The Bear Market Report: Dow working through pocket of weakness
Stock Update
August 12, 2002
Industrials: 8688
NASDAQ: 1306
Critical underlying support: 8500
Critical overhead resistance: 8750
As expected, the Dow was unable to overcome its 40-day moving average on Monday, instead closing down 56 points at 8688. After its explosive rally last week the Dow is due a minor retracement, its first test will probably be underlying 20-day moving average around 8400. The 40-day moving average has lowered to around 8750 which now becomes the critical overhead resistance for the Dow, a level which the Dow should close above that will signal the minor set-back is over.
An ideal scenario for the Dow this week based on short-term cycle considerations is for a 3-4 day pullback which, provided the recent lows near 8000 hold, would reverse Friday or next Monday and catapult the Dow into the final rally of the summer. The weakness in the tech sector hasn't been fully worked out yet, and before it is the market won't be primed for a significant rally. A few more days down for the techs should be sufficient to take out the immediate overhead supply and allow for a tradable rally. A true broad market rally must have the participation of the tech sector in order to be confirmed.
A subscriber asks, "I would like to know if we have already seen the lows of the year on July 24, especially in the S&P 500, or if the low point of the year is still to come later in Q4, for example. And if yes, how high is the percentage chance that we will see a new low for the year in the S+P 500 later this year (before Dec. 31)? 50%, 75%, 90%?"
Answer: The verdict is always out where the market is concerned - that goes without saying. Therefore we really don't know whether the Dow and S&P have seen their lows for the year yet. What we've seen over the last year is two emotional downside extremes, that is, two market panics that overshot their cyclical boundaries (namely Sept. 2001 and July 2002) and were exacerbated by extreme fear. In both cases a bottom was found somewhere near the 8000 level on extremely high volume. This makes the area between the 2002 lows around 7600 and the 2001 lows around 8000 a powerful "volume support" area that will take a tremendous effort on the downside to break this year, so soon after it has been established. Since the 4-year and 12-year cycles are due to bottom in early November and another big seasonal decline is expected around that time, there is a chance this supporting floor (7600-8000) could be broken, but we won't know until we approach closer to mid-September when the last of the short-term and interim cycles peak, followed by the magnitude of the initial decline.
On a stock-by-stock basis, the Dow 30 is split down the middle in terms of the relative strength (short-term) or weakness of the various components. The bluer of the blue chips have bottomed in the middle of their respective parabolic bowls (most of which have formed since April-May). As we've discussed many times before in the newsletter, a mid-point bottom within a bowl pattern is usually a sign of technical strength and often precedes a strong rally. Whenever the price line bottoms to the right-of-center of the bowl, it indicates weakness and usually precedes another leg of decline.
The following Dow 30 stocks show mid-point bottoms and have greater rally potential this month: Coca Cola (KO), Eastman Kodak (EK), Exxon Mobil (XOM), Du Pont (DD), Honeywell (HON), and General Electric (GE), Wal-Mart (WMT), and Johnson & Johnson (JNJ).
The following Dow components show greater-than-average weakness and have bottom to the right of their respective parabolic mid-points: Hewlett Packard (HPQ), Home Depot (HD), International Paper (IP), International Business Machines (IBM), Intel (INTC), Microsoft (MSFT), and J.P. Morgan (JPM).
Although it still has one final pocket of immediate-term weakness to work off before it becomes official, the stock sector that in our estimation looks the strongest is the biotech sector. There is a nice reverse head and shoulders in the Amex Biotech Index (BTK), showing upside potential to at least 450 in coming weeks (currently 383). Closing above 390 would confirm the breakout. This reverse H&S pattern is a theme that is repeated in many individual biotech stocks.
A nice bowl-shaped H&Spattern is visible in the daily chart of Myriad Genetics (MYGN) and the stock even managed a nice up-close by nearly 4% on Monday, a day marked by overall tech stock weakness. The close above $25 is the breakout point of the bowl pattern; however, be advised that whenever a stock breaks above the top of a bowl-shaped pattern it is usually followed by an immediate pullback so that the stock can gather its strength for the next rally leg. As long as Myriad does not close below $24 this week we consider this stock a strong short-term rally candidate.
Another similar rally candidate with a H&S-type pattern in its daily chart is Medimmune Inc. (MEDI). MEDI may be purchased on its next high-volume close above $31. Note that its rising 20-day moving average has crossed above the 40-day average, a preliminary rally signal. The official confirmation will occur when the 40-day moving average turns up.
The reverse head and shoulders is turning up in more places than just the biotechs. Even select retail stocks have this conspicuous pattern in their charts. One example is Borders (BGP), which should be considered a buy once it closes above $18. Its 20-day and 40-day moving averages are showing signs of reversing and the neckline in its H&S pattern is very distinct along the $18 level.
XAU Update
Closing Price: 65.49 (-0.97%)
Critical underlying support: 65
Critical overhead resistance: 70
The XAU traced out a lower low on the tick chart on Monday, indicative of weakness. There is a cycle channel converge in the tick chart which strongly suggests a decisive breakout, either up or down, will take place on Tuesday. The upside breakout point is 66.50 while the downside breakout point is 65. Odds favor a weak first part of the session with intra-day lows possibly as low as 63.50. This is where a 5-day upward trend line intersects.
As we pointed out on Friday, the XAU's 40-day average is currently near 70, which also happens to be the level at which the XAU failed and sold off last month. This is approximately also where the XAU's primary line of supply crosses. Therefore the XAU can't be considered fully "out of the water" until it closes above 70.
Traders be warned, there is what appears to be a bearish "flag" pattern, characterized by an anemic rally on declining volume, in the following gold stocks: ASA Ltd. (ASA), Barrick Gold (ABX), and Placer Dome (PDG). These stocks should be avoided for now, unless to sell short.
The next issue of the newsletter will be the Mid-week Update, to be published on Wednesday, August 14.
--Clif Droke
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email: clif@clifdroke.com
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