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A Short, Thanksgiving Commentary

(November 24, 2005)

Dear Subscribers and Readers,

We switched from a 25% short position in our DJIA Timing System on the morning of October 21st at DJIA 10,265 - giving us a gain of 351 points from our DJIA short on July 14th.  On a 25% basis, this equates to a gain of 87.75 points.  For now, we are still completely neutral and in cash - given that the current stock market is so overbought.  While the Federal Reserve may appeared less inclined to raise rates for the foreseeable future, such perception of the Fed can turn on a dime - as recent history has shown.  For now, the Fed, the ECB, and the BoJ are still tightening - and my guess is that the markets will respond to the tightening in due time.  Unless energy and metals prices decline soon, this author still sees a continuation of the current uptrend in the Fed Funds rate.  Again, I believe we are now late in the party.

For the subscribers who reside in the United States, I hope every one of you will have a great Thanksgiving!  It is at this time of the year that we should cherish everything that we have - and remember the things that our ancestors have done and given up just so we can be here to "give thanks" today.  As we celebrate Thanksgiving, please also don't forget that over half of the world's population today is still living in relative poverty.  These folks are not worried about what they are going to get for Christmas, nor are they concerned about their statuses among their neighbors or work colleagues.  In a world devoid of basic living necessities and material possessions, all that is driving them is "hope" - hope for a better future and more freedoms for themselves, their families, and their kids.  As Americans, we can help them achieve that - and the one thing this author has always advocated is an economically level playing field.  Such a "level playing field" will give rise to the benefits of the "comparative advantage" enjoyed by all countries - a theory first advanced by the British economist, David Ricardo.  In a world where "comparative advantages" are not suppressed (such as by agricultural subsidies, high quotas or tariffs), all free/democratic countries will benefit.  Ultimately, giving developing countries this "level playing field" is the only sensible route that average Americans can follow in helping them.

As an aside, there is another reason why we should all study Ricardo's theories: Through his thinking and innovative ideas, he became a great financier and speculator, and ultimately amassed a great fortune.  Another aside: The theory of comparative advantage basically states that unless GM moves its operations overseas, it will eventually file for bankruptcy - unless GM produces the automobile equivalent of Apple's iPod (which is not impossible, however).  This can be further extended to most manufacturing industries, such as steel.  It is as simple as that.

Dear readers, I am going to try to keep this commentary short and sweet, since the last thing that you probably want to read about during Thanksgiving is something about the financial markets.  However, there is always the minority who always have time for the financial markets (including me) - and writing a commentary usually helps me organize my thoughts and come up with a coherent strategy of what to do for the foreseeable future.

In our commentaries over the last couple of weeks, I have repeatedly said that while the market was overbought in the short-run - and was thus subjected to a potential correction at any time - the intermediate trend was still bright and intact.  As of Wednesday evening, this remains the case.  For example, the current 10-day moving average of the equity put/call ratio is still only at 0.57 - an overbought reading but not as extreme as the readings we witnessed during late November and December of last year, as well as during July of this year.  Also, while the Rydex Cash Flow Ratio have declined rather quickly from a reading of 1.10 in late October to 0.73 (as of Tuesday evening), the current reading is still not as overbought as the readings we witnessed during November to December of last year, when the range of the Rydex Cash Flow Ratio fluctuated between 0.60 to 0.70 during those two months.

Another reason why I believe that this current rally has further room to run is the still-relatively oversold condition of the NYSE McClellan Summation Index, as shown by the following chart courtesy of

The McClellan Summation Index may well peak at a lower high – but in the meantime, it most probably has further room to run.

While the shorter-term NYSE McClellan Oscillator has been in an overbought situation for quite some time, readers should note that the longer-term NYSE McClellan Summation Index is still relatively oversold.  More importantly, it is still embarking on its uptrend, and most probably would not get overbought until we get to approximately the 3000 level - which is still at least a month away.  In addition, please keep in mind that this is based on the assumption that the NYSE McClellan Summation Index will make a lower high and then reverse its course.  If the NYSE McClellan Summation Index embarks on a stronger uptrend, then this current rally could run well into January or even March of next year.

From a historical standpoint, it is also interesting to note that in all the successive cyclical bull markets during the 1966 to 1974 secular bear market, margin debt levels have made new all-time highs during each peak of these successive cyclical bull markets.  I have shown this historical chart of margin debt levels before, but it is always good to try to refresh one's memory:

Margin Debt (January 1966 to December 1974) - Source: Barron's

The interesting offshoot of the above study is this: Historically, margin debt levels at successive bottoms in a secular bear market have also been lower than previous bottoms - thus reinforcing the idea that as the secular bear market ages (which this author has argued that we are currently in) the amount of liquidation that one sees in each successive decline tends to become more severe.  Investors please take heed.

In the short-run, however, the bulls can take comfort in that the latest margin debt numbers (for the month ending October 31, 2005) - while historically high - are still at levels significantly lower than they were during March 2000.  If we are to follow historical precedent, then total margin debt should significantly exceed $300 billion before we can be reasonably confident that this cyclical bull market has ended.

Wilshire 5000 vs. Margin Debt (January 1997 to October 2005) - Total margin debt declined slightly in October from $245 billion to approximately $239 billion - a margin debt level comparable to the level of October 2000.  The margin debt to Wilshire 5000 ratio* remains near a five-year high at 1.98 - a high not seen since November 2000.  Margin debt levels, however, have still yet to surpass their all-time highs made in March 2000.

Please note that even though the level of margin debt as of October 31, 2005 is still significantly lower than the $300 billion level we witnessed back in March 2000, the level of margin debt also rises relatively quickly at the tail-end of a bull market.  For example, from month-end October 1999 to March 2000, the total amount of margin debt outstanding rose from $194 billion to $300 billion - a spectacular rise of $106 billion in only five months!  In other words, a significant top (perhaps signaling the end of this cyclical bull market) during the January to March 2006 period is not out-of-the-question - given historical precedents.  At the same time, however, we are still not yet close to making a significant top yet.  The intermediate uptrend remains intact for now.

Conclusion: Given historical precedents and the readings coming out of our more intermediate term technical indicators, the intermediate uptrend still remains intact - although, in the short-run, the market is still very overbought, and is thus vulnerable to a correct at any time.  Chances are that this latest rally will at least last until the end of December - and possibly to January or even March if we are currently witnessing a "blow off" that will usher in the end of the cyclical bull market that began in October 2002.  For now, we will remain in cash and stay neutral in our DJIA Timing System.  At this point, this author still thinks there is a potential trade in copper (and is keeping track of the situation by the hour), although as always, this should not be construed as investment advice.

Signing off,

Henry K. To, CFA

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