Dear Speculators,

Despite the holiday-shortened week the Dynamic Trading System (DTS) was able to take profits on positions in the NDX market on Friday.

In the Index Options markets the DTS took gross gain of +33% in QQQQ options. That lifts the Options Service's gross total position gains to 1,156% (since its launch in April '05) with a gross total portfolio return at +145% in the same time frame. If you would like to read more about The Agile Trader Index Options Service CLICK HERE. And if you would like a free 30-day trial to the service (offered only between now and July 9), CLICK HERE and then click SUBSCRIBE.

In the E-Mini Index Futures markets the DTS netted a gain of +8.5% in the NDX market. Net Position gains in the Futures markets are now at +369% (since July '05) with a net portfolio return of +84%. If you would like to read more about The Dynamic Trading System in the Index Futures markets or subscribe to The Agile Trader Index Futures Service, please click HERE.

(Note: All trades were executed in customer accounts in real time on the Dynamic Trading System's signals. However, because these results are representative of a compilation of accounts (and not one single account) and trades were executed by the Futures Commission Merchants and/or Securities Brokers who held limited power of attorney for the customer accounts, and not directly by The Agile Trader or by Dog Dreams Unlimited Inc., results are, for all regulatory and compliance purposes, hypothetical, with all disclosures and caveats applicable as disclosed below. Please see the Important Disclosures below my signature. -AO)

if you would like a free 30-day trial to The Agile Trader (in which we trade the less volatile QQQQ/SPY and the Rydex Funds) CLICK HERE.

We've been studying the 4-Yr Cycle in this space at some length since last December.

If you've missed these discussions, please feel free to dig through the Weekly Wrap-Up Archives to bring yourself up to speed on the subject. Why? Because we're going to drill down into the specifics of the upcoming period and we are assuming that our readers are familiar with our treatment of the topic.

This chart plots the SPX median percentage gain from the launch of the cycle (in this case back in October 2002, blue line) against One Standard Deviation (1 Std) from that median (red line).

Basically the red line tells us how much variation there is in "normal." And it does this by giving us the percentage variation from the median inside of which 68% of cases (1 Std) fall. Statistically speaking, that's how normal is often defined.

So, for instance, at Trading Day # 520, 1 Std is just 10%. That means that 68% of the time the SPX has risen +45% in the first 25 months of the 4-Yr Cycle, give or take 10.7%.

That's really an astonishing number. So astonishing to me that it bears repeating. 68% of the time the SPX has risen +45% in the first 25 months of the 4-Yr Cycle, give or take 10%.

Now compare that to Trading Day # 950 (way up in the upper right of the chart). While the median performance of the SPX has moved up to +52%, 1 Std has widened out to 54.6%. Put differently it would be within the statistical definition of "normal" (68% of cases) for the SPX to have given up all of its gains since the inception of the cycle, and perhaps to be underwater by a couple of percent! And it would also be within "normal" bounds for the SPX to have continued trending north to the point that it had DOUBLED since the beginning of the cycle.

All of which is to say that, while the first 2+ years of the cycle tend to perform performed terrifically consistently (since 1962), the back half of the cycle is where all kinds of uncertainty and variability express themselves. And why do we care so much about this right NOW? Because on Friday we completed Trading Day # 941 in the current cycle, and in 9 trading days (about 2 weeks) we will be at the cyclical peak of variability, and then (NOT particularly coincidentally just about SMACK ON Options Expiration Day) we will be starting the absolutely (statistically) WORST 34 trading days (about 6 weeks) of the entire Thousand-and-Eight-Day (4-Yr) cycle.

From Trading Day #950 through #984 the median performance falls down an elevator shaft from +52% to +35%. (That's -17% of the cycle's SPX Cycle Start Value, not a -17% correction from the current level, so, given that the median rise is about 50% to Day # 950, the drop should probably be reckoned as being (-17% * (50%/150%) * SPX Price), or about a -11% pullback from Trading Day # 950.

And if we use a similar calculation relative to the median cycle high (+54%) with a median pullback of -19% of the SPX Cycle Start Value, we get a median decline of -19% * (54%/154%)= -12.3% off the high.

