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The Popes Passing and Implications

The world's one billion Catholics (I am a Catholic as well for those who were wondering) are in mourning as I am writing this. Pope John Paul II had passed away - leaving behind a great legacy including being the first non-Italian to serve as the head of the Catholic Church and shaping the papacy into a much more dynamic, highly influential global icon. He is credited with bringing down Polish Communism and in successfully reaching out to other faiths. At the same time, his views and beliefs remained conservative. Under his reign, an additional 250 million people became Catholics, but the influence of the Catholic Church declined significantly in Europe and also in the United States as well. A full two-thirds of all Catholics now live in developing countries.

As I am writing this on Saturday evening, there is already a long list of articles on the internet discussing the list of potential successors to Pope John Paul II. I am not an expert in "Vatican-Watching" by any means but I can definitely say that with the advent of communications and with the continued increase of globalization in the 21st century, the importance of the papacy being a "global mediator" and global communicator will be much more important than ever before. The next Pope will need to find a way reassert the Church's influence in Europe and in the U.S. once again. He will also need to be a great global mediator/communicator - a trait that will be very important in reaching out to other faiths and to help the United States and certain members of Europe to mend our differences over the Iraqi War. It is certainly not my place to even comment on who would be qualified for this job. However, I sincerely believe that whoever becomes the successor for the Pope will be a very significant event, as the power and influence of the Pope could very well play a significant role in shaping the world's politics and economy in the 21st century. The succession process definitely bears watching going forward.

On a more immediate note, the "sudden decline" of last Friday carries pretty ominous signals in the weeks ahead. With the Dow Industrials closing at its lowest level since January 24th, there's a distinct possibility that I won't find a good entry point to establish a 50% short in our DJIA Timing System before favoring the long side (which is still very far away, however) once again. The decline was blamed on higher oil prices, but this author believes that the bad news coming out of AIG and the retailers probably carries more weight at this stage of the game. The news coming out of the biggest and most financially-leveraged companies in our economy (AIG, FNM, FRE, GM, etc.) are still currently in development. Keep in mind that the modern stock market and the financial companies are all based on confidence. Without confidence, the modern economy cannot survive. The continuing saga at Fannie Mae and Freddie Mac is bad enough, but what about AIG?

Frankly, I was taken aback by Friday's report of AIG in the Wall Street Journal. An article from Marketwatch.com covered this story very well. In the article, the author stated that famed New York State Attorney General Elliot Spitzer threatened to indict AIG earlier this week if Chairman Maurice Greenberg didn't resign (he did last Monday), after "lawyers hired by the big insurer to handle a regulatory probe discovered certain records were missing & Then another jolt: They also learned that an AIG employee had destroyed some computer records and tape recordings of business meetings. There was a confrontation between the lawyers for AIG and their counterparts representing Mr. Greenberg over who should secure the rest of the documents." (Source: Wall Street Journal). I was taken aback, but frankly, not surprised. How could AIG be the fastest growing insurance company for the last few decades and also the most profitable? In our discussion forum and in our past commentaries, I have consistently asked my readers to avoid AIG and I have continually said that investors have so under-reacted to the news at AIG. That all changed last Friday.

The most interesting thing with "the Buffett connection" is that in reading the annual reports from Berkshire Hathaway over the last five years, it is obvious that Warren Buffett had been having a tremendous amount of trouble and taking a lot of grief for the General Re acquisition in 1998 - something which Mr. Buffett thought was behind him as early as two years ago. This is coming to haunt him once again. Hopefully, this will not turn into anything bigger than it already is. Judging by recent history, however, I am not holding my breath. Companies like AIG, FNM, FRE, and GM are still a "sell" or an "avoid" at the moment.

