The good news is:
• The market staged a strong rally last week recovering all of its losses from the week before.
Short term
A week and a half ago the markets hit a low and recorded the 3rd highest number of new lows on the NYSE. Since then S&P500 (SPX) and most of the other indices have recovered about half of their losses from its all time high last month. There are not many examples of extreme numbers of new lows, but, every time a price decline has been accompanied by an extreme number of new lows there has been a retest of the previous low.
The chart below covers the past 2 months, there are grey dashed vertical lines on the 1st trading day of every week and dashed black lines on the 1st trading day of the month. The SPX is shown in red.
In the 1st week of August there was a low followed by a rally and then a lower low. The SPX has rallied 5.2% or about half of its decline from its July high.
The next chart looks similar to the one above, but it is from 1987.
The SPX hit a high in late August, fell to a low in early September, rallied off the low then fell to a lower low in mid September. From that lower low it recovered over 50% of its loss, the rally high, and that is were the chart ends.
There is a remarkable similarity of current price patterns to those of 1987.
I do not mean to suggest that we should expect a crash, but, at least, a retest of the lows earlier this month is not out of the question.
Intermediate term
The extreme number of new lows that we saw at the price low a week and a half ago implies a retest of those price lows.
The chart below covers the past 100 trading days with dashed vertical lines drawn on the 1st trading day of each month. The NASDAQ composite (OTC) is shown in red and a 10% trend (19 day EMA of NASDAQ new highs is shown in green.
There were not enough new highs in last weeks rally to turn the indicator upward.
The next chart is similar to the one above but ends at the rally high on October 5, 1987. The OTC had recovered to 0.4% off its all time high generating enough new highs to turn the indicator upward.
Small caps have historically been the speculators choice. Recently that preference has shifted to international markets and the most speculative of all is China. In a recent WSJ article a Chinese government official stated that over 70% of publicly traded Chinese companies were worthless.
Last Friday the FXI an ETF of Chinese stocks closed at an all time high.
Seasonality
Next week includes the last 5 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. OTC data covers the period from 1963 - 2003 and S&P 500 (SPX) data from 1928 - 2003. There are summaries for both the 3rd year of the Presidential Cycle and all years combined.
During the 3rd year of the Presidential Cycle, in the coming week, returns have been pretty good. The SPX has been up 74% of the time with an average return of 0.5% and the OTC has been up 64% of the time with an average return of 0.71%. Over all years the average returns have been negative.
Report for the last 5 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 | ||||||
| Day5 | Day4 | Day3 | Day2 | Day1 | Totals | |
| 1963-3 | 0.43% 1 | -0.20% 2 | 0.14% 3 | 0.20% 4 | 0.23% 5 | 0.80% |
| 1967-3 | -0.23% 5 | -0.59% 1 | -0.48% 2 | 0.11% 3 | 0.60% 4 | -0.60% |
| 1971-3 | 0.23% 3 | 0.11% 4 | 0.30% 5 | -0.54% 1 | -0.27% 2 | -0.16% |
| 1975-3 | 0.51% 1 | -0.82% 2 | 0.47% 3 | 1.95% 4 | 1.22% 5 | 3.33% |
| 1979-3 | 0.07% 1 | 0.02% 2 | 0.33% 3 | 0.01% 4 | 0.25% 5 | 0.69% |
| 1983-3 | -0.46% 4 | 0.27% 5 | -0.33% 1 | 0.17% 2 | 0.88% 3 | 0.54% |
| Avg | 0.02% | -0.20% | 0.06% | 0.34% | 0.54% | 0.76% |
