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The Bulls Win - Or Have They?

(September 21, 2003)

In my last commentary, I stated that I would not be "totally convinced" until the DJIA has hurdled the 9,500 level in a convincing manner.  As of today, the DJIA now stands at 9,644.82, with the Dow Transports, Nasdaq Comp, and S&P all making new highs for the week.  The price action definitely says "bull" - and under Dow Theory, if the DJIA can stay above the 9,500 level for the foreseeable future, it has a significant chance of challenging its old closing high of 11,723 set on January 14, 2000.

The breadth of the market remains good, with the A/D line and the cumulative high/lows on all the exchanges making new all highs for the week.

In the meantime, as I outlined last week, the DJIA has been lagging in this rally, with the Nasdaq, S&P 400 and S&P 600 making new highs week after week.  The latter two indices are set to challenge their all-time highs in the upcoming weeks.  To recap, let's take a look at the following chart:

DJIA vs. Nasdaq, S&P 400 and S&P 600

When the professionals are bullish, they tend to buy the blue-chip stocks, where the liquidity tends to be much better.  Stock-picking is also less of an issue, since professionals tend to take more of a "macro view" and so they tend to buy stocks that will track the economy if they see an economic recovery ahead.  Can the rest of the market rally while indices such as the DJIA and S&P 500 lag?  Of course it can, but I will be careful if I was a bull.  A stock market rally without "professional sponsorship" tends to be a very erratic and volatile market, subject to a lot of whipsaws and false movements.  This is understandable since individual investors tend to be more emotional (and also take a shorter-term view) than your average professional (even though they say they are in for the long-run).  That being said, the large caps have been showing signs of life last week, but one week does not make a trend, so it will be wise for the trader to keep track of the large caps for the foreseeable future.

Broken Indicators?

I am sure readers have heard about indicators such as VIX, etc., are now broken, given that the VIX has stayed low for the last four months while the market has been showing no signs of a top.  This phenomenon has not been observed since 1997, and certainly not in the current bear market.  That being said, the VIX has been the center of attraction for "broken indicators."  There are other ones, of course, such as the amount of insider selling, margin debt, and the decline of short interest.

As I stated last week, insider selling has been steadily increasing for the last few months with the sell-to-buy ratio peaking at 52 for the two weeks ending September 13, which was most probably a historic high.  For the three weeks ending September 20, this ratio declined back to 40, which is still a very high number but this temporary "respite" could have been one of the reasons why the stock market (and the large caps specifically since insider selling has been concentrated in the large caps) was able to muster a decent rally last week.

When we break down insider selling by industry, however, the results were more grim.  The table below breaks down insider selling by industry for the last 12 months, with data updated as of last Friday.  The industries represented in this table do not represent every industry contained in the Wilshire by any means, but in the author's opinion, they are the lifeblood of the economy.  Moreover, the recent speculation has been concentrated in these industries, on the belief that they will recover or be at the forefront of the recovery "when earnings get better."  Obviously, the insiders don't agree.  Please note that besides the banking and oil industries, the author cannot really make a bullish case anywhere else (the "N/A" represents a sell-to-buy ratio of infinity, since there were no insider purchases for those months).  It is also ominous that most of the sell-to-buy ratios for this month so far are above the total sell-to-buy ratio of approximately 40.

Insider Sell-to-Buy Ratios by Industry

There is no doubt that this is distribution in an ongoing bear market.  You just do not see anything like this if we are in a bull market.  I will be careful since the end of the quarter officially comes in the next ten days.

I cannot believe I missed this in the last commentary.  Last Monday, the NASD released a warning about the use of margin debt to speculate in securities:

I don't think that the NASD has released a warning about the use of margin debt since Spring of 2000.  Have people forgotten already or are they willing to forgive so soon?  After all, it is only a little over three years since the bubble was pricked.  A lot of thanks go to Harry at for allowing me to use his following chart:

Wilshire 5000 vs Margin

As one can see, the margin debt to Wilshire 5000 ratio has not been this high since December 2000/January 2001.  Note that the level at 1.8 is only the ratio for the month ending July 2003.  Who knows what have happened since then?

To top it all off, the NYSE released its short interest numbers on Friday.  Short interest as of September 15 declined approximately 100 million shares to 7,342,307,230 shares, on top of a 320 million decline and a 260 million decline for the prior two months.  The latest decline in short interest has been swift, as shorts have been decimated in the latest rally.  Just how far can this continue?  The NYSE short interest has been steadily rising for the last three years, and thus while the 7.3 billion number is actually a historically high number, we just have not seen this kind of swift decline in short interest since the bear market started (I will provide a more detailed study of short interest in my next commentary).  Of course, this can go on further.  But unless we are in a new bull market (which the author does not believe), given the current action, the reaction to all this may be equally swift as well.

The current rally has been the most confusing rally in this bear market, thus far.  The primary indicators still say "up," but all my secondary indicators are giving huge warning signs.  In his book "How to Trade in Stocks," Jesse Livermore stated that a bull market does not end in "one final blaze of glory"; it usually sends out warning signs long before the top - such as in the form of declining breadth or of leading industries not rallying with the general market.  Thus far, I have not been able to observe any divergence in the price action.  Except for some of the telecoms, everything that moves has been bought, and they are now all at recent highs.  Moreover, given our close proximity to Dow 10,000 and Nasdaq 2,000 I am going to go on the record and predict that the market "should" at least test make a run for these respective levels.  After that, however, anything goes.

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