The Ides of October: A warning

"He has all the virtues I dislike and none of the vices I admire."

-Winston Churchill

I started this Alert with the intent to have it out on October 1, but things kept interrupting me and it consistently got postponed. Since my expected reversal time is next week, maybe the market gods just figured it may be more appropriate to let most of this week get out of the way first.

On July 17, I wrote a Special Alert entitled “The Ides of July.” In that Alert, I stated the following: In the Roman calendar, the Ides of March was a term used to denote March 15. In general, the Ides fell on the 15th day of the months of March, May, July or October, or the 13th day of any other month. The term is still used in a colloquial sense to denote the middle of the month. In modern times, the term is best known because Julius Caesar was assassinated on the Ides of March in 44 BC. The term has come to be used as a metaphor for impending doom.

That Alert pegged the market top on July 19 to the day. I was fortunate to comment that I expected the market to have support at 1370 when a number of people called in after the market began the nasty decline that bottomed on August 16 at 1370.60. Those were two great calls and a wise man would go hide in a cave for a few months to keep the track record in tact. Unfortunately, I am getting a lot of concerned calls about “October” as it is no secret that October has a nasty history with respect to the stock market – hence, The Ides of October title for this Alert (so far, its been great).

Note the quote from Winston Churchill “He has all the virtues I dislike and none of the vices I admire." That is roughly the way I feel about the market at this point. Regarding the bearish side, it is certainly not difficult to find a good deal of bearish opinions (at least for the big picture). The bears focus on the war, debt, the weak dollar, lack of leadership and other things too numerous to list. There is also no shortage of bullish opinions. The bulls focus on the economy, earnings and, basically, a much shorter list. What makes this juncture so difficult are the crosscurrents – even in the same indicator. For example, the VIX indicator gave a monthly buy signal at the end of September. Monthly signals in the VIX can be huge. Just look at the chart below. The last signal was a buy in June of 2006 – the market never went lower and the Dow Industrials are up 32% from that point.

The prior signal is October 2002 – the absolute bottom of the bear market. September 2000 was the market top for the S&P 500 Total Return. Again, many of the signals are nothing short of spectacular. At the same time, the VIX daily indicator was close to giving a sell signal at the end of last month. The weekly VIX is in middle ground. The point is the signals are mixed. Hence, “all the virtues I dislike and none of the vices I admire."

The recent surprise rate cut by the Fed and overwhelming liquidity expansion are viewed in a similar schizophrenic manner. Was it the saving grace for the subprime loan market or will it usher in inflation, a credit crunch and a continuous dumping of the dollar? Ultimately, the answer may be ‘all of the above’. Let’s look back to last summer and make some comparisons to determine the “value” of the market at its current level. At last summer’s lows, the DJIA was at 10,683 and the S&P was at 1219. A year ago, oil was at $68 (later fell to below $50); gold was at $546; silver was at $9.45; copper was at $3.00 (later fell to below $2.40); and wheat was at $3.57. There was no problem with the real estate market and the mortgage industry was thriving. Stepping back into the present, the DJIA is at 14,060 (+31.6%); the S&P is at 1556 (+27.6%); crude oil is at $80.78 (+60% from the beginning of this year); gold is at $744 (+36.3%); silver is at $13.50 (+42.5%); copper is $3.72 (+55% from early this year); and wheat was at 960 just a few days ago (+169%). The average increase going back no further than the stock market low of last summer for these items is over 50%. Oil is up 60% and wheat is up 169% -- almost everyone is affected by these two commodities – do you think inflation might be a possibility?

What do you suppose the effect will be on the profits of the companies that have to buy these items? Does it seem that the market is a better value being up over 30% (DJIA) and the prices of these popular commodities up well over 50% in a rather short period of time? About 70% of the market is consumer driven. These consumers can no longer use the mortgage market like an ATM card because they can’t get loans any longer. Now they are facing higher prices with a weaker dollar. Nonetheless, the market has been quite robust since the Fed’s recent actions. As they say, “Don’t fight the Fed.”

Let’s revisit the Decennial pattern chart. This chart is the average of all the years ending in “7” since 1897, as compiled by Peter Eliades (www.stockmarketcycles.com). The reason this chart is important at this time is that October 3 marked the day before the precipitous decline for the years ending in 7. The average decline between October 3 and November 8 of years ending in the digit 7 since 1897 is 14.2% on a closing basis. That should get your attention. Of the 11 previous years ending in the digit 7, there was only one year that saw an advance between those two dates and the advance was a wimpy 1.7% in 1947. The declines between those two dates have been -13.2%, -16.2%, -17.9%, -3.9%, -19.5% -6.6%, -7.8%, -3.6%, -25.8%, and -5.6%. This is the most compelling time of any decennial year.

Let’s view a few more charts and see if we can derive anything from them. The Dow Jones Industrials chart below is interesting because the Dow Jones Industrials have been leading the market. My longer-term work has next week as a potential turning point. It didn’t set up perfectly as it did July 19, but there was decent convergence for next week.

With all of the other factors such as seasonality; the decennial pattern; the expectation for lower lows in the next month or so from the 4 years cycle to the history of what follows a spike in new lows such as on August 16th – there was enough to issue a warning. My turning date work is proprietary and I don’t show those charts, but this chart has a target of 14,350 (yellow circle) and a lower resistance area beginning at about 14,160.

