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Technical Market Report

The good news is:
• The news cannot get much worse.

Short Term

I think we are in a developing top that is in its final stages. In the next week or two there is likely to be an all time high in the Dow Jones Industrial Average (DJIA) and the S&P 500 (SPX), and a multi year high in the NASDAQ composite (OTC). If my interpretation is correct there will not be a new high in the Russell 2000 (R2K).

Intermediate Term

The typical pattern for developing tops is for all of the major indices to reach new highs at the same time followed by a decline and return to new highs for the blue chips but, not the small caps. The time between the first high and the final high in the blue chips is usually around 6 weeks but, it can vary by quite a bit. In 1998 there was a high in all of the major indices on April 22 followed by a dip that bottomed in June and a return to new highs in the blue chip indices and OTC 60 trading days later on July 17.

The chart below covers the period from April 22, 1998 to July 17, 1998 showing the SPX in red the OTC in blue and the R2K in magenta, dashed vertical lines have been drawn on the 1st trading day of each month. The OTC and techs were hot at the time and that index along with the SPX hit all time highs on July 17 while the R2K did not.

It has been 50 trading days since the July 19 high this year. Like the 1998 period between highs the SPX and OTC have outperformed the R2K but so far they have not surpassed their July highs. The NDX, the large cap component of the OTC did hit multi year highs last week.

The chart below is similar to the one above except it covers the period from the July high through last Friday.

During the period between highs in a developing top, breadth indicators deteriorate.

The chart below covers the past 9 months showing the OTC in blue and a 10% trend (19 day EMA) of NASDAQ new highs (OTC NH) in green. OTC NH has been rising but, it is well below its high in July which was slightly below its late February high.

The next chart is similar to the previous one except it covers the period leading up to the July 1998 high and includes several days following the high. At the July high OTC NH was well below its April high and the April high was below an earlier high. (fewer new highs as the index rose)

The NYSE Advance - Decline Line (NY ADL) is the longest running breadth indicator we have. It hit an all time high in March 1956, a record that held until 2004. Since the dip in early 2003 following the 2002 bottom the NY ADL has been suspiciously strong but, ultimately correct in forecasting the market strength of the past 4 years.

The chart below offers a perspective on that "suspicious" strength.

It covers a little over 50 years from February 1956 to last Friday showing the SPX in red and the NY ADL in green, dashed vertical red lines have been drawn on the 1st trading day of each year.

The chart below covers the past 9 months showing the NY ADL in green and the SPX in red. NY ADL hit its all time high around June 1, 2007, it was slightly lower and failed to confirm the mid July SPX high and continues to lag the index.

In 1998 I had a great deal of confidence in the NY ADL and it clearly failed to confirm the July high.

If the market was rising from a bottom in August the secondaries would be leading and the breadth indicators would be strong, they are not. The patterns we are seeing are consistent with a developing top.

Seasonality

Next week includes the first 5 trading days of October during the 3rd year of the Presidential Cycle.

The tables show the first 5 trading days in October during the 3rd year of the Presidential Cycle. OTC data covers the period from 1963 - 2003 and SPX data from 1928 - 2003. There are summaries for both the 3rd year of the Presidential Cycle and all years combined.

The first 5 trading days in October are fairly strong and, during the 3rd year of the Presidential cycle they are a little stronger than the average for all years.

First 5 days of October.
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
  Day1 Day2 Day3 Day4 Day5 Totals
1963-3 -0.32% 2 -0.14% 3 -0.12% 4 0.29% 5 -0.26% 1 -0.55%
1967-3 0.26% 1 -0.08% 2 0.21% 3 0.46% 4 0.32% 5 1.17%
1971-3 0.50% 5 0.35% 1 0.03% 2 0.63% 3 0.27% 4 1.78%
1975-3 -0.71% 3 0.49% 4 1.81% 5 0.70% 1 -0.20% 2 2.09%
1979-3 -0.26% 1 0.28% 2 0.33% 3 0.60% 4 0.57% 5 1.53%
1983-3 -0.68% 1 0.06% 2 -0.08% 3 0.41% 4 0.53% 5 0.24%
Avg -0.18% 0.22% 0.46% 0.56% 0.30% 1.36%
 
1987-3 0.94% 4 0.70% 5 0.45% 1 -1.35% 2 -0.64% 3 0.10%
1991-3 0.31% 2 -0.41% 3 -1.11% 4 -0.02% 5 -0.81% 1 -2.04%
1995-3 -1.52% 1 -0.69% 2 -1.78% 3 1.19% 4 -0.22% 5 -3.03%
1999-3 -0.34% 5 2.16% 1 0.13% 2 2.05% 3 0.12% 4 4.13%
2003-3 2.54% 3 0.22% 4 2.42% 5 0.69% 1 0.76% 2 6.61%
Avg 0.38% 0.40% 0.02% 0.51% -0.16% 1.16%
 
OTC summary for Presidential Year 3 1963 - 2003
Averages 0.07% 0.27% 0.21% 0.51% 0.04% 1.09%
% Winners 45% 64% 64% 82% 55% 73%
MDD 10/4/1995 3.95% -- 10/7/1991 2.33% -- 10/7/1987 1.98%
 
OTC summary for all years 1963 - 2006
Averages 0.01% -0.02% 0.10% 0.13% 0.01% 0.23%
% Winners 53% 57% 59% 64% 61% 64%
MDD 10/7/1998 13.65% -- 10/6/2000 8.49% -- 10/7/2002 7.77%
 
