are 92,538 contracts, an increase of 18,708 contracts (or 28%). The last time we had such a large swing on the short side was on the May 15, 2001 report, and this came a few days before the last peak. One does not want to bet along with this crowd.

How about insider buying? As the word "bargain" was being brandied about for the last few months, insider buying was nowhere to be seen-literally. See this great article on Alan Newman's website for a more detailed analysis. The put/call ratio has also stabilized at a much lower 0.6 in the last couple of weeks.

Finally, Goldman Sachs recently issued a memo to its clients urging them to go long on a short squeeze on the hedge funds. The latest rally only represented a short-squeeze, and not genuine buying. Once the short base is gone, the latest speculators on the long side will leave, and the decline will be swift as all the shares have already been covered.

What more indicators do we need? We believe the above list is as good as it gets. This latest bear market rally will is going to end soon. And when it does, watch out below.


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