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Lowry's Intermediate Sell Signal Triggered

(May 11, 2004)

Dear Readers:

This is a very important update, as the market action over the last few weeks have dangerously deteriorated. What am I saying? First of all, it looks like that both the breadth on the NYSE and NASDAQ has topped out, as indicated by the following two charts:

NYSE Advance-Decline Issues ($NYAD)

Nasdaq Advance-Decline Issues ($NAAD)

This kind of technical damage cannot be easily repaired, especially in the face of rising interest rates. That being said, this alone does not mean the major market indices cannot make new highs - it is just that the rally we have seen so far in 2003 may not be replicated anytime soon, as the market gets more narrow and as it becomes more of a stock picker's market. For comparison purposes, breadth on the NYSE peaked months before the peak in the Dow Jones Industrials back in the 1969 and 1972 tops in the great bear market of 1966 to 1974.

Secondly, mutual fund cash levels at the end of March was at 4.2%, a historically low number that was only surpassed on the downside by the March 2000 number - an all-time low number of 3.9%. This suggests to me that the modern-day investment trusts really have no buying power left and now solely rely on consistent mutual fund inflows from retail investors.

Thirdly, I know for a fact that most hedge funds are now either on the long side or on the long side with hedged positions. I also know that pension fund contributions have slowed, mainly because of the passage of the recent bill by President George W. Bush.  TrimTabs has also indicated that the offering calendar (both IPOs and secondary offerings) is very full over the next few months - suggesting that a great supply of stock should be coming into the market soon.

Fourthly, margin debt at the end of March 2004 actually rose to a recent high of $191.4 billion, despite the major decline of the stock market from late February to late March. That tells me that the hedge funds and retail investors did not panic (and even loaded up on the long side) even as the DJIA declined over 600 points in as little as three weeks. And since short interest represents only 2% of the total number of shares outstanding on the NYSE, I doubt those "margin money" were used by retail investors as "fuel" to short stocks.

Finally, the technicals. I will try to be brief here since I do not want to waste anyone's time. As the title implies, Lowry's (the oldest and still one of the most reliable technical analysis service in the country) has just issued an intermediate sell signal, reversing the intermediate buy signal that was triggered on March 17, 2003, just a few days after the great rally of 2003 began. For comparison purposes, the last intermediate sell signal that Lowry's issued was on May 10, 2002 (coincidentally, exactly two years ago with the DJIA trading at 9,940 compared to today's closing of 9,990). The market rallied for a week immediately afterwards, but then we all knew what happened in June and July 2003. This current intermediate sell signal has to be respected.

Now, let's look at some other charts. This one is straight from

Dow Jones Industrial Average ($INDU)

Please note that not only has the DJIA made a lower low today, it also closed below the psychologically important level of 10,000. Moreover, this closing also violated its 200-day simple moving average and the uptrend line on the point-and-figure chart which extends back to March 2003. The 50-day moving average has also turned decisively down, and this is now a most bearish scenario. The only consolation from a Dow Theory's point of view is that the DJTA did not confirm on the downside with the DJIA by violating its March lows. This usually suggests of at least a short-term bounce. However, any bounce coming off from today's level should be closely watched. Personally, I do not think there is much "fuel" left to maintain a sustainable rally in the next couple of months, but crazier things have happened.

Daily Closes of the Dow Jones Industrials vs. the Dow Jones Transports (January 1, 2003 to March 10, 2004)

An industry that has clearly broken down technically is the semiconductor industry - one of the important backbones of the Nasdaq. The bellwether index for semiconductors is the Philadelphia Semiconductor Index (or what they call the "Sox"):

Semiconductor Index (SOX)

Please note that the 50-day simple moving average has just made a bearish crossing below its slower-moving 200-day simple moving average. The last previous instances when this occurred are circled and shown in the above chart. And we all know what happened afterwards.

To conclude, while a further decline here may or may not happen, the latest intermediate sell signal generated by Lowry's has to be respected - and the bearish thing is that no one is really paying attention to this indicator. There is just too much complacency out there. While history has shown that the market does not really top out until the third or fourth rate hike, there have been corrections in between, such as the huge declines during the Asia Crisis in 1997, during the period July to August 1998, and September to October 1999. All such declines were followed by higher highs in the major stock market indices, but the periodic corrections during those times were very painful, indeed.

