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A Thanksgiving Message

(November 25, 2004)

Please note that we entered a 100% long position in our DJIA Timing System on November 19th at 10,474. We will continue to hold this position but we reserve the right to change our position if the market remains overbought going into December and market liquidity starts to decline.

Important news: I will be in Hong Kong during the latter part of December to the first week of January. I will try very hard to update my commentary during that time – and will let you know about our publishing schedule as it comes along. I don’t think I will have any problems updating our website during my stay there (except for the weekend during New Year’s when my partner will be in LA), but I will have a pretty hectic schedule while I am there. I may even bring in a guest commentator. I am also planning to speak to a few investment professionals while I am in Hong Kong and will appreciate it if our readers can act as a reference or recommend people that I can speak to (and which hopefully we can put up as another “interview” on our website) – on topics such as the future economic direction of China, Hong Kong, and her relationship with the United States, etc.

We have also started an entirely new charts section on our website! Please let us know what other charts you would like to see updated by either emailing me at or by voicing your opinions on our Discussion Forum!

We have also extended our survey/poll for one additional week. Please drop by and tell us what you want to see more of on our website!

First of all, I would like to wish all our readers a great Thanksgiving – I would also like to thank you for all the support that you have provided since we began writing our regular weekly commentary.

In light of the rally we have seen in the markets during the last few weeks, and in light of the current holiday mood, it is easy to start being complacent about the markets and in your long positions in the markets – whether they are index funds or individual stocks. My message to my readers is: Do not get into a complacent mood when it comes to the stock market. Once you become complacent, then it is the beginning of the end.

I currently believe the market is still moderately overbought, despite the recent “consolidation days” that we have seen over the last week or so in the major indices. Both bulls and bears will need to be careful here – a further rally is definitely possible in the short-term but if it materializes, then it will render the market in an even more overbought situation and will definitely not be a good time to initiate long positions. The market is still currently awash with liquidity – but this could change if a new flood of offerings start appearing in early December to “take advantage” of the huge dividend payout by Microsoft on December 2nd. This is what TrimTabs is currently predicting. For the next few trading days, however, offerings will be non-existent.

That being said, the longer-term action (next six to nine months) of the market still remains bright. I will take the opportunity to illustrate why by showing our readers a couple of relative strengths that I have shown before – the weekly relative strength chart of the Retail HOLDRS (RTH) vs. the S&P 500 and the weekly relative strength chart of the Philadelphia Semiconductor Index (the SOX) vs. the S&P 500. As I have mentioned before, please note that the relative strength of the RTH vs. the S&P 500 has served as a pretty good leading indicator of the stock market for the last few years (ever since it was incepted):

Relative Strength (Weekly Chart) of the Retail HOLDRs vs. the S&P 500 (May 2001 to Present) - 1) Relative Strength of the RTH bottomed and reversed in January 2003 - providing clues a major market rally was under way. 2) Relative Strength of the RTH topped and reversed a few months before the broad market topped. 3) The latest uptick represents the sixth week that the relative strength of the RTH has broken out above its recent upside resistance line.  The magnitude of the jump (and the current consolidation) also represents a very decisive breakout and suggest further gains ultimately for the stock market.

As the chart shows, the latest week represents the sixth consecutive week that the relative strength of the RTH vs. the S&P 500 has stayed above the line that has acted as resistance since February. Since this reading has acted as a leading indicator for the market during the last few years, I expect the market to continue to do relatively well – at least during the next six to nine months.

The following two-year chart of the RTH (in absolute price terms) also clearly shows that the retail sector has broken out on the upside – further confirmed by the fact that the 50-day moving average has crossed above the 200-day moving average:


Please also note that prior to the recent breakout, the RTH has been stuck in a 13-month trading range from 85 to 95 from as early as October 2003 to October 2004. The recent breakout is bullish – there is really no other interpretation.

Next, I want to discuss the relative strength of the SOX vs. the S&P 500. In my September 12th commentary, I wrote: "Readers may not know this, but relative strength (second chart) of the SOX vs. the S&P 500 as of the middle of last week [late August to early September] was at a level not seen since February 2003 - suggesting a heavily oversold condition comparable to the October 2002 bottom on a relative strength basis. Throughout the last ten years of stock market history, the SOX has always staged a very impressive performance after a reversal from such an oversold condition on a relative strength basis. This includes the May 1994 to August 1995 period, the July 1996 to August 1997 period, the October 1998 to March 2000 period and finally the October 2002 to November 2003 period. The bottoming of relative strength in the SOX ten months after the peak in relative strength would pretty much coincide with the average timing of the bottoming processes of the SOX in the past bull market. History has also suggested that the next bull cycle of semiconductors should last anywhere from 13 to 19 months. If this is the case, then both the SOX and the stock market (as represented by the major indices such as the Dow Jones Industrials and Transports, the Nasdaq, and the S&P 500) may not top out until September 2005. Readers who want to take advantage of this cycle may want to purchase either the SMH or a basket of four to five technically strong semiconductor stocks and hold them for the next 13 months."

To sum up: The relative strength of the SOX vs. the S&P 500 has had its shares of cycles over the last ten years, and there is a distinct possibility that the trough of the most recent cycle bottomed in late August to early September 2004. Based on the last ten years of history, I believe the SOX will continue its upward journey, and it should not peak (at least on a relative strength basis) until September 2005 at the earliest. The latest action of the relative strength of the SOX vs. the S&P 500 as shown in the following chart further confirms this bullish view on the SOX. Moreover, the semiconductor industry has also acted as a very important leading indicator for the NASDAQ in general – so any continued upside in the relative strength of the SOX is definitely a very positive development for both the NASDAQ Composite and also the broad stock market:

Relative Strength (Weekly Chart) of the SOX vs. the S&P 500 (May 1994 to Present) - My guess is that the relative strength of the SOX vs. the S&P 500 will have to approach the March 2001 and the March 2002 levels (and then reverse) before we can reasonably call an intermediate top in both the SOX and the stock market. Relative strength of the SOX vs. the S&P 500 bottomed 12 weeks ago at its lowest level since February 2003!

The following two-year chart of the SOX (in absolute price terms) also looks okay/bullish – as the 50-day moving average has decisively turned up while the absolute price level of the SOX is about to pierce above its 200-day moving average on the upside:


Please also note that the recent reluctance of the SOX to go down despite the disappointment surrounding AMAT’s earnings and the downgrade of Intel is a further reinforcement of my bullish views on the semiconductors (and therefore on the broad market).

Bottom line: As shown by the relative strength and absolute price charts of both the RTH and the SOX, I believe the longer-term action of the market is still bullish. In the short-term however, the current overbought conditions are still bothering me – although the stock market should still hold up unless the liquidity pillar weakens – something that can very well happen after the issuance of the Microsoft’s dividends on December 2nd. While we may see some weakness in the short-term precisely because of that, however, I believe any weakness in December because of liquidity concerns would only be a pause before we eventually see a higher high made in 2005.

Signing off,

Henry K. To, CFA

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