When it comes to the degree of the expected correction, I hasten to remind everyone that we have to get the correction first. Since there is such overwhelming history with the decennial pattern, which indicates an average decline of 14%, one has to be very leery for what could happen. The weekly charts are in position to set up a divergent sell signal and the market breadth is diverging as well. The NYSE breadth is moving into a meaningful trend line right now that should provide serious resistance and the NASDAQ breadth is anemic for the longer term, but improving in the short term. In fact, since many traders look for leadership from the NASDAQ to signify market strength, it only makes sense to look at the NASDAQ Composite chart to see if it is giving any clues.

To be fair, the NASDAQ Composite chart looks impressive. It has rallied 389 points from its August 16 low – that’s 16.3% in about six weeks – I’m impressed. It is important to take into consideration that we had a “spike in new lows” to make that August 16 bottom. That translates to a serious oversold extreme – nonetheless, this is an impressive rally and it has just broken out. Also note that my indicator in the lower part of the chart has reached a buying pressure level that is the highest level on the chart – again, impressive. Now look at those white lines on the chart. They represent the angle of ascent for the current rally …. And, for the prior two advances in this rally from July of last year. Note that it is this angle of ascent that ended the prior two rallies. My assessment is that it is this same angle of ascent (and my turn date next week) that will end this current rally. Giving this argument a bit more credence is the AAII (American Association of Individual Investors) weekly reading of Bulls and Bears. Currently, the Bulls are at 51.8% and the Bears are at 25.3%. The last time the bullish reading was above 50% was February 22 of this year. That was the top of the first wave and was immediately followed by the largest correction of the rally to that point. Investors Intelligence (30 Church St., PO Box 2046, New Rochelle, NY 10801) reports that 56.5% of investment advisors are bullish, the second highest reading of the year.

Peter Eliades points out that there are cyclical reasons for expecting a top in this time frame as well. In his recent update, Peter states “three of the most important market turning points of the past 15 years were the April 1994 bottom, the October 1998 bottom and the March-April 2003 basing formation following the October 2002 bottom. Those important turning points are separated by almost exactly 54 months. 54 months would be represented by 1643-1644 calendar days but let's simply use a 54 month time span and count forward from the April 1, 1994 bottom. The next resolution would be scheduled for early October 1998. October 1st, 1998 marked the exact closing low before the final thrust upward that carried the market upward into its January-March 2000 Major tops. The next 54-month span was due to resolve in early April 2003. The actual test of the 2002 lows occurred in March 2003 but after the initial sharp rally, there was a final significant pullback into April 1, 2003 before the market took off in earnest to the upside. Of course, moving forward another 54 months takes us to early October 2007. In case you have not been paying attention, the Dow Jones Industrial Average moved to a new all-time high on both a closing and intraday basis three days ago on October 1, 2007. The 54 month time span strongly suggests we can be looking for an important turn in this exact time zone.”

As compelling as all this may be, we still have to be aware that there are bullish factors, too. So far, my long-term indicator and my monthly and weekly indicators are still on buy signals. Even with today’s robust action, my daily charts appear to be setting up for a sell signal. Looking at the S&P chart that follows, I have a wave count on the chart that would suggest we might be in the final rally that leads into the expected correction. The inverted head and shoulders pattern projects to 1565, which could be a likely minimal target.

For the bulls in the crowd, I have an alternate count that could go much higher. It is important to remember that even if we do get the correction I am expecting, my assumption is that it will set up a remarkable buying opportunity. The real question is “When will this correction begin and how deep will it be?” Always the hard question (and I’m dumb enough to bring it up). If this is “the” fifth wave of this pattern, then it should be the largest correction of the pattern. The prior correction was 185 point, so this should be larger. If the market goes to 1565, then a 50% correction is at about 1392. However, that would not be the largest correction of the entire rally. A 61.8% correction would take the market to 1350 or so and that would be the largest correction and would be below the spike low of 1370. That stated, I have no idea what this market will do, as it seems to be getting a lot of assistance from the Fed and the ever so mysterious “Plunge Protection Team.” I am going to look for my point next week and watch very closely to see if the market chooses to confirm (or deny) my expectations.

Source - Dow Jones

The chart above is the stock market (Dow Jones Industrials) in Gold. It shows the bull market into 2000, but the bear market that followed hasn’t ended. Where is that 5-year bull market that we have all been enjoying? Beware: Pricing things in terms of the US Dollar could bring about side effects of irrational exuberance. Pricing things in gold provides a certain depth of reality. We are in a world that isn’t very interested in reality, but my advice is to keep an eye on this chart. In my experience, reality isn’t something you want to get too far away from – it has a habit of returning just when you least expect it.

In conclusion, I am expecting a top next week. Note: that is “a” top, not necessarily “the” top. I realize most world stock markets are in third waves (the powerful up wave) and we may also be in one. If so, we should know very soon. I am expecting a correction in this time period leading into a low that should be an excellent buying opportunity. This would very likely lead into an inflationary final up wave that brings us to a very meaningful top. You know about years ending in “7.” Years ending in “8” don’t have meaningful lows after March, so I am expecting one before March. The Fed has opted for inflation rather than deflation – that fact is very clear … and comes with its own set of side effects and warnings on the label – some of which may be even more dangerous than nausea, headache, incontinence or impotence. You know, all of the basic warnings that we Americans have become so used to.

Garrett Jones

garrett111@comcast.net

Note: this e-mail represents the views of the author and is intended for educational purposes only. There is risk of loss in all types of trading. Past performance is not indicative of future results.

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