My current guess is that since the market is currently very oversold, we should at least experience a bounce in the next few days. However, I believe this bounce (if any) will be weak, and should probably be sold. Another scenario would be for the market to fall straight down from here - such as the time immediately after the Lowry's Intermediate Sell Signal generated after the close on October 14, 1987 - a full two trading days before the open on Black Monday, October 19, 1987.

Signing off,

Henry K. To, CFA


Following is a nice article about Richard Russell, the last living great Dow Theorist (that I know of anyway):


Great Grump is worth a listen

By Peter Brimelow,
Last Update: 1:10 AM ET May 10, 2004

Could a crash be coming? After one of the worst weeks for stocks since 9/11, the Great Grump is getting grumpier.

I watch none of the geezers (my term for the letters that were around during the last bear-market low in 1974 -- see my May 5 column) that I watch closer than Dow Theory Letters' Richard Russell.

Russell actually did call the market bottom in 1974, and (arguably early) the top in 1999. More recently, he remained bearish in early 2002, when virtually everyone else assumed happy days were here again. Not for nothing did I head my July 15, 2002 column on this remarkable call "The Triumph of Richard Russell."

Now, on the eve his 80th birthday, Russell is shaping up for another dramatic test. A superbear who nevertheless recognized the strength of the 2003 rally he now thinks the primary bear market may be about to reassert itself.

During Friday's down day, he wrote: "The 'internals' of this market continue to be horrendous. As I write now, three hours after the opening, there are 2,254 more declines than advances on the NYSE and over 500 new lows with only 28 new highs. Yet the Dow as I write is down only 32 points and Transports are down 26 points.

"This kind of action can't continue. It should be only a matter of time before the stock averages catch up with the internals of the market. On this basis, nothing would surprise me during the days ahead.

"I hate to use that dreaded word, 'crash,' but it would not surprise me if this market were to crash."

On Saturday (Russell writes six days a week) he commented: "I just read Barron's and I went though a batch of this morning's newspapers. And I must say I was rather surprised. I saw hardly anything about last week's rotten stock market performance. If there's any anxiety or even uneasiness about the market's swoon, I didn't see it. Confidence, it seems, reigns supreme."

This makes Russell even more nervous. His recommended investment posture: "The ideal position at this time is cash often termed 'liquidity' (T-bills, money market funds, CDs -- cash). Gold is our insurance policy just in case "everything goes wrong," and in a primary bear market yes -- everything CAN -- and often will -- go wrong."

Russell is a cunning old codger. Because he's been officially in cash for a long time, but occasionally hints at plays for speculators, I get emails complaining the Hulbert Financial Digest monitoring system is either (a) too soft or (b) too hard on him.

But for some time now, Russell has been getting more uneasy. This despite the fact that he says a formal Dow Theory Sell signal can't occur unless the market violates its March lows (i.e. about 10,000 on the Dow.)

And despite the fact that one indicator he flows closely, Lowry's Selling Pressure Index, has still to give a bear signal.

With Russell, what you get is not just his indicators, but his instincts. Right now, they're really bothering him.

Because Russell's reactions are so instinctive, it's never clear how much weight to place on the actual reasons he gives for his opinions. Right now, he complains that the Fed head "Greenspan has created what I consider to be the greatest "debt bubble" in recorded history .."

Russell is negative on the U.S. dollar, but he writes:

"We could see a situation where there could be panic in the U.S. to accumulate dollars, a "dash for cash" with which to carry our enormous debt ...This could conceivably give us a counter-intuitive situation where everybody in the U.S., would be frantic to accumulate dollars, while simultaneously the dollar would be sinking in terms of major foreign currencies."

I'm not sure the simple numbers actually justify Russell's alarmism. (See my column with Ed Rubenstein, Dec. 29, 2003).

But that doesn't matter. The bottom line is whether he's right on the stock market. And, on that, experience suggests he's worth listening to.

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