| 1987-3 | 0.29% 2 | 0.04% 3 | -0.10% 4 | -0.33% 5 | 0.37% 1 | 0.26% |
| 1991-3 | 0.06% 1 | 0.07% 2 | 0.87% 3 | 0.02% 4 | -0.13% 5 | 0.89% |
| 1995-3 | -0.09% 5 | -1.16% 1 | -0.46% 2 | 0.90% 3 | 0.74% 4 | -0.06% |
| 1999-3 | 1.93% 3 | -1.10% 4 | -0.57% 5 | -1.67% 1 | 0.98% 2 | -0.43% |
| 2003-3 | -0.06% 1 | 0.36% 2 | 0.65% 3 | 1.01% 4 | 0.57% 5 | 2.53% |
| Avg | 0.43% | -0.36% | 0.08% | -0.02% | 0.51% | 0.64% |
| OTC summary for Presidential Year 3 1963 - 2003 | ||||||
| Averages | 0.24% | -0.27% | 0.08% | 0.17% | 0.49% | 0.71% |
| % Winners | 64% | 55% | 55% | 73% | 82% | 64% |
| MDD 8/30/1999 3.31% -- 8/29/1995 1.69% -- 8/29/1967 1.30% | ||||||
| OTC summary for all years 1963 - 2006 | ||||||
| Averages | 0.26% | -0.15% | -0.13% | -0.16% | 0.18% | -0.01% |
| % Winners | 59% | 52% | 57% | 61% | 77% | 61% |
| MDD 8/31/1998 16.63% -- 8/30/2001 6.53% -- 8/30/1966 6.30% | ||||||
| SPX Presidential Year 3 | ||||||
| Day5 | Day4 | Day3 | Day2 | Day1 | Totals | |
| 1931-3 | 1.68% 3 | -0.57% 4 | 1.01% 5 | 0.79% 6 | -1.70% 1 | 1.20% |
| 1935-3 | -2.97% 2 | -0.18% 3 | 0.63% 4 | 0.63% 5 | 0.71% 6 | -1.18% |
| 1939-3 | 2.61% 6 | -1.85% 1 | 2.78% 2 | -1.05% 3 | -1.58% 4 | 0.92% |
| 1943-3 | 0.34% 4 | -0.68% 5 | 0.09% 6 | -0.09% 1 | 1.11% 2 | 0.77% |
| 1947-3 | -1.42% 1 | 0.00% 2 | 0.13% 3 | -0.20% 4 | 0.66% 5 | -0.83% |
| 1951-3 | -0.13% 1 | 0.22% 2 | 0.79% 3 | 0.69% 4 | 0.17% 5 | 1.74% |
| 1955-3 | 0.45% 4 | 0.44% 5 | -0.07% 1 | -0.09% 2 | 0.61% 3 | 1.33% |
| 1959-3 | 0.20% 2 | 0.14% 3 | 0.96% 4 | -0.25% 5 | 0.18% 1 | 1.24% |
| 1963-3 | 0.21% 1 | -0.54% 2 | 0.73% 3 | 0.17% 4 | 0.47% 5 | 1.03% |
| Avg | -0.14% | 0.05% | 0.51% | 0.06% | 0.42% | 0.90% |
| 1967-3 | -0.42% 5 | -0.06% 1 | 0.26% 2 | 0.20% 3 | 0.61% 4 | 0.59% |
| 1971-3 | 0.01% 3 | -0.17% 4 | 0.24% 5 | -0.96% 1 | -0.49% 2 | -1.37% |
| 1975-3 | 0.93% 1 | -1.29% 2 | 0.56% 3 | 2.33% 4 | 0.56% 5 | 3.08% |
| 1979-3 | 0.50% 1 | -0.11% 2 | 0.00% 3 | 0.00% 4 | 0.28% 5 | 0.66% |
| 1983-3 | -0.25% 4 | 0.81% 5 | 0.07% 1 | 0.20% 2 | 1.12% 3 | 1.94% |
| Avg | 0.15% | -0.17% | 0.23% | 0.36% | 0.41% | 0.98% |
| 1987-3 | 1.03% 2 | -0.65% 3 | -0.95% 4 | -1.31% 5 | 0.84% 1 | -1.04% |
| 1991-3 | -0.08% 1 | -0.20% 2 | 0.91% 3 | -0.04% 4 | -0.26% 5 | 0.32% |
| 1995-3 | 0.47% 5 | -0.19% 1 | 0.17% 2 | 0.16% 3 | 0.17% 4 | 0.79% |
| 1999-3 | 1.34% 3 | -1.43% 4 | -1.01% 5 | -1.80% 1 | -0.27% 2 | -3.17% |
| 2003-3 | 0.07% 1 | 0.30% 2 | 0.01% 3 | 0.61% 4 | 0.52% 5 | 1.50% |
| Avg | 0.57% | -0.43% | -0.17% | -0.48% | 0.20% | -0.32% |
| SPX summary for Presidential Year 3 1931 - 2003 | ||||||
| Averages | 0.24% | -0.32% | 0.38% | 0.00% | 0.19% | 0.50% |
| % Winners | 68% | 26% | 79% | 47% | 74% | 74% |
| MDD 8/31/1999 4.44% -- 8/28/1935 3.14% -- 8/28/1987 2.89% | ||||||
| SPX summary for all years 1928 - 2006 | ||||||
| Averages | -0.02% | -0.09% | -0.10% | -0.08% | 0.14% | -0.14% |
| % Winners | 44% | 45% | 59% | 50% | 63% | 59% |
| MDD 8/31/1998 12.39% -- 8/29/1938 6.10% -- 8/29/1966 5.74% | ||||||
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
I am uncomfortable drawing comparisons to 1987 and do not mean to imply that a 1987 style crash is likely. 1987 like 2007 was the 3rd year of the Presidential Cycle and there are similarities in many of the indicator and price patterns. Be careful.
I expect the major indices to be lower on Friday August 31 than they were on Friday August 24.
This report is free to anyone who wants it, so please tell your friends. They can sign up at: http://alphaim.net/signup.html. If it is not for you, reply with REMOVE in the subject line.
Last week's negative forecast was a miss.
