Clif Droke
September 18, 2006
©2002 - 2006 Publishing Concepts

Getting ready for the next bull market

With the 8-year cycle behind us and September seasonal weakness almost over we are within reaching distance of the next meaningful bull market in equities. The stock market will soon once again be the "only game in town" compared to other financial investment areas and the lethargy of the past year will gradually be replaced by excitement as the next bull market commences in the fourth quarter and continues into what should be an exceedingly bullish 2007.

It has been two full weeks since the latest major trading cycle has bottomed. Since that time the major indices and financially sensitive stock market sectors have gradually firmed up and are actually showing signs of wanting to move higher into the fourth quarter. The internal indicators (price oscillators) are still mostly in an "overbought" status, which makes a move higher from here without a corrective pullback or pause a low probability. But beyond a short-term "hiccup" we should continue to see improvement in the stock market in the upcoming weeks.

The most important "heads-up" signal for the market's next move seems to be coming from the overall NYSE hi-lo momentum indicator. This particular indicator is a simple rate of momentum measure of the net number of 52-week highs on the NYSE from a 30-day, 60-day and 90-day rate of change basis. For the past few weeks the 30-day and 60-day hi-lo indicators have been moving higher almost every day and both are in positive territory. Only the 90-day hi-lo indicator has lagged behind and is still in negative territory. This has been the missing ingredient to the stock market really taking off on the upside up until now, for the 90-day rate of change indicator in *any* internal momentum measure is the dominant bias indicator (just as the 90-day moving average of price in a stock market index, such as the Dow, is considered the dominant interim bias indicator). By the time October rolls around, however, the 90-day NYSE hi-lo indicator will have turned around and accelerating its advance as it enters positive territory in a few weeks.

This will present a favorable backdrop to the equities market and allow for the best positioned stocks (namely those showing relative strength and strong earnings momentum) making higher highs in the upcoming months. It should also continue to present quite a few turnaround opportunities for us as the stocks that have been hardest hit since April/May (mainly among the NASDAQ stocks) should be able to participate in this rally.

Speaking of the tech stocks, once the market becomes more settled (presumably sometime in October) and the bullish seasonal bias kicks in I expect the NASDAQ to lead the way higher with many major tech industries soaring to higher levels. Along these lines there is an interesting chart showing the trend of DRAM prices, which in turn tend to lead the overall NASDAQ sectors at major tops and bottoms. After a nasty decline in 2004 and 2005, DRAM prices have bottomed out and since April of this year have turned up, including the 50-day and 200-day moving averages of the DRAM Index. Here you can see this rather stunning chart, reprinted with Don Hays' permission. It bodes extremely well for the intermediate-term outlook for the tech stock sector.

Another clue that the market's next broad move beginning sometime in the fourth quarter will be to the upside is provided courtesy of trading volume patterns on the NYSE. One July 19 the upside-to-downside ratio of trading volume on the NYSE was 10:1 in favor of upside volume. This same 10:1 ratio was also seen earlier this summer. Marty Zweig used to call a relatively rare 10:1 positive volume day a "volume blast-off" signal. By this he meant that a 10:1 volume ratio underscored the fact that the insiders were so heavily loading up on stocks that a major upside move was a virtual guarantee, and usually one lasting several months. With two volume blast-off days in the market's quiver this summer, it's only a matter of time before the next sustained bull market gets underway.

Market psychology is an important backdrop to any bull market, and you've all heard the adage that bull markets climb a proverbial "wall of worry." That much-need background of fear and worry (from a contrarian standpoint) is still very much present in this current market environment. In fact, the fear in some quarters is so thick you could cut it with a knife. The cumulative bull/bear statistics adequately show this bearish sentiment and have done so for weeks on end.

To take one example, the flow of funds into the Rydex series of mutual funds has been decisively downward since January of this year even as the S&P 500 has risen in recent months. This positive divergence of price-to-bearish bets on the stock market harbingers higher prices ahead for the broad market, including the Dow 30 and S&P 500 indices. Note the chart below showing the comparison of the S&P to the Rydex Ratio from Carl Swenlin's Deciosionpoint web site.