The good news is:
• The market is extremely oversold and likely to bounce.
Short Term
Most of the breadth oscillator style indicators are near their lows of the past year which suggests there will be a rally in the next few days. Rallies from extremes like we are currently seeing usually take a little while to get going, that is, the market is unlikely to go straight up from here.
The first chart covers the past year showing the S&P 500 (SPX) in red and a 50% trend (3 day EMA) of NYSE upside volume to down side volume (NY UD Ratio) in green. Dashed vertical lines have been drawn on the 1st trading day of each month and dashed horizontal lines have been drawn at 10% levels for the indicator. A solid horizontal line has been drawn at 50, the neutral level for the indicator.
The two other times in the past year the indicator has been near its current level there was a brief rally followed by a retest of the low.
Intermediate term
There were 809 new lows on the NYSE last Thursday.
The last time there was a larger number of NYSE new lows was May 10, 2004 when there were 845 and before that 917 on July 24, 2002.
Every time there have been an extreme number of new lows (I once defined extreme in this context as in excess of 400) the low has been followed by a rally and a retest of the old low. In 1990 there were two retests of the low.
The chart below covers the past 4 years showing the SPX in red and a 10% trend (19 day EMA) of NYSE new lows (NY NL) in brown. NY NL has been plotted on an inverted Y axis so increasing new lows move the indicator downward (up is good). Dashed vertical lines have been drawn on the 1st trading day of each year.
This chart was selected to show what followed the peak in new lows in May of 2004. After a rally there the SPX made a lower low about 2 months later that was not confirmed by the indicator.
Assuming the typical pattern plays out there should be a rally beginning Monday or Tuesday followed by a decline to a new low sometime in October. Part of that assumption includes the expectation there will be no further expansion of new lows.
Seasonality
Next week includes the last two trading days in July and the first three trading days of August during the 3rd year of the Presidential Cycle.
The tables show the daily returns for the week during the 3rd year of the Presidential Cycle. NASDAQ composite (OTC) data covers the period from 1963 - 2003 and SPX data from 1931 - 2003. There are summaries for both the 3rd year of the Presidential Cycle and all years combined. SPX data begins with 1928 for the summary of all years combined.
Seasonally the week has little to recommend it. Except for a modest average gain for the SPX over all years all of the averages are negative.
Last 2 days of July and first 3 days of August.
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 3 | ||||||
| Day2 | Day1 | Day1 | Day2 | Day3 | Totals | |
| 1963-3 | 0.18% 2 | 0.90% 3 | -0.27% 4 | -0.12% 5 | 0.24% 1 | 0.93% |
| 1967-3 | 0.76% 5 | 0.09% 1 | 0.44% 2 | 0.50% 3 | 0.69% 4 | 2.47% |
| 1971-3 | -1.53% 4 | -0.51% 5 | 0.30% 1 | -1.12% 2 | -1.10% 3 | -3.95% |
| 1975-3 | 0.44% 3 | 0.19% 4 | -1.65% 5 | -1.03% 1 | -1.00% 2 | -3.05% |
| 1979-3 | 0.37% 1 | 0.56% 2 | 0.40% 3 | 0.45% 4 | 0.06% 5 | 1.85% |
| 1983-3 | -2.09% 4 | -1.54% 5 | -0.53% 1 | 0.36% 2 | 0.22% 3 | -3.58% |
| Avg | -0.41% | -0.24% | -0.21% | -0.17% | -0.22% | -1.25% |
| 1987-3 | 0.55% 4 | 0.31% 5 | -0.41% 1 | -0.08% 2 | 0.81% 3 | 1.17% |
| 1991-3 | 1.00% 2 | 0.76% 3 | 0.42% 4 | 0.30% 5 | -0.61% 1 | 1.87% |
| 1995-3 | -0.53% 5 | -0.41% 1 | -1.01% 2 | -0.74% 3 | -0.11% 4 | -2.80% |
| 1999-3 | -2.43% 4 | -0.06% 5 | -0.56% 1 | -1.36% 2 | -1.85% 3 | -6.26% |
| 2003-3 | -0.60% 3 | 0.82% 4 | -1.12% 5 | -0.09% 1 | -2.37% 2 | -3.36% |
| Avg | -0.40% | 0.29% | -0.54% | -0.39% | -0.83% | -1.88% |
| OTC summary for Presidential Year 3 1963 - 2003 | ||||||
| Averages | -0.35% | 0.10% | -0.36% | -0.27% | -0.46% | -1.34% |
| % Winners | 55% | 64% | 36% | 36% | 45% | 45% |
| MDD 8/4/1999 6.13% -- 8/1/1983 4.11% -- 8/4/1971 3.90% | ||||||
| OTC summary for all years 1963 - 2006 | ||||||
| Averages | -0.05% | 0.04% | -0.10% | -0.14% | -0.15% | -0.40% |