SPX Presidential Year 3
  Day1 Day2 Day3 Day4 Day5 Totals
1931-3 -1.85% 4 1.78% 5 -3.40% 6 -5.87% 1 12.36% 2 3.02%
1935-3 -0.95% 2 -3.31% 3 1.44% 4 0.89% 5 0.70% 6 -1.23%
1939-3 -1.08% 1 -0.85% 2 0.16% 3 0.23% 4 -0.16% 5 -1.69%
1943-3 0.08% 5 -0.08% 6 -0.50% 1 -0.42% 2 -1.17% 3 -2.08%
 
1947-3 0.33% 3 0.07% 4 0.46% 5 0.13% 6 0.13% 1 1.12%
1951-3 0.90% 1 0.72% 2 0.63% 3 -0.29% 4 0.25% 5 2.22%
1955-3 -2.70% 1 0.78% 2 0.40% 3 -0.67% 4 -0.75% 5 -2.95%
1959-3 0.11% 4 0.46% 5 -0.10% 1 -0.09% 2 -0.26% 3 0.11%
1963-3 0.73% 2 0.11% 3 0.73% 4 0.03% 5 -0.21% 1 1.39%
Avg -0.13% 0.43% 0.42% -0.18% -0.17% 0.38%
 
1967-3 -0.40% 1 0.34% 2 -0.23% 3 0.25% 4 0.61% 5 0.57%
1971-3 0.60% 5 0.28% 1 -0.10% 2 0.72% 3 0.20% 4 1.70%
1975-3 -1.12% 3 1.07% 4 2.54% 5 1.08% 1 -0.13% 2 3.45%
1979-3 -0.70% 1 0.95% 2 0.00% 3 0.53% 4 1.00% 5 1.78%
1983-3 -0.16% 1 0.28% 2 0.88% 3 1.51% 4 0.31% 5 2.82%
Avg -0.36% 0.59% 0.62% 0.82% 0.40% 2.06%
 
1987-3 1.71% 4 0.23% 5 0.00% 1 -2.70% 2 -0.21% 3 -0.98%
1991-3 0.35% 2 -0.24% 3 -0.98% 4 -0.84% 5 -0.46% 1 -2.17%
1995-3 -0.46% 1 0.11% 2 -0.15% 3 0.20% 4 -0.02% 5 -0.33%
1999-3 0.01% 5 1.70% 1 -0.25% 2 1.84% 3 -0.58% 4 2.73%
2003-3 2.23% 3 0.20% 4 0.94% 5 0.44% 1 0.47% 2 4.29%
Avg 0.77% 0.40% -0.09% -0.21% -0.16% 0.71%
 
SPX summary for Presidential Year 3 1931 - 2003
Averages -0.13% 0.24% 0.13% -0.16% 0.64% 0.72%
% Winners 53% 79% 53% 63% 47% 63%
MDD 10/5/1931 9.17% -- 10/2/1935 4.23% -- 10/7/1955 2.95%
 
SPX summary for all years 1928 - 2006
Averages 0.11% 0.21% 0.15% -0.16% 0.33% 0.64%
% Winners 49% 69% 53% 55% 55% 63%
MDD 10/5/1932 9.33% -- 10/5/1931 9.17% -- 10/7/2002 7.39%

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.

October

Since 1928 the SPX has been up 59% of the time in October with an average gain of 0.3%. During the 3rd year of the Presidential Cycle the SPX has been up 47% of the time and on average it has been flat. In October 1929 the SPX was down 19.4% and 1987 it was down 23.1%. 1929 was in year 1 of the Presidential Cycle and 1987 like this year was in year 3 of the Presidential Cycle. The best October ever for the SPX was 1974, up 16.6%.

Since 1963 the OTC has been up 58% of the time in October with an average gain of 0.9%. During the 3rd year of the Presidential Cycle the OTC has been up 55% of the time with an average loss of 2.4%. October 1987 was the worst month ever for the OTC, down 27.9%. The best October ever for the OTC was also 1974, up 17.6%

The charts below show plots for an average October over all years and during the 3rd year of the Presidential Cycle. The number of trading days in the month varies, but, on average, there are 21. The charts have been calculated by averaging the return for each of the 1st 11 trading days and the last 10. There are dashed vertical lines drawn after the 1st trading day and at each 5 trading days after that. A solid vertical line has been drawn at the 11th trading day, the dividing point. Any daily move more than 2% has been has been calculated at 2% to minimize the effect of the crashes of 1929 and 1987.

The first chart shows the OTC for all years in blue and the 3rd year of the Presidential Cycle in green.

The next chart is similar to the one above except is shows the SPX for all years in red and the 3rd year of the Presidential Cycle in green.

The next chart is similar to the first two except it shows the DJIA for all years in black. I included this chart because the data goes back to 1885 and the patterns are similar to those in the charts above.

Conclusion

Since the July highs, breadth indicators have deteriorated and the secondaries have underperformed. This pattern is consistent with a developing top. To fill out the pattern there should be new highs in the blue chip indices but not the secondaries. With the help of seasonal strength, next week would be the ideal time frame for new blue chip highs. After next week the seasonal pattern for October during the 3rd year of the Presidential Year deteriorates.

I expect the major indices to be higher on Friday October 5 than they were on Friday September 28.

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 the blue chips were up and the secondaries were down so I am calling last weeks negative forecast a tie.

 

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