Okay, let's now discuss the technical action of the stock market. I have continually said over the last few weeks that the market was getting very oversold per some of my technical and sentiment indicators (such as the McClellan Oscillator, the AAII Surveys, etc.) but were still at a neutral to moderately overbought condition based on other technical and sentiment indicators that I have been also keeping track of (such as the ARMS Index, the Market Vane's Bullish Consensus, etc.) - something which hasn't happened since early July 2002. I had also been looking for a hard bounce last week. Well, we got a one-day bounce on Wednesday last week but the market took a dive again on Friday. As I stated in my previous commentary, I had been looking for a two-week consolidation phase which we can hopefully short into in our DJIA Timing System. The dive on Friday coupled with the AIG/oil factors may change all that. The one-day ARMS reading last Friday hit a pretty high level of 1.96 - the highest level since January 19th. I would not be surprised if we actually get our watershed decline in the next few weeks. If, however, we do enter a consolidation phase, then my position remains the same as last week's: Look for a bounce during the next week or so and go 50% short in our DJIA Timing System. We will keep our readers updated.

The action of the Dow Jones Industrials and the Dow Jones Transports is still not currently giving any hints of a tradable bottom here either:

Strictly looking at the above chart, it is difficult to see how we can make a case for the market being "very oversold" here. In fact, the intermediate term support for the Dow Jones Transports does not come until the 3,500 level - still a full 186 points or another 5% on the downside. A potential bullish scenario based on the mechanical version of the Dow Theory is for the Dow Industrials to break its January 24th low with the Dow Transports hitting the 3,500 support level without confirming on the downside (by breaking its own January 24th low of 3,454.78). Even then, investors should be careful as I have mentioned this over and over again: We are now late in the cycle!

Turning to the three most popular sentiment indicators that we keep track of - the Bulls-Bears% Differential in the American Association of Individual Investors (AAII) survey declined once gain and is now extremely oversold, while the readings in the Investors Intelligence Survey got slightly oversold but are still not fully confirming the readings in the AAII surveys. The message remains the same: The last time such a divergence occurred was in early July 2002. I think the market is now ripe for a watershed decline - a watershed decline which will take us below the August 2004 levels and which will finally give us a tradable bottom once again. If we have a hard bounce this week, then we will go short in our DJIA Timing System. If not, then we will sit it out and wait and then go on the long side once we believe the market has achieved "capitulation." Following is the latest weekly chart of the Bulls-Bears% Differential in the AAII survey vs. the DJIA:

Under "ordinary circumstances" we would be going fully long based on the extremely oversold readings in the AAII survey. However, these are not "ordinary" times. While the one-day ARMS reading was definitely oversold at 1.96 on Friday, the 10-day moving average (which we mostly use in our commentaries) is still at 1.06 - nowhere near an oversold situation. In fact, the one-day reading of 1.96 may actually be signaling of a more severe decline going forward in the weeks ahead.

The Bulls-Bears% Differential in the Investors Intelligence survey got a little bit more oversold last week. Following is the relevant weekly chart of the Bulls-Bears% Differential in the Investors Intelligence Survey vs. the DJIA:

The latest reading of 23.6% brings this in line with the mid September 2004 reading, but it is still nowhere near as oversold as I would like - especially at this late stage of the cycle. A "better" reading would be a reading of sub 10% in the weeks ahead - which would also confirm the extremely oversold reading in the AAII survey.

Now, following is the weekly chart of the Market Vane's Bullish Consensus readings vs. the DJIA:

Out of the three popular sentiment indicators that we consistently look at, this is the least oversold of the three. Is this important? Definitely - the Market Vane's Bullish Consensus has had it very good contrarian record, and I would not be comfortable going long here until we get a reading that is at least below the August 2004 low of 56%. A "better" reading would be a reading near the 50% line - which had acted as support during the July to October 2003 consolidation period.

Conclusion: The underlying theme over the last few weeks still remains: We are now late in the cycle and this author would like to see a more oversold bottom than we have seen at anytime (and on huge volume which we have not gotten so far) during the last 15 months before going long again. The only change that we have in our position is that this watershed decline (given Friday's decline instead of a continuation of the bounce from Wednesday) may actually be quicker than we thought - in which case we will just sit and watch instead of moving to a short position in our DJIA Timing System. Two other indicators to watch over the next few days is the Bank Index (huge support at the 95 level) and WMT - which declined below the psychologically $50 level and proceeded to hit a two-year low. Again, readers who have not initiated long positions here should just sit back and watch. We will send our readers a "special alert" once we think the market is safe to jump back in (on either the long or the short side) once again.

Signing off,

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