Market Insights™

Depending on who is doing the drawing, the S&P 500 has probably broken out of its long-term bear market channel that goes all the way back to the September 1, 2000 high, when plotted on a linear price scale. Until it also breaks out of the following log-scale chart of the daily S&P 500 index, we will continue to treat these bear market channel lines as significant resistance levels (chart courtesy of StockCharts.com).

Should the S&P 500 manage to close above the channel, it would find itself face-to-face with a massive overhead supply of stock. Further progress will become exceedingly difficult as the index approaches a zone of resistance defined by the 1180-1310 price levels. Similar resistance zones await the Dow at 10300-11000 and the NASDAQ at 2300-2800.

Because a 13-week inflection is due next week (+/- one week) there is a good chance that we are very near an important reversal. Currently our long-term model is in SELL mode, our intermediate is in BUY mode, our index of Bullish Minus Bearish Newsletter Writers has been in BUY since September 28, and our short-term model has been in BUY since September 22.

However, all three bullish models are very near SELL signals. The S&P 500 index would first have to move above 1184 next week in order for the index to get overbought enough to trigger a SELL signal in our short-term model. Our index of Bullish Minus Bearish Newsletter Writers would have to exceed 26 to move into SELL (currently just over 21). To get a SELL signal in our intermediate model, the 30-year U.S. Treasury bond must exceed 6.00%. It closed Friday at 5.54% after making a double bottom on November 1 at 4.66%. This model is accurate to within about +/- six weeks.

If the top that accompanies the 13-week inflection point is to be an important one, we would probably need to see some cooperation out of at least three of the following five variables: the Chicago Board's VIX index below 21.5 at the point of the market peak (it closed at 22.3 on Friday), our Bull-Bear index above 26 sometime over the next three weeks, the 30-year Treasury above 6.00% sometime over the next six weeks, our liquidity index (RPCM2) topping out over the next month, our short-term model in SELL mode at the peak.

On the other hand, should the S&P 500 exceed 1180, the Dow move above 10300, and the NASDAQ top its recent December 6 high of 2066 all accompanied by strong volume, the next targets would be 1250 S&P, 11000 Dow, and 2300 NASDAQ. In that event, we would more than likely be witnessing a cyclical bull market within a secular bear market setting. We define a bull market in the broader market as a rally that takes the 50-day moving average of the S&P 500 above its 200-day average for a minimum of two consecutive months.

We believe this scenario is unlikely primarily because of our interpretation of the long term charts of the Dow and S&P. If we are correct, both indices have formed four-year long head-and-shoulders patterns beginning with a left shoulder formation back in 1998, a head that peaked in 2000, and a right shoulder formation in the current year. [A good tutorial of the head-and-shoulders chart pattern can be found at Stockcharts.com].

As you can see in the following head-and-shoulders charts, the neckline in each index was penetrated to the downside three months ago in September. That is a very bearish indication that projects the S&P 500 down to around 700 and the Dow down to 6500. After the markets bottomed on September 21, they rallied back up to the neckline which is quite common price action for this chart pattern. Occasionally the index can even penetrate back up above the neckline before rolling over and taking prices to new lows. So while 1250 and 11000 are not out of the question, ceilings of 1180 and 10300 are the odds on favorites based on our interpretation.

Our long term model is currently recommending a maximum of 50 percent stocks while our intermediate model is all the way down to 0 percent max. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.

For those who like to keep their finger on the short term pulse of the markets, we offer the subscription based Weekly Insights newsletter for a very reasonable $49.95 each six months. We welcome you to join the growing list of satisfied readers.

Market Statistics
DJIA 10136.99	S&P500 1161.02
DJTA 2643.05	Nasdaq 1987.26
DJUA 294.50	30 YR BOND 5.54%

28-November-2001

Long Term Model asset allocation:
stocks	bonds	cash	gold stocks
50%	20%	30%

Intermediate Model asset allocation:
stocks	bonds	cash	gold stocks
0%	20%	80%

Last month we suggested that the S&P 500 index could very likely be on its way toward the upper boundary of its long-term bear market channel. As long as prices remained within that channel, we would not shrink from our long held view that U.S. stocks were in a secular bear market. In this weekly S&P chart it can be observed that the index is snuggling right up next to that upper channel line.

We also expressed our belief that stocks would have an extraordinarily difficult time penetrating through considerable overhead supply at 1180, 10000, and 2000 for the S&P 500 index, Dow Jones Industrial Average, and the NASDAQ Composite, respectively. Since the September 21 bottom, the Dow has climbed as high as 9993, the S&P 1163, and the NAS 1965.

Since reaching those cycle highs just yesterday, stocks have pulled back and now show signs of a reversal. The question now becomes, are we about to witness a reversal of the short-term trend followed by a continuation of the intermediate-term rally, or will the intermediate-term trend turn negative and resume the long-term bear market?

Although our short-term model has not yet delivered a SELL signal, it is within a cat's whisker of doing so. The current signal which our model flashed on September 24 remains a BUY. Our intermediate-term model continues in SELL mode, although our index of Bullish Minus Bearish Newsletter Writers gave us a BUY signal back on September 28 when it approached a -9 reading. This latter indicator is now at a +18.3, which is high enough for us to be looking for an intermediate market top.

All the major indices are in the process of testing their 200-day moving averages. These levels are currently at 10167, 1181, and 1961 for the Dow, S&P, and NASDAQ. It is not unusual for an index to stall at its 200-day average line. A significant break above this barrier would, by definition, indicate a change in the long-term trend.

Our belief remains that equities are in the early stages of a secular bear market -- one where the averages will sell off dramatically over the first three years. We use as our guides the two prior stock manias in our 200 year history: 1835 and 1929. In those earlier declines, stocks fell at an average monthly rate of approximately 2 percent of the bull market high. That would project the S&P below 800 a year from now and below 500 by November 2003.

As far as the economy goes, the National Bureau of Economic Research (who are the official scorekeepers of the business cycle) declared that the current recession officially began in March of this year. That coincides well with our own Slump Index which allowed us to declare in our March 28 newsletter that the economy had entered into a recession [correction: we announced in our April 28 letter that the economy had likely entered a recession in March].

Just because we believe that stocks will behave similarly to the crashes of 1929 and 1835 doesn't mean that the economy will follow suit. Indeed, unemployment rates in the recessions that followed these two former periods were starkly different from each other -- peaking at between 6 and 8 percent in the 1840s and as high as 25 percent in the 1930s.

The 1835 mania, arriving 66 years after James Watt's steam engine was patented, was a euphoric celebration of the birth of the Industrial Revolution. The 1929 boom-bust cycle appeared near the end of that historic era. Today's mania peaked 62 years after the invention of the ABC computer by John Atanasoff and Clifford Berry which launched us into today's Information Revolution. Because of that, our best guess is that today's economy will end up more like the 19th century experience rather than the much bleaker economy of the 20th century.

However, don't get swept up in all the recent euphoria over the Fed's record setting pump-priming efforts. Remember that this recession was not the result of a maxed out consumer but rather due to an over-extended producer -- too much capacity rather than too little demand. Low interest rates can stimulate spending, which was already roaring along, but does little to work off excess captial investment.

What low interest rates have done, however, is rattle the long bond market. When earlier in the month the Treasury Department announced that it was retiring the 30-year bond, the bond market spiked higher, driving interest rates to three year lows.

We commented at the time [in our Weekly Insights newsletter] that recent government efforts to stimulate the economy would be a drag on bond prices as borrowing demands drive real interest rates higher. If real interest rates rise, nominal rates follow unless inflation falls more quickly. Absent the 30-year maturity, shorter term maturities like the 20-year bond would simply rise instead.

It didn't take long for the bond market to figure this out as the following weekly long bond chart indicates. Notice that the bond seems to be putting in a double bottom [in yields, double top in price] after retesting the October 1998 low (note that the yield scale is inverted). If so, rates could be on their way to much higher levels.

Now that short-term rates are below 2 percent with inflation running over 2 percent, real rates have gone negative for the first time in eight years. We have found that gold often launches into a pretty good rally after shorter rates go negative.

Anyone interested in playing the gold market should consider purchasing gold stocks, which pay a dividend, over owning gold bullion itself. Some candidates to consider are Newmont Mining (NEM), Placer Dome (PDG), Homestake Mining (HM), and Barrick Gold (ABX) which all appear to be basing at this time. We would suggest that you wait until gold bullion closes above $310/oz before placing your bets.