Moreover, this malevolent 6-week period sees 1 Std contract from 54.6% to 39.5%, which indicates that there is increased uniformity (diminished variability) of results, which is to say that the bearishness is broadly/often seen. (5 of the past 10 cycles have seen large down moves during this period, 3 have seen significant up moves -- but 2 of those came after 2 years of harsh declines-- and twice the period was fairly flat).

Looking again at the 4 "middling" cycles prior to the current one, we see that a "decision point" is due in the next 7 to 10 trading days.

We have zoomed way in on this chart, showing just the back half of the 4-Yr Cycle. Arrow A points out the loci at which the 1990 and 1966 cycles turned sharply down. Those calendar dates were 7/18/90 (the Wednesday of Expiration Week) and 7/18/66 (the Monday after Expiration, though I suspect that Options were less of a factor back then than they are now).

In 1978 and in 1994 no such 2H July decline was seen and indeed in both instances the market rallied straight through 2H July, through August, and into mid September when tests of the cycle highs occurred...and failed.

So, what can we take away from this study? Given that we are clearly in one of the "middling" 4-Yr Cycles (1 Std for these series at Day #941 is just 3.3%...talk about bunching!), it would appear that:

• if the SPX starts making or even challenging the June closing low of 1223 in 2H July, that we may very well be off to the races to the downside (malevolent).
• However, if weakness and news lows are NOT seen in 2H July, then precedent suggests (benevolently) that
• a rally is likely to persist through August and into September, and that a (weak and failing) test of the May highs will occur in that time frame, and
• a sharp decline (but one that is contained by the summer lows) should follow in 2H September that lasts into October.

EARNINGS

Earnings Season is kicking into high gear over the next 2 weeks as we head into Expiration Week.

On its face the picture for SPX EPS continues to look extraordinary with Forward Operating, Trailing Operating, and Reported EPS all continuing to make new highs.

Price/Earnings Ratios remain low by historical standards...

...especially when compared to the Price/Dividend Ratio of the 10-Yr Treasury (TNX).

Indeed the Earnings Yield of the SPX (the inverse of its PE) is 7.13% while TNX is 2% lower at 5.13%. That 2% spread is our Equity Risk Premium (ERP), now above its post-9/11 median, and indicative of a market that is scared (pricing in a LOT of Risk).

What is the market so scared about when growth remains so robust?

Indeed the Y/Y change in the F52W EPS consensus (blue line) remains at a high level (+14.2%) while the 3-month annualized change in the F52W EPS (red line) continues screaming higher, now at +19.9%. There doesn't appear to be any danger here!

Indeed the risks lie in several areas.

First, the flat-to-inverted Yield Curve. Until the blue line on this chart begins to reverse its downtrend (or until the market becomes convinced that the downtrend will shortly begin reversing), PE Expansion is a tough row to hoe. (And we continue to anticipate an even lower low on the PE (red) line before the 4-Yr Cycle Low has finally been formed.)

Second, growth in earnings as distributed by sector...

Obviously the still-dominant story on this chart is the yellow line. The largest plurality of growth in EPS over the past 2 years has been in Energy stocks. And that's inflationary, as we have discussed ad nauseum in the past.

This chart may make the story even clearer.

Over the past 52 weeks the Forward 52-Week Consensus for the Energy Sector is up 47%. Meanwhile the F52W Consensuses for Utilities, Telecom Services, Materials, and Industrials are all up in the 20% range. However, Information Technology, Health Care, Financials, Consumer Discretionary, and Consumer Staples stocks all show much weaker growth (5-9%).

Growth in estimates for Energy, Materials, Utilities, and Industrials stocks are all predicated on high input prices and strong global demand, which keeps those input prices high (inflationary). The 2 Consumer sectors are lagging along with Tech, Financials, and Health Care (there's a lot of New Economy in this list). Before a new bull cycle can begin, we will very likely need to see some of those short columns get taller and some of those tall columns get shorter.

I'm out of time and room now. But if you'd like to join us for our more technically oriented daily Morning Call, Afternoon Note, and Trading Alerts, please join us at the links posted in the early paragraphs of this missive.

Have a great week!

Best regards and good trading!