Opening Whisper

The markets continue to confound the experts. The hype of the day is that the FOMC must halt the raising of the short end interest rates very soon. And as a result of the cheerleading, the equities held up well this week in the face of economic indicators that are slipping and slipping badly. Chicago PMI, ISM Manufacturing and ISM Services indexes all came in below consensus. Jobless claims were up and non-farm new jobs for May came in at half of the recent average. After all of the bad news is in, why are the equities markets holding up so well? Now let me get this straight; the economy is slowing, so inflation is not going to be a problem confirmed by gold and the CRB commodities being in a three month downtrend; the Fed will stop raising short rates; manufacturing, services and jobs creation are slowing; and weekly leading econ indicators are falling. This sounds like a slowdown at best or recession at worst. And how is this supposed to be good for our economy, jobs and subsequently the stock markets?

Through all of this obtuse logic, can we agree on one thing? That is, that all of the economic, political, consumer and market emotions are built into the current price of the market indices. Whether the hype is correct or absolutely illogical is not the issue. If we can agree that every piece of data is built into the price, then how can we predict what the market will do next week? Doing so would require us to know all factors that will affect the markets next week, before they happen. Do markets cycle? Yes. Do markets tend to follow Elliott Wave patterns? Yes. Can I determine what the next cycle period or wave count will be next week and next month? No way! Maybe you can, but it's all beyond me. And that's why I stick with the trend timing approach that I have found very useful. How useful is it? The obtuse logic of the markets has the NDX down 4.9% on the year. As of the close this week our model is up 24% for just over 5 months in this calendar year based on the signals given in this newsletter and using Rydex Dynamic funds trading at beta of 2.0/-2.0.

To implement our money making system model requires that we check our biases at the door and focus on what our long and short term indicators are telling us. What is the trend? When should we take our profits and implement our Cash Safety Stop (CSS) strategy? Our returns so far this year tend to prove that we can profit from short term moves in trend even if they are only a few weeks in length. The recent rally off of the short term lows in late April appears to be a contra-trend rally, but who cares! We can profit in the conundrums and opaque logic of the markets. Keep them coming. I love it.

Our Trading System - What The Numbers Are Telling Us

Our weekly system model is flashing buy signals across the board in spite of Friday being a down day. This strengthened buy signal should be viewed with respect. Only the ROC is losing some acceleration but it is still 4 point above the zero line. The Slow STO and StochRSI are now in overbought territory, but are not yet showing signs of weakening. When they do weaken, we will likely go to cash.

Today's down day on the NDX is the only significant down day in the last 5 weeks! This has been a powerful rally albeit on hesitant volume. The Nasdaq equities were in need of a retracement. And this retracement needs to continue into next week before we can have another move to the upside. The NDX/SPX relative strength ratio (below) has "blinked" and the uptrend is dented but not broken.

Is it possible that the NDX is now going to rollover from here and fall dramatically? Perhaps, but the momentum showing up in our system model says that we are going to power higher from here. Next week could be a down week forcing us to go to cash by next Friday. We just need to wait and see. If you have some profit from our system at this point, you may just want to go to cash early next week and wait for a clearer signal. But our model is telling us that we are on the verge of another leg higher over the next couple of months. Our model would have to be totally out of sync for us to see a major sell-off from here. That's possible, but does not appear likely given the fact that our MACD has just gone positive. Protective cash stops must be used to protect our profits in the case that our model timing is incorrect.

NDX - 6 month Chart Model - Friday June 3, 2005

Over the last couple of weeks our model's fast and slower indicators have positioned themselves to "line up". We now have "buy" signals across the board on our Market Listener Indicator table which is always updated at the end of this report. Sometimes, the market moves in opposition to our buy signals because the market cycles have a periodicity which is shorter than our MACD. We need to be ready to take our profits quickly if the market tells us that we are out of synchronization with the current rally cycle.

What Is The Current Sentiment?

The Nasdaq tech stocks have led the recent 5 week rally. The chart below shows us that the Nasdaq Comp / Nasdaq Volatility ratio is in nosebleed territory. This ratio of the Composite Index divided by its underlying option volatility has never been this high - even during the Nasdaq Tech bubble! What does this mean? It means that more stock options are in speculative use than we saw in the bubble days. These options are an attempt by speculators to make profits when the underlying stocks are not providing trading profits. This extreme ratio is vulnerable to pull backs in which the Nasdaq Composite goes down and the VXN fear index increases.

7 Year Weekly Chart - Nasdaq Composite / VXN Relative Strength

The CBOE Put/Call Ratio (symbol $CPC on chart below) rose slightly on the week. We need the CPC to increase, and the NDX to pull back a little in the next few trading days (fear increasing) or this rally may stall!

6 Month Chart - CBOE Put/Call Ratio

I will be watching the 8 day moving average of the CPC. If that blue line 8 MA, which is currently at 0.84, gets down to 0.80 then the rally could be nearing an end.

VIX Volatility Index - 12 months

The falling VIX (above chart) was halted this week on its journey south. A falling VIX tends to confirm our buy signal. Once the 9 day EMA on this chart gets below 13, we will have enough extreme complacency in the markets to prepare for a market decline. We're not quite there yet. Watch for the VIX to rise if the markets pull back a little more next week.

Where Do We Go From Here and How To Listen For the Next Signal?

Our weekly MACD has given a buy signal on a down week. We look for a 2-3% pull back next week on the NDX before we find our legs to move higher this summer. However, a pull back below 1500 on the NDX could signal the end of this rally. If the 1500 level holds, then our model's buy signals will be confirmed and will lead us to more profit in the June - August time frame. I would set much tighter stops were it not for the fact that our system model weekly MACD has just turned positive.

We should always set our stops at the point where we would surmise that our model is out of synchronicity with the markets and just plain wrong. The 200 day moving average on the NDX is just below the 1500 level. A drop below that level could signal very negative things again for the technology sector in the short term.

Here is the daily chart of the NDX showing the 200 and 50 day moving averages.

The Market is challenging our system model! Keep listening?

The Market Listener Indicators
(YTD Gain/Loss with RYVYX & RYVNX = +24.27% as of June 3 Close)

¹ This Market Listener signal is our base signal. The MACD is our primary weekly input, but can be "out-voted" by the other faster indicators on a daily basis when we need to go to cash to implement our Cash Safety Stop (CSS). You should not base your trading on this or any other single indicator or set of indicators. With Rydex Dynamic funds, we can trade in the morning and 5 minutes prior to the close during the trading day/week when I see that one or more of the fast signal indicators have changed signals. This is particularly important if I am going to a CASH position in order to preserve capital. The above table shows the results of the end-of-week, WEEKLY SYSTEM MODEL SIGNALS.

Listen To What He Says

KJV 1 Peter 3:15 "But sanctify the Lord God in your hearts: and be ready always to give an answer to every man that asketh you a reason of the hope that is in you with meekness and fear."

I am working on the art of listening and hope that you are also.