We do not believe that this is the beginnings of a major run in gold, like was seen back in 1972. That would require that inflation, now running at about 2 percent, would first have to exceed the 5 percent level. We do not anticipate inflation numbers like that to occur for another 25 or so years. Instead, if gold does rally, we believe it will not exceed resistance at $500/oz.

Inflation is a cyclical phenomenon that is closely tied in with the Growth Innovation cycle we presented in some detail in our article entitled Inventing Booms & Busts. Inflation dominates the economy only as a new Growth Innovation is moving into the fast growth phase of its life-cycle, a period we refer to as the integration phase. This creates a serious strain on the economy's resources as the public retools and retrains so that it can transition away from the prior, now mature, Growth Innovation.

This occurred in 1853 when the railroad was displacing the textile factory as the dominant engine of growth in the economy. We witnessed it again in 1913 with the arrival of the assembly-line manufactured automobile and in 1970 with the microprocessor-powered computer. Notice how these dates line up well with a rising rate of inflation as shown in the Figure 1 chart we presented in our article Is There A Seven-year Cycle?.

As we forecast in our article entitled The Next Technology Boom, we believe the fuel cell in general and the fuel cell vehicle in particular will eventually supplant the computer as the economy's main thruster. The fuel cell, assuming it is to carry that banner, is not scheduled to reach its full stride until about 2023. Not until that year should we expect inflation to play an important role in the economic landscape.

The "war on terrorism" had some notable winners and losers this past month. Once again a U.S. bombing campaign appears to be a winner while the Taliban, down but not yet out, is thus far a loser. George II (papa Bush was George I) is a winner at 85-90 percent approval rating.

Usama bin Laden and Al-Qaeda are winners for surviving and for having suckered the U.S. into bombing the bejeezus out of innocent Muslims, thus surrendering the moral high ground it had enjoyed following the 911 incident (in the eyes of most of the world's population).

Perhaps the biggest winner of all was Russia and Russian premier Putin who now control most of Afghanistan through their proxy group, the Northern Alliance (NA). The U.S. had asked the NA (a group of thugs the Soviet Union has been supporting for 10 years ever since they were run out of Afghanistan by another group of thugs, now called the Taliban, that the U.S. had supported in the 1980s) to NOT take the capital city of Kabul.

Putin's boys proceeded to ignore the request and have since declared themselves the new government and refuse to allow in either British or U.N. forces. The NA is allied with Russia, Iran, and India but has little love for Pakistan. The U.S. and Pakistan have long before 911 wanted to run an oil pipeline from the Caspian basin through a friendly Afghanistan out to Pakistan's Arabian Sea ports.

Indeed, U.S. oil company Unocal was in serious talks with the Taliban government to do just that before American women's rights groups caught wind of the deal-making and demanded an immediate end to it. The Clinton administration complied and the U.N., under U.S. request, slapped economic sanctions on Afghanistan.

A June 26 special report by indeareacts.com claims that discussions were in the works then for "limited military action" against the Taliban if sanctions didn't work.

Eric Margolis, author of War at the Top of the World -- The Struggle for Afghanistan, Kashmir and Tibet, in a Los Angeles Times article states "The Russians have regained influence over Afghanistan, avenged their defeat by the U.S. in the 1980s war and neatly checkmated the Bush administration, which, for all its high-tech military power, understands little about Afghanistan."

The biggest losers by far? The U.S. public who are being put directly in harm's way by the gross over-reaction of their commander-in-chief, George II. They are also losing civil rights almost daily as George II and his henchman, Ashcroft, run roughshod over the U.S. Constitution. According to eight former high-ranking FBI officials, Ashcroft's strategy not only needlessly violates constitutional rights, but has been proven to be ineffective.

For details, read Ex-FBI Officials Criticize Tactics On Terrorism on washingtonpost.com.

Our long term model is currently recommending a maximum of 50 percent stocks while our intermediate model is all the way down to 0 percent max. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.

For those who like to keep their finger on the short term pulse of the markets, we offer the subscription based Weekly Insights newsletter for a very reasonable $49.95 each six months. We welcome you to join the growing list of satisfied readers.

Market Statistics
DJIA 9711.86	S&P500 1128.52
DJTA 2457.95	Nasdaq 1887.97
DJUA 279.95	30 YR BOND 5.36%

30-October-2001

Long Term Model asset allocation:
stocks	bonds	cash	gold stocks
50%	20%	30%

Intermediate Model asset allocation:
stocks	bonds	cash	gold stocks
0%	20%	80%

The market hates uncertainty. And clearly so do consumers. Concerns over the anthrax scare as well as nervousness about further terrorism rocked consumer confidence in October. The market was looking for a slight downward bias from the 97.0 obtained in the September survey. What it got today was much worse than that with a reading of 85.5.

Additionally, last week existing home sales for September tumbled to 4.89 million units from 5.54 million the prior month. Durable goods orders that same month fell a much worse than expected 8.5% and initial unemployment claims were higher than expected.

In the face of all the uncertainty and negative news on the economic front, investor sentiment has been improving and the stock market has been rising. We believe that the Bush Administration's warnings notwithstanding and in spite of public opinion polls that indicate otherwise, most Americans are subconsciously replaying images of the Persian Gulf War against Iraq in their minds.

The wide-open desert terrain of that small nation was made to order for the vastly more superior military technology in the U.S. arsenal. What followed was a good old-fashioned turkey shoot or -- for you high-tech types -- a long distance and safely impersonal video war game.

This time around the disparity in military might is even greater but the terrain is vastly different. So too may be the fervor of our latest enemy. These apparently have gone unnoticed in the investment community so far.

The latest data show that our index of Bullish Minus Bearish Newsletter Writers has now risen to a +11.3 after falling as low as -8.4 a few weeks ago. While a bona fide SELL signal would require this index to rise to above 26, we will be on alert for a top with any reading over 16 or so.

Sentiment is a contrary indicator so tops normally show up just when investors in general are their most positive. In the lastest Big Money Poll in Barron's this week, 67 percent of respondents were either bullish or very bullish on stocks over the next eight months. On average they expect the S&P 500 to be up 15 percent by June of next year.

This is the most bullish these portfolio managers have been for a number of years. Bullish consensus typically runs in the neighborhood of the 45 percent mark. Remember that most of those years were very good ones for stocks so a bullish consensus below 50 percent meant most of these guys were on the wrong side. Furthermore, their stock picks in May 2000 returned a -17% over one year while their October 2000 selections netted a -48% twelve-month return. So the bear market has not been kind to these professionals.

All things considered, then, we view a very bullish consensus among these folks as a negative for the stock market, reinforcing our view that the secular bear market is intact. Especially because the reason most commonly given for their ebullience is the actions of the Greenspan Fed. That is a view that we believe was thoroughly discredited in our article entitled Fight the Fed.

What does make us a little nervous is that in the same issue of Barron's was published Value Line's Market Forecaster model results. It is showing a reading that is the most bullish since 1968. This objective mathematical model has been quite accurate in predicting turns in the market over that period. Value Line is one of the forecasting firms that we have a great deal of respect for so we cannot dismiss their signal lightly.

However, at this juncture, our certainty that uncertainty will rule the day has kept us from changing the allocation recommendations for either our short, intermediate, or long-term portfolios. They all remain in bearish mode with a strong bias toward cash. We will view Value Line's model in the same suspicious light we are casting on our own RPCM2 indicator in recent months-- things truly are different this time.

Future uncertainty was guaranteed, so it seems to us, when the U.S. government made a crucial error in judgement. The gaudy spectacle of the collapsing twin towers on September 11 placed heavy demands on the Bush administration for an equally ostentatious response. Our hope was that cooler heads would prevail but in their haste to show that they were "doing something", a measured and thoughtful plan was not even on the table.

What happened on September 11 was an international crime just as was the World Trade Center bombing by Egyptian terrorists eight years earlier. Following that 1993 attack, suspects were arrested, brought to trial, convicted and sentenced. The magnitude of the damage in the more recent attack meant that tremendous strength, wisdom, and courage not to mention the ability to communicate a vision to the American public was required from our leadership to avoid military retaliation. Such was not forthcoming.