| % Winners | 59% | 55% | 53% | 39% | 48% | 52% |
| MDD 8/5/2002 10.28% -- 8/4/1998 6.98% -- 8/4/1999 6.13% | ||||||
| SPX Presidential Year 3 | ||||||
| Day2 | Day1 | Day1 | Day2 | Day3 | Totals | |
| 1931-3 | 0.44% 4 | -0.51% 5 | 0.80% 6 | 0.65% 1 | -0.65% 2 | 0.73% |
| 1935-3 | -0.91% 2 | 1.28% 3 | -0.36% 4 | -0.82% 5 | 1.55% 6 | 0.75% |
| 1939-3 | -0.25% 6 | -0.58% 1 | 0.00% 2 | 1.00% 3 | -0.33% 4 | -0.16% |
| 1943-3 | -1.90% 5 | -1.43% 6 | -1.80% 1 | 2.18% 2 | 0.60% 3 | -2.36% |
| 1947-3 | -0.45% 3 | 1.55% 4 | 0.25% 5 | -1.14% 1 | 0.32% 2 | 0.53% |
| 1951-3 | 0.44% 1 | -1.02% 2 | 0.49% 3 | 1.38% 4 | 0.13% 5 | 1.43% |
| 1955-3 | -0.59% 4 | 0.05% 5 | -1.36% 1 | 0.23% 2 | 0.14% 3 | -1.53% |
| 1959-3 | -0.20% 4 | 0.02% 5 | 0.33% 1 | -0.16% 2 | -0.51% 3 | -0.53% |
| 1963-3 | 0.83% 2 | -0.16% 3 | -0.09% 4 | 0.33% 5 | 0.59% 1 | 1.51% |
| Avg | 0.01% | 0.09% | -0.07% | 0.13% | 0.13% | 0.28% |
| 1967-3 | 0.15% 5 | 0.28% 1 | 0.65% 2 | 0.43% 3 | -0.13% 4 | 1.38% |
| 1971-3 | -1.08% 4 | -0.46% 5 | 0.40% 1 | -1.51% 2 | -0.66% 3 | -3.31% |
| 1975-3 | 0.73% 3 | -0.09% 4 | -0.86% 5 | -0.95% 1 | -1.06% 2 | -2.23% |
| 1979-3 | 0.05% 1 | 0.64% 2 | 0.35% 3 | -0.07% 4 | -0.06% 5 | 0.91% |
| 1983-3 | -1.52% 4 | -1.50% 5 | -0.32% 1 | -0.02% 2 | 0.88% 3 | -2.48% |
| Avg | -0.34% | -0.23% | 0.04% | -0.42% | -0.20% | -1.15% |
| 1987-3 | 0.76% 4 | 0.19% 5 | -0.34% 1 | -0.42% 2 | 0.70% 3 | 0.89% |
| 1991-3 | 0.92% 2 | 0.29% 3 | -0.18% 4 | 0.02% 5 | -0.55% 1 | 0.50% |
| 1995-3 | -0.41% 5 | -0.15% 1 | -0.43% 2 | -0.15% 3 | -0.01% 4 | -1.15% |
| 1999-3 | -1.79% 4 | -0.92% 5 | -0.05% 1 | -0.44% 2 | -1.27% 3 | -4.46% |
| 2003-3 | -0.18% 3 | 0.29% 4 | -1.03% 5 | 0.27% 1 | -1.77% 2 | -2.42% |
| Avg | -0.14% | -0.06% | -0.40% | -0.15% | -0.58% | -1.33% |
| SPX summary for Presidential Year 3 1931 - 2003 | ||||||
| Averages | -0.26% | -0.12% | -0.19% | 0.04% | -0.11% | -0.63% |
| % Winners | 42% | 47% | 37% | 47% | 42% | 47% |
| MDD 8/2/1943 5.05% -- 8/4/1999 4.39% -- 8/2/1983 3.33% | ||||||
| SPX summary for all years 1928 - 2006 | ||||||
| Averages | 0.12% | 0.13% | 0.07% | 0.01% | 0.10% | 0.42% |
| % Winners | 62% | 64% | 54% | 49% | 52% | 61% |
| MDD 8/5/2002 8.45% -- 7/31/1933 6.84% -- 8/4/1998 6.19% | ||||||
August
The OTC has been up 82% of the time in August during the 3rd year of the Presidential Cycle with an average gain of 2.6%. There were 2 down years 1975 and 1983, both followed down July's. Over all years the OTC has been up 61% of the time in August with an average gain of 0.6%.
The next two charts plot the average daily return in August for the 3rd year of the Presidential Cycle in green and all years combined in red. The average month has 21 trading days and the charts have been constructed by averaging the daily return of the first 11 trading days and the last 10. Days have been excluded when the month had more than 21 trading days and days in the middle have been counted twice when there have been less than 21 trading days. A dashed vertical line has been drawn after the 1st trading day and at intervals of 5 trading days after that. A solid vertical line has been drawn on the 11th. trading day, the break point.
Since 1931 the SPX has been up 68% of the time in August during the 3rd year of the Presidential Cycle with an average gain of 0.9%. Since 1928, over all years, the SPX has been up 61% of the time with an average gain of 0.7%.
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
809 new lows on the NYSE a week after an all time high in the DJIA is a first (the black swan thing). In one week we have gone from looking at a developing top to looking at a developing bottom. Tops usually take a while to develop with the blue chips making new highs while the secondaries deteriorate. So it would not surprise me to see another all time high in the DJIA before a final collapse. Short term the market is very oversold and I expect it to rally.
I expect the major indices to be higher on Friday August 3 than they were on Friday July 27.
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Last weeks positive forecast based on seasonal strength was a miss.
