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Technical Market Report

The good news is:
• The market gave a solid hint as to its intermediate term direction last week.

In technical analysis we look for common patterns to give hints about what will happen in the future. The events of the past two weeks have pushed most indicators to uncommon extremes.

Last week the market closed down after opening higher on Tuesday, Wednesday and Thursday as the buy the dips crowd were overwhelmed by the sell the rallies crowd.

Short term

The sell off last week was extreme in every way, many of the breadth oscillators have fallen to their lowest lows since July 2002.

The chart below shows the NASDAQ composite (OTC) in red and an oscillator of NASDAQ volume of advancing issues - volume of declining issues in blue. Grey vertical dashed lines are drawn on the 1st trading day of each month and a red vertical dashed line is drawn on the 1st trading day of the year.

This oscillator is at its lowest level since July of 2002. Oscillators gravitate toward neutral so there is nowhere to go but up.

Intermediate term

Last Thursday the Russell 2000 (R2K) completed a run of 9 consecutive down days an event that has occurred 12 times since 1979.

The chart below covers the past year showing R2K in red with an indicator showing the percentage of the previous 9 trading days that were up in blue. The indicator touches the bottom of the screen when there have been 9 or more consecutive down days and it touches the top of the screen when there have been 9 or more consecutive up days.

Of the 12 times the R2K has had a run of 9 or more consecutive down days only three of them have been near tops, the one that ended last Thursday and the two shown in the charts below.

The chart below covers the period from late May 1998 to late November. The first occurrence of 9 consecutive down days was near the July high with two more following as the bottom was developing first in late August then again at the early October low. 1998 like the current year was the 2nd year in the Presidential Cycle.

The next chart covers 1982. There was a bear market rally that ran from mid March to mid May. From the rally high in mid May there were 9 consecutive down days that initiated the final down leg of that bear market. 1982 was like 1998 and 2006 the 2nd year of the Presidential cycle.

Seasonality

Next week includes 5 trading days prior to Memorial Day during the 2nd year of the Presidential cycle.

Memorial Day was first observed on May 30, 1868 and continued to be observed on May 30 until 1971 when congress passed the National Holiday Act moving it to the last Monday in May to create a 3 day weekend.

The tables below show daily returns for the OTC and S&P 500 (SPX) from 1971 - 2005 during the 2nd year of the Presidential Cycle. There are summaries for both the 2nd year and all years combined.

Over all years the average returns for the week have been slightly positive, however, during the 2nd year of the Presidential Cycle they have been slightly negative.

Report for the 5 days before Memorial Day
The number following the year represents its position in the presidential cycle.
The number following the daily return represents the day of the week;
1 = Monday, 2 = Tuesday etc.

OTC Presidential Year 2
  Day5 Day4 Day3 Day2 Day1 Totals
1974-2 -0.61% 1 -0.17% 2 -0.70% 3 -0.21% 4 1.12% 5 -0.58%
1978-2 0.30% 1 -0.79% 2 -0.97% 3 0.02% 4 0.03% 5 -1.41%
1982-2 -0.38% 1 -0.32% 2 -1.29% 3 -0.23% 4 0.10% 5 -2.13%
 
1986-2 -0.24% 1 0.40% 2 0.32% 3 0.81% 4 0.59% 5 1.87%
1990-2 1.02% 1 0.22% 2 0.66% 3 0.31% 4 -1.00% 5 1.21%
1994-2 -0.24% 1 0.90% 2 0.18% 3 -0.16% 4 0.21% 5 0.89%
1998-2 -0.82% 1 0.78% 2 -0.76% 3 -0.59% 4 -0.88% 5 -2.27%
2002-2 -2.29% 1 -2.20% 2 0.56% 3 1.44% 4 -2.13% 5 -4.61%
Avg -0.51% 0.02% 0.19% 0.36% -0.64% -0.58%
 
OTC summary for Presidential year 2 1974 - 2002
Averages -0.41% -0.15% -0.25% 0.17% -0.25% -0.88%
% Winners 25% 50% 50% 50% 63% 38%
MDD 5/24/2002 4.59% -- 5/22/1998 2.26%
 
OTC summary for all years 1971 - 2005
Averages -0.26% -0.17% 0.11% 0.22% 0.15% 0.05%
% Winners 44% 49% 60% 60% 63% 63%
 
SPX Presidential Year 2
  Day5 Day4 Day3 Day2 Day1 Totals
1974-2 -0.40% 1 0.06% 2 -0.93% 3 0.23% 4 1.48% 5 0.43%
1978-2 0.99% 1 -1.05% 2 -0.99% 3 -0.29% 4 -0.23% 5 -1.57%
1982-2 -0.09% 1 -0.34% 2 -1.13% 3 -0.40% 4 -0.69% 5 -2.64%
 
1986-2 0.19% 1 1.25% 2 -0.28% 3 1.98% 4 0.51% 5 3.65%
1990-2 0.95% 1 0.12% 2 0.24% 3 -0.24% 4 -1.07% 5 -0.01%
1994-2 -0.38% 1 0.36% 2 0.34% 3 0.16% 4 0.06% 5 0.53%
1998-2 -0.26% 1 0.33% 2 0.87% 3 -0.40% 4 -0.37% 5 0.17%
2002-2 -1.33% 1 -1.10% 2 0.57% 3 1.02% 4 -1.21% 5 -2.05%
Avg -0.17% 0.19% 0.35% 0.50% -0.41% 0.46%
 
SPX summary for Presidential Year 2 1974 - 2002
Averages -0.04% -0.05% -0.16% 0.26% -0.19% -0.18%
% Winners 38% 63% 50% 50% 38% 50%
MDD 5/28/1982 2.62%
 
SPX summary for all years 1971 - 2005
Averages -0.08% -0.04% 0.00% 0.08% 0.15% 0.10%
% Winners 54% 51% 54% 51% 60% 60%

Conclusion

The market is extremely oversold and likely to bounce.

The highs observed earlier this month came about 2 weeks later than average for the 2nd year of the Presidential Cycle and if anything near the average pattern unfolds those highs are likely to hold until at least the 4th quarter.

I expect the major indices to be higher on Friday May 26 than they were on Friday May 19.

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