What is being heralded as great leadership is simply the government following the path of least resistance. When you are the lone undisputed superpower in the world, it becomes much easier to shower bombs down on innocent people in some far off land that few Americans could find on a map two months ago, than to quell the angry masses at home and follow international law overseas. A spreading of the violence to Iraq cannot be far off.

And we're not just talking about civilian deaths, which contrary to what viewers of CNN may believe, are probably in the thousands by now (see Geov Parrish' article entitled Where the bodies are for more information). No evidence has been produced by the U.S. that Osama bin Laden is behind the attacks because it probably does not exist. Criminal investigations take time but there was no time. Something had to be done.

No one has even intimated that the Taliban were behind the World Trade Center horror. But the Taliban, who took power in Afghanistan with the blessing of the U.S. State Department and the financial support of Saudi Arabia and Pakistan -- our allies in the great fight against terrorism -- suddenly find themselves the target of American vengeance. Somebody had to pay.

Leadership demands a focus on the big picture. Understanding what it is that motivates terrorist activity against the U.S. is essential to minimizing future danger to its citizens. But it takes courage to admit to 50 years of failed foreign policy in the Middle East, even for a newly elected administration that had nothing to do with past mistakes.

Instead President Bush, the leader of the free world, is quoted saying "How do I respond when I see that in some Islamic countries there is vitriolic hatred for America? I'll tell you how I respond. I'm amazed. I just can't believe it because I know how good we are."

It is a sentiment echoed by a lot of decent Americans who are equally naive of the history of U.S. foreign policy. Our ignorance is what has allowed the activities of our government overseas to degenerate to the level that it has. Those actions are detailed in Chalmers Johnson's excellent book Blowback and excerpted on the Internet by Third World Traveller.

For those with limited time who prefer a synopsis, see Arundhati Roy's well-written article entitled The Algebra of Infinite Justice.

It takes courageous and confident leadership to make the hard choices -- to track down the guilty while minimiizing "collateral damage" to the innocent. That applies on the homefront as well as overseas. As long as the issues that worked those Saudi Arabian extemists into such a violent rage remain unresolved, the government is putting us, its own citizens, in harm's way. Incessant bombing of the wretched in Afghanistan only throws fuel on a raging fire.

Bush's declaration on September 11 that "Freedom itself was attacked this morning" was premature. That line would have been more aptly spoken this past Friday, after he signed the USA Patriot Act, the anti-terrorism bill that was railroaded through congress and greatly expands police power to the FBI. This is the very same organization that was being ripped just two months ago for being incompetent and corrupt, not to mention virtually immune to oversight.

Yes, future uncertainty is a certainty. So our position on the stock market remains simply this: the market is in a long-term downtrend until proven otherwise. The "otherwise" part of that statement would require that the downward sloping channel of the following weekly S&P 500 chart would have to be violated to the upside. An even stronger case could be made should the line labeled "overhead resistance" at the 1180 level be broken to the upside.

Until that occurs, we will stick to our forecast that this bear market will be just as severe as those that began in 1835 and 1929. That means that we can expect to see an average 25 point decline each month in the S&P 500 index for at least the next 1 1/2 years.

From an intermediate term perspective, all the major averages are now officially in an intermediate uptrend, having all closed above their 50-day moving averages last week. While our intermediate model did not register a BUY, our index of Bullish Minus Bearish Newsletter Writers did so when it approached a -9 reading the week ending September 28.

On a shorter term basis, our short-term model gave us a BUY signal on September 24, the day after the S&P 500 index made its bottom with a closing low of 965.8. Since then the market has climbed over 14 percent. Some weakness has surfaced the last two days but our short-term cycle work says that stocks should get a lift over the next couple of days.

The intermediate term outlook will remain positive if the markets can break out above last Friday's close. Those levels were about 1105 for the S&P, 9545 Dow, and 1769 NASDAQ Composite. That would lead us to believe that stocks could then head higher to our targets of last month: 1180, 10000, and 2000.

On the other hand, a close below 9000 on the Dow and 1150 on the S&P, particularly on increasing volume would greatly raise the specter of new bear market lows.

Market Statistics
DJIA 9121.98	S&P500 1059.01
DJTA 2195.26	Nasdaq 1667.41
DJUA 292.02	30 YR BOND 5.24%

28-September-2001

Long Term Model asset allocation:
stocks	bonds	cash	gold stocks
50%	20%	30%

Intermediate Model asset allocation:
stocks	bonds	cash	gold stocks
0%	20%	80%

Three weeks ago, on September 9, we warned the subscribers of our Weekly Insights newsletter that it looked to us like both the S&P 500 index and the NASDAQ Composite were headed to their October 28, 1998 lows [editor's note: we meant the October 8, 1998 lows] over the "next few weeks". Those lows on a closing basis were 959.4 and 1419, respectively.

We recommended a shift to 0% equities for portfolios structured around an intermediate term perspective, and no more than 50% equities for those who take a long term view. This recommendation was also emailed to users of our free HIPPO portfolio optimizer.

Furthermore, we recommended that those who believe, as we do, that stocks are in a secular bear market should consider investing as much as 50 percent of their portfolios in the Rydex Series Trust Ursa Fund (ticker symbol RYURX) for the duration of the bear market. The RYURX fund seeks to provide investment results that inversely correlate with the S&P 500 index. Over the last twelve months this fund has appreciated 43 percent while the S&P 500 is off 29 percent.

On September 21 last week, the S&P 500 index closed at 965.80 after falling to an intraday low of 944.75. The NASDAQ closed that same day at 1423.19 with an intraday drop to 1387. Our targets have been met.

In between our warning and the subsequent market swoon, the world witnessed the greatest tragedy ever inflicted on U.S. soil. On September 11, television viewers watched in horror as the World Trade Center twin towers disappeared from view. The terrorist assault sent more than 6000 people to an early grave and forced a four-day suspension of U.S. stock trading.

When trading resumed the following Monday, the equity markets experienced their worst week in over 60 years. The Dow Jones Industrial Average fell more than 14 percent, while the Dow Transports, home of the airline stocks, fell an unseemly 23 percent.

For the most part, the markets were making up for lost time. They appear to have met the targets we laid out prior to the catastrophe and now look as though they are finding support there. Thus far, then, the terrorist attacks have not in our eyes had a significant impact on the markets in general. There are, however long-term implications that we will discuss later on.

On Monday September 24, our short-term model switched from SELL to BUY. The SELL had been in force since May 22 when the S&P 500 index was in the 1300s and began a 28 percent descent. What we see ahead over the next two weeks is a retest of the recent lows. Odds favor that those lows will hold which should provide us with a profitable trading rally.

Our reason for such short-term optimism is the overwhelming bearish sentiment out there. Our index of Bullish Minus Bearish Newsletter Writers has just reached a -8.4, the lowest level since -9.5 on September 25, 1998. Back then stocks were in a very similar bottoming process that saw a successful retest of September lows on October 9.

How high markets will climb is hard to say but expect the rally to be explosive, not unlike the April/May move. That one was somewhere around 2000 points on the Dow, 200 on the S&P 500, and 600 on the NAS. That would bring all three indices back up to what we consider to be insurmountable resistance levels -- 10000 Dow, 1180 S&P, and 2000 NASDAQ.

The damage done to the Dow this past month was huge. The following weekly Dow chart shows how that average has now broken down out of the downward sloping channel it has traded in for nearly two years. This indicates to us that the Dow is now in a whole new ball game that should allow it to play catch up with the S&P 500.

While the Dow is only off about 24 percent from its all-time high of around 11700, the S&P 500 is down 32 percent. That index is still trading in the downward sloping channel it has been in since the middle of last year. It has also reached a very important technical level that we projected in October of last year.

In last year's October letter we said: "According to Beckman's Elliot Wave Explained, a wedge formation...is 'a sign that a major up move is coming to an end and that the early stages of the bear market are likely to be extraordinarily violent'...That would mean to a level of 950 on the S&P 500 index..."

With the S&P 500 reaching that target this past month, we were prompted to see if we could define the entire move down to date in Elliot Wave terms as an A-B-C correction. The following weekly S&P 500 chart demonstrates that such an interpretation is feasible.

The Fed continued its record rate cutting pace having dropped the discount rate eight times already this year with more on the way. The erie parallels with the 1929-1932 experience also continue. When the Fed began cutting rates back in November 1929, the discount was at 6.00%. Seven months later it was down to 2.50%.

