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Bulls Overpowered - Can They Still Hang On?

(September 28, 2003)

I have promised to provide more analysis of short interest in relation to the market this week but I want to start off with something else.  Therefore, let's cut to the chase and look at the following chart:

Monthly Chart of the Commodity Research Bureau Index (January 1956 to August 2003)

As one can see, the yield on the 30-year Treasury Bond and the level of the Commodity Research Bureau Index (please see the following link for a history and description of the CRB Index: has had a significant positive correlation with each other since the mid-1950s.  The top of both indicators in the early 1980s also coincided with a favorable environment for stocks - for the first time since the mid-1960s.  This persistent downtrend throughout the last two decades has allowed the stock market to perform relatively well, but as one can see on the chart, we are now at a critical juncture.

What am I saying, you may ask?  Please look at the above long-term monthly chart carefully.  The current yield on the 30-year Treasuries is sitting right at the downtrend line - a downtrend that began 20 years ago with the Treasuries yielding 15%.  Today, the yield is just slightly south of 5%.  If the yield touches 6%, then the downtrend is most probably over.  The CRB index is even more telling.  Since late 1998, one can make a case that the downtrend has been discontinued.  In fact, if or when the CRB Index surpasses the 250 level, one would be able to make a new case claiming that the CRB index is in a new bull market - as gurus such as Jim Rogers are currently saying.

It is also interesting to note that the rise in the CRB index in the late 1960s lagged the rise in yields, as artificial price controls were implemented in various commodities.  Once those price controls were lifted, commodity prices went sky-high very quickly - with great fortunes being made and lost during that period.  Today, the author believes that such an artificial market exists in the 30-year bond market, with foreign governments currently owning approximately 50% of our treasuries concurrent with a foreign deficit of over $40 billion per month and a still tanking dollar.  If or when these governments start selling, then there would be no one to sell to except at very low prices (and thus, much higher yields).  Such a new uptrend in the 30-year Treasury yield and the CRB Index would most probably usher in a period of high inflation and a "new era" for the stock market - an era which will finally take the stock market back to "great values" per the definition by Charles Dow.

Last Week's Action

The market fell out of bed last week, with the DJIA declining over 300 points, the DJTA 130 points, the Nasdaq 110 points, and the S&P 500 35 points for the week.  The bulk of the declines came during Wednesday, Thursday, and Friday.  Volume was high and breadth was horrible.  Small and mid caps did much worse, with the S&P 400 declining 9.6% and the S&P 600 9.4% for the week.  Both indices closed at their respective lows.

Even though the blue chips did relatively well, one significant point to be made from the Dow Theory's point of view is that the DJIA failed to hold the 9,500 level, which is approximately the 50% retracement level from its all-time high set on January 14, 2000 to its recent lows in October 2002.  This 50% retracement level acted like a magnet for the last couple of weeks.  The breakout of two weeks ago can now be labeled a false breakout - and this makes it doubly bearish.

Short Interest

In my last commentary, I promised that I will provide a more detailed commentary on short interest this week.  This commentary is also the most up-to-date, since the Nasdaq short interest was released just last week.  For the monthly period ending September 15, 2003, the total Nasdaq short interest increased approximately 120 million shares - from 4.40 to 4.52 billion shares.  This is near a record high of 4.68 billion shares set on July 15, 2003.

Since both the short interest on the Nasdaq and the NYSE are near record highs, one may wonder if this is a bullish scenario.  On first blush, it seems like it.  Take a look at the following charts, however, and one may not be so sure, after all.

Nasdaq Short Interest vs. Value of Nasdaq (September 15, 1999 to September 15, 2003)

As one can see, the short interest on the Nasdaq has been steadily increasing ever since the bear market began in early 2000.  Sure, this huge amount of shares that have been shorted may provide some "fuel" in a bear market rally or in a new bull market, but in a primary bear market, "the shorts" are aligned with the primary trend - resulting in an indicator that may not be too predictable.  One can find many such examples in history, such as the record number of shares shorted at the top of the bear market rally in 1930 and just before the ultimate 1949 to 1966 bull market top in January 1966.

A similar situation exists on the NYSE:

NYSE Short Interest vs. Dow Jones Industrials (November 15, 2000 to September 15, 2003)

While the NYSE short interest remains relatively high, the number of shares shorted has declined dramatically over the last few months.  Since I believe we are still in a primary bear market, this short-covering in the face of a concurrent rally in the major indices implies a pretty bearish scenario just ahead (please note that I did not use the NYSE Composite since a new methodology to calculate the index was implemented in January of this year, and I believe it may provide some confusion to the reader - the author believes the comparison with the DJIA is an adequate comparison).


The secondary trend has turned bearish, and unless the DJIA can rally above 9,500 in the days ahead, the stock market looks to be in serious trouble - resulting in at least a serious correction (over 10%?) for the major indices.  The short interest indicators are probably neutral to bearish, with the NYSE short interest having the more bearish implications.  At the same time, treasuries have been rallying and the CRB index has been declining, so we do not foresee serious trouble immediately ahead.  One should clearly wait here for a bounce to occur before making a judgment, but if the bounce ahead is weak (weak breadth) or if the DJIA fails once again to clear the 9,500 level, serious pruning of one's portfolio would be greatly recommended.

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