The following is an excerpt from May's Market Focus letter.

May 9, 2004 - In April's Market Focus, we looked closely at several areas in addition to the stock market, two of which were the Bond market and Gold stocks. In just four short weeks, both Bonds and Gold stocks have broken significant long-term trend lines that leave little doubt that their recent highs were significant and will not be surpassed in the near future. In this month's Market Focus, we will go through some charts that are strikingly simple yet unambiguous in their conclusions.

The stock market is also showing more conclusive evidence that the highs in the 1st quarter were significant. The NYSE Advance/Decline line remains bearish, as does the SPX/VIX ratio. These were early indications that the market was in the process of making a major turn, and there are now more conclusively bearish price charts of indexes and individual stocks piling up. In the case of some individual stocks it has become clear that the rally from October 2002 has been an A-B-C correction that is complete, and not the first waves of a "new bull market." We will look at some of these charts in the following pages. We'll also look at the Financial stocks which put in new all-time highs this year, but by doing so may have completed long-term EW patterns that most major indexes did in 1999 and 2000. In this way, the next leg of the Bear market may be more synchronized to the downside than the 2000-2002 decline. There are lots of charts to get to this month, so lets get started.

Stock Market Update

When you watch the market day in and day out, once in a while there are moments where you take a step back to look at the charts and it occurs to you that this may be one of those times that marks a significant point in market history, a point that you will probably spend some time reminiscing about later on. You may think back about how the market felt, what others around you were saying, which technical indicators gave hints that turned out to be correct, and which ones gave false signals.

The last crystal clear moment like that in my mind is July 2002, at the bottom of the dramatic waterfall decline from March 2002. At that time the market had gone through a painful series of months where almost every week ended in the Red until it seemed like stocks would never catch another bid. Then in late July the Dow declined more than 100 points - and a few times more than 200 points - for 4 days straight. When the market opened the next day, on July 24th, the market sank into the red again with the Dow quickly losing 150 points, except this time the market began to turn around. The buying was subtle at first, but it was steady, it did not stop and the volume was huge. The market climbed at solid pace until the Dow ended the day up 488 points, right at the day's high. Looking back at it now, it was the kind of reversal that etched a permanent memory of how a 50% slide in the market over 2 years came to an end, and how it began the process of forming what we now know was a significant bottom.

The decline to the July 2002 low from the Spring highs caught most people by surprise. The rally from the post-9/11 low in 2001 had been almost universally proclaimed as the start of a new Bull market, and the decline in early 2002 was labeled a "healthy pullback" that new bull markets always have along the way. While the Dow rallied to a new high in March, the Nasdaq and the Semiconductors were conspicuously off their December 2001 highs. The S&P 500 was caught in the middle, but it was emitting its own signal that all was not well. Below is a chart of the S&P 500 from January 1, 2000 through April 1, 2002, and you can see the rally from the September 2001 low at 944 on the right.

Fibonacci retrace levels are the single most important tool in assessing whether a move in the stock market is with the larger-degree trend or against it. If a move is against the trend, it will almost always respond to the 38.2%, 50% or 61.8% retrace level of the move that preceded it. There are many other minor Fibonacci retrace levels, but these are the most useful and commonly seen.

In the Spring of 2002 while the rally off the September 2001 low was being proclaimed as a new Bull market, the S&P 500 was having trouble with the 38.2% retrace level of the decline from the highs in 2000 (the Dow and NDX were having the same trouble with other retrace levels, but we'll stick to the SPX here). You can see in the chart above that the SPX rallied to this level 3 times between December and March, and was rebuffed each time. Even though the economy was showing positive signs, even though the September 2001 low showed positive divergences with the March 2001 low in many technical indicators, and even though the vast majority of market participants were convinced The Low in the Bear market had been seen, Fibonacci was suggesting otherwise. The chart at the top of the next page shows what we all know happened next.

From the March high the SPX declined to a new Bear Market low, and all that was needed to see through the haze of Wall Street media hype were Fibonacci retrace levels. This Bear market has been full of them. The July and October 2002 lows in the S&P 500 were both in the 770 area, which is a 50% retrace level from when the index was well below 100 30 years ago at the 1974 low (the Dow's low in 2002 was a 38.2% retrace from that low). From July 2002 to March 2003, the SPX hit the floor at this Fibonacci retrace level 3 times and it would not push through - just as it would not push above the 38.2% retrace in the chart above. The response of the SPX and Dow to Fibonacci retrace levels in the Spring of 2002 suggested the post-9/11 rally was a correction of the entire decline from the 2000 high, and the 2002-2003 lows suggest this Bear market is a correction of the entire Bull Market from the 1974 low.

Just as in the Spring of 2002, the SPX and other indexes have now been trying to push through a significant Fibonacci retrace level for the last 4 months but has been unable to do so. You can see on the chart below that the 50% retrace of the 2000-2002 decline has been like a solid brick wall.

If the March high at 1163 turns out to be the high of a corrective rally from October 2002, the below chart is probably one for the Bear Market scrapbook. It just does not get any clearer. In March of 2002, the SPX was turned away from its 38.2% retrace of the decline to the low in September 2001 in much the same way it may have just been turned away from the 50% retrace shown above. And just as the failure to rally beyond that retrace in 2002 paved the way for a decline to a new Bear Market low, the current failure of the SPX to rally beyond its 50% retrace will likely be looked back at as a clear signal alerting those who care to listen that the low of this Bear Market had yet to be recorded.