When Greenspan & Company began the latest round of cuts in January, the discount rate was again at 6.00%. Now eight months later the rate is down to 2.50%. We're not suggesting that the economy is heading for another Great Depression. But it will slow further with unemployment perhaps approaching double digits before it's all over (a far cry from the 25 percent levels seen in the 1930s). The outcome for stocks, however, we believe will be nearly as gruesome as that experienced 70 years ago.

The terrorist attack this past month and the U.S. response are likely to have very important consequences for the markets. We think that a profound change in perception is underway. For the last ten years, since the collapse of the Soviet Union, the U.S. has been a safe haven for global investors. The September 11 assault and the U.S. commitment to a long-term anti-terrorism campaign will change that perception.

Perhaps more importantly, our sense is that Americans believe that the U.S. government will be able to successfully thwart the perpetrators of terrorism. History shows us that it won't be that easy. We will have our share of victories for sure, but terrorists can be a determined lot.

The British have been victims of Irish terrorism for more than a century. The Israelis have been targets of Palestinian violence for half a century. If these governments have been unsuccessful at rooting out terrorism that originates from relatively small geographic areas, how are we going to bring down a network that may be scattered all over the globe?

We as a country are seeking retribution for last month's assault. Unfortunately, the September 11 attack was retribution. Terrorism is a tool employed by a less powerful group against a more powerful one that they believe has wronged them and continues to wrong them. The terrorist's goal is to alter the policies of the more powerful entity.

In our case, the Muslim extremists are hitting us back for perceived atrocities against them beginning with the Persian Gulf War where over 100,000 Iraqi Muslims were killed in battle. Since then, post-war sanctions imposed by the U.S. have led to over 1.5 million civilian deaths. UNICEF claims that 5000 Iraqi children die every month due to the sanctions.

As Rick McDowell prophetically warned back in 1999, "A policy that has led to so much suffering and death will one day come home to the people of the U.S."

Add to this the 1998 bombings of Afghanistan, Sudan, and Iraq that President Clinton ordered in classic "Wag the Dog" fashion during his impeachment proceedings, the 1999 bombing and utter destruction of Kosovo, U.S.-led sanctions against Afghanistan, Pakistan, and Sudan that are responsible for the misery of millions of civilians, and so on.

Sanctions harm the common people of a nation more than they do its government, the intended target. They tend to stiffen the resolve of the people and increase support for their government. If you think these people hate us now, just wait to see what the survivors of the up and coming generation think of us.

When sanctions were imposed on Germany after WWI, the "civilized" world destroyed the German economy as hyperinflation reached astronomical proportions in the 1930s. The victimized younger generation that grew up under these sanctions turned to Hitler and nearly conquered Europe.

We need to look at the world as it is rather than how we wish it to be. The Muslims want the U.S. out of the Middle East and out of what they see as their affairs. They also want us to treat the Israeli-Palestine conflict in a more even-handed manner. Whether we personally agree or disagree with the actions of our own government, terrorism against the U.S. is likely to continue so long as our policies remain as they are. And our lives and our markets may be disrupted for years to come.

Market Statistics
DJIA 8847.56	S&P500 1040.94
DJTA 2194.68	Nasdaq 1498.80
DJUA 301.67	30 YR BOND 5.42%

28-August-2001

Long Term Model asset allocation:
stocks	bonds	cash	gold stocks
70%		30%

Intermediate Model asset allocation:
stocks	bonds	cash	gold stocks
20%		80%

So much for the traditional summer rally.

Our intermediate portfolio allocation shifted from 45 percent equities down to 20 percent this past month because of our belief that the S&P 500 index will remain within its long-term bear market channel. There simply isn't enough sustained buying and that means that a likely retest of the April 4 low is imminent.

To determine the direction stocks will take in the near term, keep your eye on the Dow Jones Industrial Average. For more than two months now, that index has been unable to close above 10610 nor has it broken below the 10175 support level that was tested first on July 10 and again just last week on August 21. A violation of either of these two levels will indicate that an important move is underway.

Our guess is that the Dow will retest the upper band one more time before breaking down below the 10175 support. The S&P 500 should be limited to the 1220 area on the upside while the NASDAQ Composite will not likely see the north side of 2000 anytime soon.

Recall that our intermediate term model gave us a well-timed BUY signal in April. Recall also that it will not move to a SELL anytime soon unless the 30-year Treasury yield moves above 6.00%. Meanwhile, our short term model has been in SELL mode since May 22. Should stocks begin a resumption of the down trend as we anticipate, it would mean that our intermediate model has let us down.

Out of curiosity, we back-tested our intermediate model to see how it would have performed during the last great stock market bubble in 1929-1932. Recall that our intermediate model has a built-in switch that toggles the model between a Discount Rate Model (DRM) and a Long Bond Model (LBM). The switch we refer to is simply long term Treasury yields adjusted for inflation -- we find that when they move below 3.4%, the DRM works best while above 3.4% we should be looking to the LBM.

As can be seen in the table below, the similarities between the model performance in the current era and the back-tested model performance in the Great Depression era are striking. All stock data are based on monthly averages of daily closes. Monthly stock dividend yields (which are used in the DRM model) had to be estimated from annual data for the 1929-32 period.

The final SELL signal during the Great Depression bear market came after most of the damage was already done. For that reason, and being that we believe the markets are now in a secular bear trend, we made the decision to sell out of this market prior to receiving a bona fide SELL signal from our intermediate model.

The only caveat at this particular time is the transient inflation signal we have been discussing for a couple of months now. Since January 2000, when CPI inflation has fallen below 3.10% it has led to a 150 point rally in the S&P 500. July's CPI number resulted in a 2.72% annual inflation rate. If this indicator is still effective, stocks could rally farther than our expectations.

Economically, things are getting weaker each month. A consensus is building among Wall Street economists that tomorrow's GDP revision could take this statistic down from the preliminary annual growth rate of +0.7% into negative territory. That would confirm the prediction we made back in April in our article Be Careful What You Wish For and signal that the economy is in recession.

In the first chart of that same article we presented a correlation between the number of consecutive discount rate cuts and the peak unemployment rate. Now that the Fed has cut a seventh time (in a record eight months), we are projecting a peak unemployment rate of around 8.5 percent.

The Fed's highly accomodative posture has contributed to an explosion in liquidity as measured both by M2 and our own RPCM2. All that money has done very little to support the nation's businesses which are swimming in overcapacity as a result of the great investment bubble of the late 1990s.

It has not done much to prop up share prices either, as most investors know all too well. 'What gives here,' you may be thinking. 'I thought stocks were supposed to move higher when RPCM2 expands.' Normally that is the public's inclination -- more money in the pocket means more money moving into the stock market.

Something is very different this time, though, and we discuss that subject at length in our latest posting The Money Effect Redux.

What the Fed's recent liquidity expansion is doing is driving the U.S. dollar lower. A surfeit of dollars chasing foreign goods works just fine as long as those dollars flow back to the U.S. to buy securities. And that's what has been going on these past few years.

The balance tipped against our currency, however, when the stock market went into decline. The flow of funds into U.S. stocks by foreign holders of U.S. dollars no doubt has slowed in recent months. Sure U.S. Treasuries may still look attractive but at the margin, fixed incomes paying 5.50% are not as attractive as equities that once returned double digits.

Once the process begins to unwind, it will feed on itself because a falling dollar reduces the net return foreigners can make in the U.S. securities markets. On top of that, with Japanese and European economies slowing, those folks may find themselves in need of some pocket money.

This poses a problem for Greenspan & Company. Thus far they have been given a free pass -- they have been able to expand money supply without fear of inflation because overcapacity and oversupply have provided deflationary counterbalances.

It's not inflation pressures that will force the Fed's hand but rather a falling dollar. As the dollar depreciates, more and more foreign money will leave U.S. stocks and bonds, driving the stock market lower and driving real long term interest rates higher.

The Fed will find themselves between the proverbial rock and a hard place. At some point money growth will have to slow and that's when RPCM2 will begin to nosedive, taking stocks down with it. The stock market will continue lower and the Fed will be powerless to halt it.

Changing the subject for a moment, we have taken our seven-year cycle analysis of the stock market and the economy to a new level. In our 1994 article, Social Dynamics and the Investment Cycle, we divided the economy into periods of Inflation-Deflation-Contraction-Expansion.

