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The Quarter Ahead
AT A GLANCE: The Goodman Price/Volume Stock Selection System (GPS) bought three stocks and sold two. My working hypothesis for the first quarter of 2005 has been created and is discussed below. It is based on Bollinger Bands, the Smart Money Indicator, the AAII, the Trend Indicator and the Summary Index, all of which are moving similarly to their moves in late 1999 and in 2000. For the short term, both the Price/Volume Charts and the Summary Index are getting ready to produce buy signals. The Goodman Price/Volume Stock Selection System (GPS) selected one buy and two sells in the GPS S&P 100 Portfolio and two buys in the GPS NASDAQ 100 Portfolio. S&P 100
Sells
NASDAQ 100
Today marks the first sells since I started publishing the results of GPS on Monday, so let me remind you that this is a long only system. It does not identify stocks to be sold short -- so all sells are for stocks already held in one of the portfolios. Under GPS, a stock to be sold is simply no longer technically strong -- that's very different than saying it is technically weak. Short-selling will be a subject for future research and enhancement of the strategy. We have added a Frequently Asked Questions page for GPS in which I respond to some of inquiries I've gotten from readers. Always feel free so send me your questions via email. The complexion of the market is certainly different now than it has been during the last two months following the October 25 low. I always attempt to visualize, and to put into words, what I expect the market to do in the weeks ahead -- a working hypothesis if you will -- even though I know that there will be frequent changes as the future unfolds. Today I will show some charts that have helped me develop my expectations. But first, lets look at the indicators. On net, one neutral indicator moved to negative yesterday. We now have 18 negative indicators, just one away from the 19 necessary to set up for a Quick Summary Index buy signal, which will occur when the number of negative indicators drops to 16 or below after reaching 19 or more. The totals are now 18 negative, 8 neutral and 3 positive. The Summary Index stands at 8.95, down from 9.8 a day ago. It will drop to 5.05 in a week if there are no further changes by the indicators. Not only that, but if there are no changes through next Friday's close, the SI will end up at 4.3 and will therefore be below the buy signal trigger level at 4.5. Once there, a buy signal will be produced by any rally that raises a few indicators, enough to move the SI back above 4.5. Furthermore, since there are now only 3 positive indicators, a Quick Summary Index buy signal can also occur when the number of positive indicators rises to 7 or more. As a result, a buy signal is just a matter of time. It could take more than a week, but my guess is that it will happen within a day or two of January 15, if not before. Since the Trend Indicator is in an Uptrend and continues to advance, when the SI buy signal occurs, we will buy SPY and QQQQ for the Technical Trading Model Portfolio and Portfolio "Q" in the amount of 200% of equity.
The S&P 500 50-day moving average closed at 1181.50 on Thursday and the S&P 500 bounced before engaging the average, just as expected. It closed at 1187.89. Today, the average will advance to 1182.75 if the index remains unchanged, and it will take just a 5 point decline to penetrate it. The 200-day moving average reached 1130.72 and will continue to advance unless the S&P 500 closes below 1150 within the next two weeks. Part of my working hypothesis is based on the moving averages. I do not expect to see penetration of the 200-day moving average at this time. From its close yesterday at 1130, the average will rise to 1133 over the next two weeks.
The S&P 500 14-day Relative Strength Indicator (RSI) moved back up to 39.5% yesterday and will close above 40% today unless the S&P 500 declines more than 9 points. The indicator is still following the script written last March, and I expect to see the market advance just as it did then, after this correction plays out its hand. The fact that there will be either an SI or QSI buy signal within the next week or two supports the possibility that there will be a significant advance thereafter, just as there was in March.
The S&P 500 Price/Volume Chart has positioned itself so that a clockwise basic buy loop can be completed anytime over the next several days, by a move in the direction of the green arrow. We got the low volume rally that we needed to make this possible. Since volume is usually low on Friday and Monday, it is likely that the buy loop will not be completed before Tuesday. We don't know for sure, but if it happens, the Quick Summary Index buy signal will probably occur at the same time as the number of positive indicators exceed 6.
The NASDAQ Price/Volume Chart is in the same situation.