As you can see on this chart of the S&P 100, it has not just been the S&P 500 that has been responding strongly to Fibonacci retrace levels. The S&P 100 has been unable to rally beyond its 38.2% retrace; the Dow Industrials has been unable to rally beyond its 78.6% retrace; the Dow Transports have been unable to rally beyond its 61.8% retrace; and the Wilshire 5000 Total Market Index has been unable to rally beyond its 50% retrace. There are many others, and although there is a while to go before we will have confirmation that this has been a large Bear market rally (the S&P 500 will have to move below its December 2002 high at 954 for that), the appropriate question now might be how the market will make a new low versus if it will. The 3 Elliott Wave scenarios that appear most likely are:

The US market has entered a Japan-like trading range that may last a good portion of this decade. The S&P 500 would largely stay between 800 and 1200, although there would probably be highly volatile swings up and down.

The market is now starting another leg down similar to the 2000-2002 decline. The target would be around 600 on the S&P 500, and the low would probably occur at the 4-year cycle low in 2006.

A more Bearish decline is beginning, where the S&P 500 would likely decline well below 600 in the next two years, and not rally above the 2002 low for some time (this is the Prechter scenario).

At this point, there is no way to consider one of the above scenarios any more likely than the others - and the reality is, no one else can either. A 6 year trading range is just as probable as a decline to new Bear lows from this point and those who suggests a crash is the most likely outcome are expressing their subjective opinion, not objective Elliott Wave analysis.

The chart below of the Nasdaq Composite shows what objective EW analysis has to say at this point. The Compq has traced out 3 waves up from its October 2002 low, and these waves can be labeled as a corrective A-B-C rally (as shown below), or 1-2-3 of a yet-to-be-completed rally. If the Compq declines and breaks below the December 2002 high at 1521, the A-B-C count will be confirmed. If the Compq declines for a few more weeks or months (without declining below 1521) and then rallies beyond the January 2004 high at 2153, the more bullish 1-2-3 count will be confirmed. These scenarios are basic Elliott wave, and anything beyond that is speculation.

Having said that, let's speculate a little. Even though both Bullish and Bearish counts on the Nasdaq Composite remain valid here, there are signs that the bearish A-B-C count is more likely than the bullish 1-2-3 count. As we've just discussed, the heavy resistance provided by Fibonacci retrace levels on other indexes is a strong signal that this has been a corrective rally, and the most likely form of a corrective rally is the A-B-C form. This provides the strongest evidence that the rally from October 2002 will ultimately take a corrective A-B-C form. And one of the signs this is playing out is seen in the Compq having now broken its Weekly trend line from the 2002 low, which you can see on the chart at the bottom of page 4. In the last week, the Compq rallied to retest the trend line before breaking down again. This suggests the uptrend from 2002 has yielded to a new down-trend, and the Compq will have to rally significantly in the next few weeks to regain its bullish trend.

There are other hints found within the index itself. Below is a chart of KLAC, a member of the NDX. KLAC broke its uptrend line in December, retested it with a new rally high in January, and has since declined significantly. In the last month, KLAC broke through its December 2002 high (shown by the Red line). In order for a more bullish 1-2-3 count of the rally from the October low to have remained a possibility, KLAC needed to stay above the Red line because in bullish Elliott Wave counts there will be no overlap in the wave 1 high and the wave 4 correction. By breaking through the Red line, KLAC has told us that its rally from the 2002 low was most likely an A-B-C correction, and that there will be a new Bear market low ahead. The far less likely bullish alternate is that a 1-2-1-2 series of waves has traced out and KLAC is about to rally explosively through its $62.82 high in a wave 3 of 3.

In a recent Short-Term Update, we looked at a bearish chart of Microsoft which showed that MSFT has broken down from a huge 3 year wedge. Despite the huge gap up 3 weeks ago, that assessment remain valid as MSFT has decline below the lower trend line again. Like MSFT, Intel broke down through a significant trend line this last month - in this case, from the October 2002 low. A short rally successfully retested the break in late April, and the trend is now clearly down. Like the Compq and the NDX, an A-B-C count of INTC's rally from October 2002 is considered more likely at this point, but it is not confirmed. Like KLAC, a break below the December 2002 high will give that confirmation, so watch $22.09 in the coming months.

Microsoft, Intel and Qualcomm together make up nearly 20% of the NDX. Microsoft's chart is clearly bearish. If Intel breaks $22.09 it will be clear that the Bear market low has not been seen for INTC either. Qualcomm is sitting right on its Weekly trend line from its March 2003 low, and it's Weekly MACD has turned down for the first time in more than a year. If the trend line breaks, QCOM's December 2002 high at $42.89 is the level to watch - a break of this level would leave a confirmed A-B-C corrective rally from the 2002 low, just like KLAC.

If the Generals that make up 20% of the Nasdaq 100 had confirmed Bearish wave counts, the odds would shift significantly towards the bearish A-B-C count from the October 2002 for the Nasdaq as a whole - if it had not already been confirmed by then. If the current decline continues to accelerate to the downside in the coming months, the December 2002 highs are the levels to watch for individual stocks and stock indexes.