The "7-year economic wave" link at the top of this page now takes you to a newly posted article entitled Is There A 7-year Cycle?. There you will learn how the economy can be divided into eight periods of Inflation-Deflation-Contraction-Expansion-Overcapacity-Growth1-Growth2-Stagnation that last on average seven years each.

The current 7-year wave is the Overcapacity phase. Historically, that turns out to be the worst period for stocks of the eight.

Our long term model is currently recommending a maximum of 70 percent stocks while our intermediate model is all the way down to 20 percent max. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.

For those who like to keep their finger on the short term pulse of the markets, we offer the subscription based Weekly Insights newsletter for a very reasonable $49.95 each six months. We welcome you to join the growing list of satisfied readers.

Lastly, we would like to get some feedback from you all on a new Home Page design we are considering. You can view it at this location. Please e-mail us and let us know what you think.

Market Statistics
DJIA 10222.03	S&P500 1161.51
DJTA 2831.13	Nasdaq 1864.98
DJUA 349.60	30 YR BOND 5.41%

28-July-2001

Long Term Model asset allocation:
stocks	bonds	cash	gold stocks
70%		30%

Intermediate Model asset allocation:
stocks	bonds	cash	gold stocks
45%		55%

It was a particulary confusing month in the stock market as our short term model remained on its May 23 SELL signal while the intermediate picture changed from positive to mixed. As such, our intermediate portfolio allocation shifted from 70 percent equities to 45 percent.

What made it so confusing was that stocks were unable to mount any kind of lasting rally yet never showed the kind of selling conviction we have seen in prior declines over the last year or so. Also, as stocks continued their two month long sideways-down action, sentiment uncharacteristically improved.

We suspect the better mood around Wall Street was due primarily to an improving economic picture (or should we say it wasn't deteriorating as fast as it had been) and indications from the Greenspan Fed that they are willing to fight the good fight. Our take on the economy is that this is simply a pause that refreshes before the news gets bad again. As for the Fed, we'll get to that later.

From a very short term perspective, it is likely that a bottom in stocks was made this past Tuesday. We expect to see a 50 percent retracement of the recent decline that began on May 22. That would take the S&P 500 index up to about 1242 and the Dow to 10790. From there, we believe the market will resume its long term downtrend.

The reasons for this conclusion are many. First, recall that last month we said that we would need for the S&P 500 to move above 1240.8 and the Dow to break above 10760 to indicate that the intermediate term trend was still postive. Neither did. A 50 percent retracement would take both indices to right around these resistance levels but not significantly beyond.

Other reasons for our increasingly bearish outlook is the high level of enthusiasm for stocks as measured by our index of Bullish Minus Bearish Newsletter Writers (it is hovering very near the 30 area, a level that has been a danger signal in recent years), a reported increase in the amount of corporate insider selling, and a weakening dollar (which makes holding U.S. securities less attractive to foreigners).

Finally, remember last month we discussed a transient indicator that has worked quite well since early 2000. As you can see in the following inflation indicator chart, whenever CPI inflation exceeds about 3.60% stocks go into retreat and when inflation falls below 3.10%, they responded with a rally. Right now, this indicator still points negative.

With all these negatives, we believe that the major indices will be unable to penetrate their long term bear market channels. While the Dow Jones Industrial Average and the NASDAQ are far from their upper channel lines, the S&P 500 is within 3 percent of its. On a weekly average basis, this should limit the S&P 500 to the 1230 area, which points to a daily close somewhere around 1240 (there's that number again).

Mind you, there are still some indicators that are positive. These all find their roots in an accomodative Federal Reserve Board: expanding RPCM2 liquidity, a BUY signal from our intermediate model, and an unprecedented six rate cuts from the Fed in as many months. Let's examine each of these more closely.

As you can see by clicking on the RPCM2 link at the top of the page, liquidity is still expanding. In our Barron's article, The Money Effect, we showed how there is a strong correlation between expanding liquidity and rising equity values (conversely, between contracting liquidity and falling equity values).

We use this as a long term indicator because in the short run and even the intermediate run, more money in the hands of individuals may or may not translate into higher equity values. In recent years, corporate and individual debt levels have been climbing to record levels while savings have plummeted to rates not seen since the Great Depression. Much of the increased liquidity, then, may be moving toward paying off debt and rebuilding depleted savings rather than chasing after falling equity values.

At some point RPCM2 will turn down again, signalling that the worst is yet to come for equity values. That event may not be too far away. The bulk of the recent monetary expansion we suspect is due mostly to mortgage refinancing. Certainly rates have been attractive, but how much more debt can consumers handle? It very well could be that we are in the blowoff stage of a real estate bubble this year much as we were in stocks last year. Once consumer borrowing stops, the liquidity bubble will finally burst.

Our intermediate model moved to BUY in April after short term yields dropped to 4.50% (courtesty of the Fed). Stocks rallied at that point before stalling at the end of May. We will not get a SELL signal until long term rates move above 6.00% which does not seem to be imminent at this point.

Even after factoring in an accuracy of +/- one month, there is no way our model would correspond to the May 22 top. That can only mean one of two things: the market will exceed the May 22 highs or our model will miss giving a timely SELL signal (has to be the former, ahem). [Editor's note: lame attempt at tongue-in-cheek humor -- we actually believe the latter is more likely at this point].

As to the aggressive nature of the Fed, forget about it. Our newly posted article, Fight the Fed clearly shows that the Fed is not as powerful as they (or many of us) think. More important than what the Fed is doing is where stocks are from a long term overbought/oversold standpoint. After reading the article, you will understand that history is telling us that even though the Fed has aggressively cut rates six times, the stock market is likely to FALL 30 percent over the next twelve months.

If it does, the S&P 500 index will be in the 850 neighborhood, a 45 percent decline from the September 2000 double top of 1530. Is that possible? We think so. If you extrapolate the long term bear market channel in that S&P 500 chart above, the index will be between 825 and 965 by June 2002 (twelve months after the 6th discount rate cut).

If today's stock market bubble deflates like the prior two in U.S. history in 1835 and 1929 (please read our article Turning Point if you haven't already), then we should anticipate precisely such a decline.

The following projection chart of the S&P 500 compares the current decline projected out to June 2002 with the decline from September 1929 to July 1931 (both based on monthly averaged data). The index is normalized so that the stock market peak in each case is set to 100. At the end of the 23-month period, both indices decline to the mid 50s.

Also shown in the chart is the 1929-31 decline based on annual data with monthly interpolations. This curve is placed on the chart so that the end point falls on the end point of the monthly averaged data. Then the 1835-37 stock market decline based on annual data is placed on the chart so that its starting point lies on the 1929-31 annual data's starting point.

This exercise was performed to compare the 1835-37 decline, for which there is no monthly data available, with the 1929-31 and projected 2000-02 declines. All three fall between 50 and 60 after 23 months. Conclusion: we think 850 is a reasonable projection for the June 2002 S&P 500 index.

Market Statistics
DJIA 10416.67	S&P500 1205.82
DJTA 2909.88	Nasdaq 2029.07
DJUA 348.08	30 YR BOND 5.54%

28-June-2001

Long Term Model asset allocation:
stocks	bonds	cash	gold stocks
70%		30%

Intermediate Model asset allocation:
stocks	bonds	cash	gold stocks
70%		30%

Another tepid response to a Fed rate cut. You'll recall that last month Greenspan & Co. slashed rates 50 basis points on May 15 and investors stood around waiting to see what everyone else was going to do. The next day equities rocketed higher but just a few days later our short-term model flashed a SELL signal on May 23.

Stocks have been trending lower ever since. After yesterday's 25 basis point cut, stocks sold off slightly. Not too surprising considering that a 1/4 to 1/2 percent cut was already factored into the market. Today there were signs of life among the bulls, with the NASDAQ composite breaking out of its short term trading range and both the Dow Jones Industrial Average and the S&P 500 Index bouncing off of support.

While it is certainly possible that we could get a replay of last month's bounce and a stumble, we believe odds favor a resumption of the uptrend from here. Our intermediate term indicators are all pointing higher and each of the major indices have completed a 50 percent retracement of the entire move up from the early April lows to the late May highs.

In a bull market, 50 percent retracements of a rapid advance like we saw over April and May are normal and expected. Sure, when the Dow penetrated down through its 10774 pivot low and the S&P likewise fell below 1240.8, it put us on alert that the intermediate term trend could be changing directions.