The NASDAQ Long Term Price/Volume Chart has already completed and confirmed a bullish, clockwise false reversal. The long term charts are posted using the 5-day moving averages of the price, rather than the daily values themselves. They generally are a bit more reliable than the 1-day, and usually precede longer rallies.
The Dow Price/Volume Chart caught up to the others and can produce a buy loop as indicated.
Here is the Dow Long Term Price/Volume Chart. It has not yet completed a loop, but the one it's working on is different from that of the NASDAQ. The green arrow will complete a counterclockwise continuation buy loop, while the red arrow will complete a basic sell loop. So the Dow is the index to watch closely over the next few days. If volume increases, the index better advance if we are to see the end of this pullback.
Back in the 1999/2000 holiday season the Dow was doing much better in the first week of January than it did this week. There was also a huge rally on the first Friday of that year. I do not expect to micro-follow 2000 any longer, but after the rally that I anticipate for this quarter, there are likely to be serious pullbacks just as there were then.
Gold can still complete the clockwise buy loop drawn below, but Thursday's decline does make it somewhat less likely. Also, the fact that gold declined as the Dollar Index advanced makes it quite likely that the decline will continue since gold usually rises as the dollar declines.
The Smart Money Indicator (bright blue line) lost another 32 points and appears to be accelerating to the downside.
Here is the Smart Money Indicator going back to 1997. Notice the free fall that started in mid-September 1999. At that time the indicator declined 5300 points while the S&P continued to advance. This is both disquieting and a relief at the same time. Disquieting because the market fell for the next two years, and a relief because the market rallied from September 1999 through late March 2000 and didn't really start its major slide until the following September. The parallel between the present market and that occurring at the end of the bull market is apparent in the response of several indicators. I think it is important that we try to get as much as possible out of the next three months then, as spring begins we can become more cautious -- that is my working hypothesis, and of course, it is subject to modification as events play themselves out.
The members of the American Association of Independent Investors (AAII) became very scared by the events of the week, and who can blame them. However, as usual their bullishness was at its height last week, just before the decline occurred. Contrast that with our profit taking in tax-advantaged accounts last Friday and our sales in taxable accounts on Monday. Note too that there is a similarity between the current decline from above the 70% level and the one that occurred at the beginning of 2000.
Another parallel between now and late 1999 is the action of the Bollinger Bands. In the next chart I have constructed the bands, which are simply two times the standard deviation of the daily average of any measurement added to, and subtracted from that average. I have applied the calculation to the daily CBOE put/call ratio. Note that the bands were very close together in the early part of 2000 and that were pulled apart as the market topped out later that year. This shows an increase in the volatility of the put/call ratio. Currently the bands are once again quite close together, and will pull apart when this market turns down.
The distance between the upper and lower Bollinger Bands -- the bandwidth -- is plotted above as the brown line at the bottom of the chart, and it is enlarged in the chart below. It clearly shows how narrow the bandwidth was on this date in 2000 (black arrow) and how it expanded as the market bubble burst. Since the end of the bear market, the bandwidth has reached a high point at every market bottom and reached a low point at every market top. It is now close to the lowest point in three years and it will be a bearish event if those lows are taken out. The good news is that it is considerably above the lows reached in early 2000. This fits with the hypothesis that calls for a rally during the first quarter and a slide thereafter.
Fred Goodman, CFP, is a fee-only Certified Financial Planner based in Los Angeles. You can send him your questions and comments via email at Fred@MarketMonograph.com. Emails sent to Fred may be published on this web site edited for clarity and brevity, and including your name unless you specify anonymity or not for publication. The charts and commentary represent what Fred is thinking about the market and thinking of doing for his own account and for accounts he manages at the time of writing. Fred, his clients, or his family may have positions or make trades in securities mentioned in these commentaries. Mutual funds mentioned by Fred may be advised by institutional consulting clients of Trend Macrolytics LLC; Fred has no economic interest in such business relationships. There is no guarantee that you will profit from trading as discussed herein. You may lose money and both Fred and Trend Macrolytics LLC assume no responsibility for what you do or do not do with this information. Copyright 2001, 2002, 2003, 2004, 2005 and 2006 Fred Goodman and Trend Macrolytics LLC. 
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