The good news is:
• All of the major indices closed at all time or multi year highs on Friday.
Short Term
After falling sharply on Tuesday all of the major indices advanced for 3 consecutive days to new highs on Friday, however, there were signs of exhaustion.
The chart below covers the past six months. The NASDAQ composite (OTC) is shown in orange and a 50% trend (3 day EMA) of the ratio of NASDAQ upside to downside volume (OTC UD Ratio) is shown in blue. Dashed vertical lines have been drawn on the 1st trading day of each month and dashed horizontal lines have been drawn at 10% intervals; the horizontal line is solid at neutral.
OTC UD Ratio fell on Friday as prices rose. I have marked nine other examples on the chart of similar occurrences, each was followed by a short term decline.
Intermediate term
New lows are a good indicator of bottoms because they diminish quickly after a bottom has been reached. They are an imprecise indicator of tops, but, increasing new lows while the averages are making new highs is not a good sign.
The chart below covers the past year showing the OTC in orange and a 10% trend (19 day EMA) of NASDAQ new lows (OTC NL) in black.
OTC NL has been plotted on an inverted Y axis so increasing new lows move the indicator downward (up is good).
OTC NL has been falling for the past several weeks while the average has been rising. At some point soon the average and the indicator will get back in synch. I think the resolution will favor the indicator.
Seasonality
Next week includes the week ahead of options expiration in July during the 3rd year of the Presidential Cycle.
The tables show the daily returns for the week prior to the 3rd. Friday in July during the 3rd year of the Presidential Cycle. NASDAQ data covers the period from 1963 - 2003 and SPX data from 1953 - 2003. Data prior to 1953 has been omitted because the market traded 6 days a week. There are summaries for both the 3rd year of the Presidential Cycle and all years combined.
By all measures the coming week has been weak, up about 40% of the time with negative average returns.
Report for the week before the 3rd Friday of July
The number following the year is the position in the presidential cycle.
Daily returns from Monday through 3rd Friday.
| OTC Presidential Year 3 | ||||||
| Year | Mon | Tue | Wed | Thur | Fri | Totals |
| 1963-3 | -0.21% | -0.32% | -0.32% | -0.59% | -0.39% | -1.83% |
| 1967-3 | -0.03% | -0.14% | 0.92% | 0.19% | 0.18% | 1.12% |
| 1971-3 | 0.30% | -0.43% | -0.38% | 0.34% | -0.67% | -0.84% |
| 1975-3 | -0.29% | -1.21% | -1.28% | -0.57% | -0.64% | -3.99% |
| 1979-3 | 0.27% | -0.74% | -0.44% | 0.23% | 0.30% | -0.39% |
| 1983-3 | 0.13% | -0.96% | -0.74% | 0.29% | -0.83% | -2.11% |
| Avg | 0.08% | -0.70% | -0.38% | 0.10% | -0.33% | -1.24% |
| 1987-3 | -0.59% | -0.50% | -0.02% | -0.39% | 0.35% | -1.14% |
| 1991-3 | 0.71% | -0.52% | -0.04% | 0.69% | 0.15% | 0.98% |
| 1995-3 | 0.60% | -1.44% | -4.15% | 1.14% | 0.12% | -3.72% |
| 1999-3 | -0.10% | -0.44% | 1.44% | 0.76% | 0.88% | 2.54% |
| 2003-3 | -1.59% | 1.47% | 0.77% | -1.03% | 1.72% | 1.34% |
| Avg | -0.19% | -0.28% | -0.40% | 0.23% | 0.65% | 0.00% |
| OTC summary for Presidential Year 3 1963 - 2003 | ||||||
| Avg | -0.07% | -0.48% | -0.39% | 0.09% | 0.11% | -0.73% |
| Win% | 45% | 09% | 27% | 64% | 64% | 36% |
| OTC summary for all years 1963 - 2006 | ||||||
| Avg | -0.10% | -0.24% | -0.03% | 0.03% | -0.10% | -0.44% |
| Win% | 58% | 32% | 47% | 58% | 50% | 43% |
| SPX Presidential Year 3 | ||||||
| Year | Mon | Tue | Wed | Thur | Fri | Totals |
| 1955-3 | 0.26% | 0.00% | -1.19% | 0.02% | 0.36% | -0.56% |
| 1959-3 | -0.47% | 0.85% | 0.34% | 0.10% | -0.03% | 0.78% |
| 1963-3 | -0.63% | -0.09% | -0.30% | -0.64% | -0.20% | -1.86% |
| 1967-3 | 0.01% | 0.81% | 0.16% | 0.21% | 0.20% | 1.40% |
| 1971-3 | 0.13% | -1.31% | -0.28% | 0.06% | -0.17% | -1.57% |
| 1975-3 | -0.82% | -1.07% | -1.39% | -0.12% | -0.87% | -4.26% |
| 1979-3 | 0.41% | -0.89% | -0.14% | -0.08% | 0.21% | -0.48% |
| 1983-3 | 0.62% | -1.53% | -0.04% | 0.33% | -1.04% | -1.66% |
| Avg | 0.07% | -0.80% | -0.34% | 0.08% | -0.33% | -1.32% |
| 1987-3 | -1.02% | -0.91% | -0.03% | -0.21% | 0.47% | -1.69% |
| 1991-3 | 0.56% | -0.22% | -0.09% | 1.10% | -0.30% | 1.05% |
| 1995-3 | 0.51% | -0.76% | -1.34% | 0.46% | 0.01% | -1.11% |
| 1999-3 | -0.30% | -0.39% | 0.33% | 0.82% | 0.65% | 1.11% |
| 2003-3 | -1.46% | 0.95% | 0.05% | -0.71% | 1.74% | 0.57% |
| Avg | -0.34% | -0.27% | -0.22% | 0.29% | 0.52% | -0.02% |
| SPX summary for Presidential Year 3 1955 - 2003 | ||||||
| Avg | -0.17% | -0.38% | -0.30% | 0.10% | 0.08% | -0.64% |
| Win% | 54% | 25% | 31% | 62% | 54% | 38% |
| SPX summary for all years 1953 - 2006 | ||||||
| Avg | -0.12% | -0.30% | 0.01% | -0.02% | -0.05% | -0.46% |
| Win% | 48% | 28% | 51% | 57% | 50% | 39% |
Mutual Fund
Compliance issues demand that I not mention the mutual fund that I manage by name or symbol in this letter. To see a current chart of the fund go to: http://finance.yahoo.com/q/bc?s=APHAX&t=6m&l=on&z=m&q=l&c=. For information about the fund go to: http://www.thealphafunds.com/index.htm. The fund now has service class shares available.
Conclusion
The market is overbought and many of the short term volume indicators turned negative on Friday. Seasonality is another short term negative.
I expect the major indices to be lower on Friday July 20 than they were on Friday July 13.
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