The steady and orderly decline over the past month, however, makes it look more like a correction in a cyclical bull market. The next few days should crystallize our read on what investors are thinking. Key short-term upside resistance levels are 1240.8 for the S&P 500 and 10760 for the Dow. Clearing these hurdles would make us feel secure that the intermediate up move has resumed. In that case, we would be looking toward the upside targets we laid out last month: 11750 for the Dow, 1370 for the S&P 500, and 2500 for the NASDAQ.

A break below 1203 in the S&P 500 and 10454 for the Dow would make us very nervous that things were not well in the land of equities. The points of no return where we would head for shelter are 1182 for the S&P 500 and especially 9948 for the Dow.

Keep in mind that the Dow Jones Industrial Average, the S&P 500 Index, and the NASDAQ Composite are all still in the bear market channels we showed you last month. In fact, all these averages are still under water since the day before the Fed first cut rates back on January 3 of this year. The Dow is off 1 percent, the S&P 500 is down about 4.5 percent, and the NASDAQ is negative by nearly 7 percent. All those rate cuts were much ado about nothing.

Then again, how bad would things be without them? By the way, with six interest rate cuts in as many months, the Greenspan Fed now holds the record for the shortest time to six consecutive cuts since the creation of the Federal Reserve in 1913. While this may seem like a good thing, history indicates quite the contrary. We will be posting a new article this coming month dealing with this interesting subject.

Until the averages break out of those long term bear market channels, we must be on constant alert that a resumption of the long term decline is possible. Certainly a BUY signal from our intermediate term model back in April gave us the go ahead to jump back into stocks. And that is where we have been. But understand there is a big difference between a secular bull market and a cyclical bull market within a secular bear trend.

We have to chuckle when we hear the pundits confidently declaring a resumption of The Bull Market. Not because we know they are wrong -- only charlatans KNOW which way the market is heading. It's just that old habits are hard to break. After 18 years of higher highs and higher lows (a secular bull market), many professionals have come to accept this as the way markets will behave forever.

That's why we never get too far removed from market history. When we got a BUY signal in April, our intermediate term model was declaring a cyclical bull market. So technically we are on the side of the bulls. But when most of the prognosticators say we are in a bull market, what they mean is a secular bull that will take all the major averages to new highs.

That is where we part company. Our work indicates that the S&P 500 and most certainly the NASDAQ Composite are in secular (meaning long time) bear markets. By long time we mean a decade or two. Many of you might be shocked to think that stocks could actually decline for that long a period. Quite the contrary, that is normal stock market behavior.

In this long term S&P 500 Index chart adjusted for inflation, we have identified two secular bull markets and two secular bear markets with large green arrows. Each of these lasted on average 18 years. In addition, we have marked two cyclical bull and two cyclical bear markets with small red arrows.

The first cyclical bull began in 1953 and ended in 1956. The bear market that followed lasted into 1958. These cyclical turns were part of an overall secular bull market that began in 1949. As such, the cyclical bear markets tend to be shorter in duration and price swing than the preceding bull markets. Together they form a rising stair-step pattern.

In contrast, the second cyclical bull/bear pair that began in late 1974 and terminated in 1980 are part of an overall secular bear trend. These cycles together form a falling stair-step pattern with lower highs and lower lows.

Since we believe that a new secular bear trend began in 2000, by definition the markets should top out below their previous all-time highs. That is a pretty safe bet for the NASDAQ and reasonably good bet for the S&P 500. The Dow and NYSE Composite are poised to challenge their old highs -- even these should play out as double tops at best.

The catalyst for the next down leg according to our work is most likely to be rising long-term interest rates. If the long bond were to exceed 6.00%, that could be enough to trigger a SELL in our intermediate model. With an outside reversal day today by the 30-year treasury yield, long term rates could be ready to resume their climb higher.

As things now stand, our model is not likely to give a SELL before August. Since our model is accurate to within +/- one month, the earliest we should anticipate a resumption of the bear market decline would be this coming month in July.

A 13-week inflection point is due the week of July 13 (+/- one week) so a quick run up to a top is not out of the question. As things look at the moment, however, it is more likely that we will see some kind of a cycle low in mid July like a retest of recent lows or simply a pullback in the bull market move. A top no sooner than late July/early August looks more likely at this juncture.

Both our long term and intermediate term models are still recommending a maximum of 70 percent stocks. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.

For those who like to keep their finger on the short term pulses of the market, we offer the subscription based Weekly Insights newsletter for a very reasonable $49.95 each six months. We welcome you to join the growing list of satisfied readers.

One last thing before we go. We have been hearing a lot of talk that the May inflation numbers were relatively tame and that investors see this as a positive because it means the Fed can cut rates to help bolster the economy without fear that inflation will rear its ugly head. We don't understand this bullish spin on the numbers, and here is why.

The twelve-month inflation rate has ranged between 2.92% and 3.76% in the 16 months beginning February of 2000. The figure for May 2001 is 3.62%, near the upper end of the range. Now get this. Whenever the inflation rate exceeded 3.50% during this period, the stock market responded with an important decline within two months. Whenever inflation dropped below 3.10%, stocks mounted important rallies within a month.

Specifically, inflation climbed to 3.76% in March 2000 the same month the NASDAQ Composite and S&P 500 Index bear markets began. It reached 3.73% in June 2000 and 3.66% in July 2000 just before the double top in the S&P 500 formed on September 1. Then it hit 3.67% in January 2001 and 3.53% in February 2001 just as the February 1 slide in stocks began. When stocks bottomed in April 2000, the inflation rate dipped to 3.07% the same month. Then in March of 2001, the inflation rate fell to 2.92% as the major stock indices began cyclical bull markets between March 22 and April 4.

Something to contemplate...

Market Statistics
DJIA 10566.21	S&P500 1226.20
DJTA 2764.83	Nasdaq 2125.46
DJUA 359.68	30 YR BOND 5.68%

28-May-2001

Long Term Model asset allocation:
stocks	bonds	cash	gold stocks
70%		30%

Intermediate Model asset allocation:
stocks	bonds	cash	gold stocks
70%		30%

From their March 22 intraday lows, the Dow Jones Industrial Average is currently up an impressive 21 percent while the S&P 500 Composite Index is 18 percent higher. Last Tuesday they had posted gains as high as 25 and 22 percent, respectively.

The NASDAQ Composite Index now stands an incredible 39 percent above its April 4 intraday low after climbing as high as 44 percent this past Tuesday. If you followed our BUY recommendation in early April, you have handsome profits to show for your effort.

After the Fed's fifth 50 basis point rate cut in as many months, all the major averages broke up through down trendlines extending back to September 2000 for the NASDAQ and S&P 500, and all the way back to January 2000 for the Dow. Stocks at this point are overextended and just a little tired. The all important question: is there any gas left in the tank or is the intermediate counter-trend rally about to give way to a resumption of the bear market downtrend?

Based on all our indicators, we think the following targets make the most "sense" to us at this time: 11750 for the Dow, 1370 for the S&P 500, and 2500 for the NASDAQ. The three indicators that support our view that the intermediate rally still has further to go are an expanding RPCM2 liquidity indicator (see the latest update by clicking on the link at the top of this page), a BUY signal from our intermediate term model thanks to aggressive rate cuts by the Fed, and our index of Bullish Minus Bearish Newsletter Writers that stands at a neutral 15 after dipping down to nearly zero.

Yet, a case could certainly be made that the markets completed their intermediate rallies on Tuesday of last week when our short term model handed us a SELL signal. First of all, the major averages are still struggling with strong overhead resistance. The Dow has been the strongest of the three indices, having climbed to the top of its resistance zone where it has stalled for the time being.

The NASDAQ, which has been the weakest index, was turned away at the very bottom of its resistance band. The S&P 500 is in between the other two, having struggled to about halfway through its consolidation zone before turning south.

Perhaps more interesting, price action for each of the averages is still contained within bear market channels that stretch all the way back to 2000 when they made their all-time weekly highs (January for the Dow, March for the NASDAQ, and September for the S&P 500).

For those who have an interest in Elliot Wave analysis, we offer our latest wave counts for all three averages in the above channel charts. With the weekly S&P chart touching the 1300 level this past week, we were forced to revise the wave count we offered in March. At that time we believed we were in a major Wave 3. In order for that count to be correct, the recent rally could not exceed the termination point of major Wave 1 at the 1287 level.

With this most recent count, we have nearly come full circle to the original forecast we made last December. This A-B-C wave count could give one powerful ammunition for making a case that the bear market ended on April 4. The same could be said for our NASDAQ analysis. However, bear markets do not end with sky-high valuations (as measured by P/Es and dividend yields) nor with such lofty sentiment levels (as measured by newsletter writers).

What is more likely is that both the S&P 500 and NASDAQ will continue lower in what Elliot called a "complex correction". That requires that the recent rally be labeled with an "X" to be followed by a second A-B-C correction. The Dow, on the other hand appears to be tracing out a more typical A-B-C flat correction, with the C downleg potentially much deeper than the A downwave.

Key support levels are 10774 for the Dow and 1240.8 for the S&P. A close below these pivot points will likely mean the intermediate term trend has turned down again.

From an economic standpoint, the one variable that is still behaving negatively is the 30-year treasury bond yield. It rose to the 5.90% level two weeks ago before taking a breather. It looks to be racing toward that level again and if it exceeds it, we believe rates will climb deep into the 6 percents.

By our analysis, a move above 6.00% could be potentially damaging to stocks since it might be enough to trigger a SELL signal in our intermediate model. Since that model relies on monthly data, its timing is accurate at best +/- one month. Should we receive a SELL signal for the month of June, that would mean it is signalling a top in the stock market sometime between May and July.

Those of you who are curious as to why we follow the fuel cell industry so closely should check out our latest addition to the Mind Stretch section entitled The Next Technology Boom.

At this time, both our long term and intermediate term models are still recommending a maximum of 70 percent stocks. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. HIPPO users are emailed any change in the intermediate or long term market status.

For those who like to keep their finger on the short term pulses of the market, we offer the subscription based Weekly Insights newsletter for a very reasonable $49.95 each six months. We welcome you to join the growing list of satisfied readers.

Market Statistics
DJIA 11005.37	S&P500 1277.89
DJTA 2929.20	Nasdaq 2251.03
DJUA 390.07	30 YR BOND 5.84%

28-April-2001

Long Term Model asset allocation:
stocks	bonds	cash	gold stocks
70%		30%

Intermediate Model asset allocation:
stocks	bonds	cash	gold stocks
70%		30%

"Happy Days Are Here Again!". Yes, durable goods orders, new & existing home sales, and 1st quarter GDP all reported higher than expected numbers this past week. The recession threat is over and a new bull market in equities is underway. The pain is over...

Not so fast. While all these surprises to the upside are welcome news, they don't come close to signalling that the Good Times are ready to roll again. U.S. GDP growth is still clearly in a downtrend in spite of the single quarter uptick. To put it in perspective, that statistic was growing at a year-over-year rate of 8 percent as recently as the 4th quarter of 1999 and has steadily slid to its current 2 percent rate.

Consumer confidence continued its free fall, coming in this week below expectations at 109.2. You may recall it was around 145 this time last year. Unemployment continues to rise as first time claims were higher than expected this week. Housing meanwhile looks to be in a blow-off stage. Long-term rates are rising rapidly which ultimately can't be good for mortgage rates and home sales.

More importantly, our proprietary Slump Index has just moved into recession territory. Since 1970 this indicator has predicted every downturn in the economy including 1970, 1974-75, 1980, 1981-82, and 1990-92. Whenever the index has fallen below -1 it has signalled within one quarter that GDP year-over-year growth will be negative. Since the indicator slipped below -1 last month, we expect the 2nd quarter growth to be negative. For a full explanation of the Slump Index, please read our recent article Be Careful What You Wish For, posted in the Mind Stretch section.

In spite of all the excitement we are now hearing about the stock market, we continue to believe the current move up is nothing more than an intermediate-term counter trend rally within a secular bear market. The S&P 500 Composite Index and the Dow Jones Industrial Average made their intermediate lows on March 22 and then retested those lows the first week of April, which was the inflection point we had been waiting for.

The Nasdaq hit bottom on April 4, right in the week of the inflection point hitting an intraday low of 1620. It now stands 28 percent above that mark -- not a bad month's work. The Dow has gained 20 percent, while the S&P is up a none too shabby 16 percent. Stocks received a huge shot in the arm with the Greenspan Fed's surprise move on interest rates.

On April 18, the discount rate fell another 50 basis points to 4.00%. Stocks exploded higher, the Nasdaq rising 8.1 percent in a single day. That was a far cry from its record one day move of 14.2 percent following the first rate cut on January 3. But it was still enough to qualify for fourth place on the all-time list.

The Dow responded in like fashion. After wowing us with a violent breakdown out of its diamond formation, it wowed us with an equally impressive move right back up into that same diamond formation.

Bear markets are notorious for the volatile price action we have seen lately. Since it made its all-time closing high in March of 2000, we have witnessed the eight greatest one day percentage gains in the history of the Nasdaq. Nine of the top ten largest one day advances in the Dow Industrials were recorded in its worst bear market ever during the Crash of 1929-32.

Those who are using our FREE HIPPO software were sent an email the day before the "April Surprise" on April 17 recommending an increase in equity holdings from 20 percent stocks/50 percent cash/30 percent bonds to 70 percent stocks/30 percent cash for the growth portion of their portfolios. We will discuss a little later our reason for moving out of bonds. Readers of our Weekly Insights newsletter were told that the bottom was in for short term investors a week earlier.

After all this positive movement in share prices, stocks are due for a breather here. All the indices are approaching extremely important resistance zones. As you saw in the Dow chart above, that average is approaching a down trendline that goes all the way back to its January 2000 record high. That trendline offers resistance this coming week in the 11000 neighborhood. That is the same neigborhood that the Dow has failed to break through on the upside no fewer than five times since September 2000.

The Nasdaq and the S&P 500 are confronting down trendlines that go back to the September 2000 highs. In the upcoming week, resistances are at 2250 and 1300, respectively. These resistance levels are associated with an enormous supply of stock from buyers who believed the market was bottoming back in December of last year. Those buyers may be more than a bit nervous about their holdings after witnessing the subsequent devastation. Nervous shareholders make eager sellers when their losing positions reach the break-even point.

This is shaping up to be quite a battle. Most of our indicators are quite positve for stocks right now. As you know, last month we reported that our intermediate model had moved into BUY territory after the Fed rate cut on March 20. Add to that an unsustainable explosion in our liquidity indicator RPCM2 (see the latest update by clicking on the link at the top of this page) and a very favorable move in our index of Bullish Minus Bearish Newsletter Writers. The last time that indicator was down at this level near zero was in October of 1999 after which time the S&P 500 moved up about 300 points from its lows.

With all of this positive force behind the market, we would not be surprised to see these averages penetrate their down trendlines. If so the Dow is poised to retest its all-time high of 11750 set last year. Perhaps the S&P will as well. The best that could be expected for the Nasdaq would be a 50 percent retracement of the bear market decline -- somewhere in the 3400 neighborhood. But we're getting a little ahead of ourselves here. The first thing we need to focus on is to see whether these markets can get through the above resistance levels.

The one variable that is behaving negatively is very likely the one that could turn the lights out on this party. The 30-year treasury bond yield has just broken down out of a rising wedge formation on our inverted yield chart. The projected yield based on the technicals is 6.75%. Any move above 6.00% would be enough to trigger a SELL signal in our intermediate model assuming inflation drops below 2.50%. If inflation remains at its current 2.90%, a move above 6.50% in the 30-year bond would be needed to trigger a SELL.

Our intermediate-term models use monthly data. As such, their timing is accurate at best +/- one month. The 30-year Treasury bond rate has moved up over 50 basis points from 6.22% to its current 6.79% in just one month. It is quite possible it could trigger a SELL in our model as early as June. That would mean it would be signalling a top in the stock market sometime between May and July. And May begins on Tuesday of next week.

Regardless of when the markets start to turn lower, the blowoff phase of the 1995-2000 stock mania appears to be over. The blow-off phase began in October 1998 when the technology-heavy Nasdaq Composite began its surreal climb. The following comparison chart makes it clear that the blowoff has been fully corrected, as the Nasdaq (symbol IXIC) is back in line with the NYSE, Dow, and S&P 500 averages. Our expectation is that the averages will now move more or less in synchrony much as they did prior to the blowoff period.

Buy and Hold. Buy the Dips. We promised you last month we would tell you why these seemingly sensible approaches to making money are on the way out and why Market Timing will soon replace them as the favored strategy.

Buying the dips was a favorite strategy when the Nasdaq was in its blow-off stage, simply because no matter what level investors committed their funds, they were quickly rewarded. If share prices fell 20 percent and an investor bought after a 10 percent decline, the market was higher than their entry price within a month. That is what is referred to as a Bull Market. And a maniacal one at that.

Now we are in a Bear Market. Investors who continued with that strategy after March of 2000 are feeling great pain at the moment. Many have become more than a little gun-shy and probably quit buying the dips. Now having watched the Nasdaq power ahead over 30 percent in less than a month, we suspect that they are afraid they may have been left behind. Out of panic, we also suspect that they will jump back in just in time to become the proverbial bagholders.

That will be the end of the Buy the Dips crowd.

A strategy that enjoyed even greater popularity in recent years was the Buy and Hold. As stocks soared in the late 1990s, study after study was unleashed on the public showing how investors could have made enormous gains even if they made their purchases at the cyclical peaks in the market.

What a number of unsuspecting investors were unaware of was that these studies were often based on a period of time when stocks were in a bull market. Usually a very extended and record setting bull market that began in 1982 and lasted until 2000. There have been times in the not so distant past, however, when this strategy produced much different results.

If an investor were so unfortunate as to get swept up in the stock mania of the 1920s right at its peak on September 3, 1929 he or she would not have recouped his or her entire investment for 30 years! On an inflation adjusted basis, the Dow Jones Industrial Average did not get back to those prior lofty levels until July 2, 1959.

That doesn't count the dividends, however. Over that 30 year period stocks paid out dividends of 4.93% on average. Compared with an average Treasury bill rate of 1.15%, stocks were still a better investment. There are still two problems with the Buy and Hold strategy, however.

First not every investor has 30 years before they need to draw down on their stock holdings. Second, and this is the biggest problem with this strategy, not many investors have the stomach to hold on while share values are being cut by 50, 60, 70, 80 or in the case of the 1929-32 bear market, 90 percent.

It's one thing to say "I just buy good stocks and let them do the work for me" when you're in a bull market surrounded by people who love stocks and think that only an idiot wouldn't own them. It's entirely a different situation when you're losing money and surrounded by folk who have no desire to discuss the market and believe that only an idiot would own stocks.

In case you think that the 1930s were an anomoly, anyone who jumped into the market with both feet on December 13, 1968 didn't get above water again until April 21, 1995 after deducting inflation. And those poor souls didn't even benefit from dividend gains. In that inflationary period, dividend yields averaged 3.93% while someone holding those mundane risk-free Treasury bills was collecting nearly 7.00%.

NOTE: Last month we stated that secular bear markets began in 1929 and 1972. Actually, they began in 1929 and 1968. The 1972 bear market was a severe cyclical downturn within a larger secular bear. For our purposes we define a secular bear market as one that doesn't return to its former high for at least 15 years.

Market Statistics
DJIA 10810.05	S&P500 1253.05
DJTA 2862.37	Nasdaq 2075.68
DJUA 396.00	30 YR BOND 5.79%

28-March-2001

Long Term Model asset allocation:
stocks	bonds	cash	gold stocks
70%	30%

Intermediate Model asset allocation:
stocks	bonds	cash	gold stocks
20%	30%	50%

"DON'T FIGHT THE FED!". That was Wall Street's battle cry once the Fed began aggressively cutting interest rates in early January. Throughout the balance of that month it seemed to most investors that this was sound advice indeed. However, when Greenspan & Co. lowered the discount rate a second time on January 31, investors in technology stocks found themselves on the wrong side of the tape.

The desolation was historic as the Nasdaq Composite experienced its third worst performace in history in February. On a closing basis, the index lost 22.3 percent -- worsted only by the two months of October 1987 (-27.2 percent) and November 2000 (-22.9 percent). Notice that two of history's worst three months belong to the current bear market. When asset bubbles burst, the ensuing panic is never a pretty sight.

To those with holdings in America's elite companies, it appeared for a time that the Blue Chips were exempt from the bloodbath. Both the NYSE and the Dow Industrials drifted lower but not enough to shake them out of their sideways patterns. By March 12, however, the Big Dogs had joined the parade to the downside. The seemingly aloof Dow Jones Industrial Average moved out of its two year long diamond pattern and crashed wrecklessly through its lower support line.

The Fed's third rate cut on March 20 did little to lift investors out of their malaise and plenty to increase their confusion. Readers of this column should not have been confounded by the perverse market reaction to these normally welcome moves by the Fed. In the January 28 issue of Market Insights we speculated that "If a discount rate cut is to be the catalyst, then the current rally could end as early as February 1 when Greenspan & Co. are expected to lower rates again."

Admittedly, we thought it more likely that stocks were in a bottoming phase at the time. In retrospect it would appear that we were about a month premature on that call. Nonetheless, we raised the possibility two months ago that stocks would behave in a counter-intuitive fashion due to our belief that we are in the throes of a secular bear market. One not unlike that experienced in the early 1930s. Remember this: in this bear market most surprises will be to the downside just as most surprises were to the upside in the mania of the prior five years.

Readers of our Weekly Insights newsletter were warned on March 4 to watch three benchmark support levels to determine the near-term direction of the markets. Violating the 1214.5 level of the S&P, we warned, would mean that the intermediate bottom we had been anticipating would be delayed. Our precise words were "Should the S&P 500 close below its Thursday intraday low of 1214.5 we would turn very bearish on the markets in the short term... A close below 10300 by the Dow and 611.4 by the NYSE Composite would reinforce this view."

All three support levels were laid to waste on March 12. The same day we issued a portfolio adjustment via email to users of our free HIPPO portfolio management system. We now believe that this Elliot Wave interpretation is the most plausible.

The above Elliot Wave projection looks remarkably similar to the forecast we offered back in December 2000 when it became clear that the S&P 500 had broken down out of a diagonal triangle (a.k.a. rising wedge) formation. That formation predicts a rather dramatic and sharp decline to the 900-1000 area. The Elliot Wave interpretation above shows that we believe we are currently in the grip of the second leg down (Wave 3) since the September 2000 double top.

If our count is correct, there will be one more move down to the 1075 level on the weekly chart which could easily correspond to an intraday low of 1000. The time frame for such an event would be the second week of April (+/- one week) when a thirteen week inflection point is due. Typically the April inflection point represents a solid buying opportunity and the evidence suggests that is what we will get this time around. Don't rule out the possibility, however, that last Thursday's low of 1081 on the S&P will ultimately turn out to be the intermediate low.

Regardless, we are quite certain that stocks are ready to mount an important intermediate rally. That is because a Federal Reserve discount rate of 4.50% (as of March 20) has triggered a BUY signal for the month of April in our disount rate model of the stock market. This model is accurate to within +/- one month so it predicts an intermediate bottom sometime between March and May. A still expanding RPCM2 liquidity measure supports this view (to look at the latest update, click on the link at the top of the page).

Does this mean that the bear market is over? Not in our minds. This intermediate bottom would set up a move to perhaps the 1300 level for the S&P 500 Composite index as it forms an Elliot Wave 4. After that we would expect the third and final leg down (Wave 5) to complete the damage to 1994 valuations. The trigger for that decline is very unlikely to be a rise in short term rates as occured in early 2000. Our expectation is that short term rates will continue to fall throughout the remainder of the bear market.

This time around we would anticipate a SELL signal from our long bond model of the stock market. At this point in time, it looks like the 30 year bond would need to rise over 6.00% in order to trigger such a sell signal. While just a week ago that seemed an unlikely event, the 30 year bond yield has jumped from a two year low of 5.22% to 5.48% in just four days.

Looking out over the horizon, history gives us a little insight into how this bear market might unfold. The last two secular bear markets began in 1929 and 1972. On an inflation adjusted basis, S&P 500 stock prices fell about -2.4% per month in the Great One, and about -2.2% per month in the 1970s bear. Thus far, the current bear market (which we believe to be secular in nature) is following a trend channel that slopes downward at about a -2.2% rate, including an inflation component of -.2%.

That translates into a decline in the S&P 500 of roughly 30 points per month. Since we are targeting the 450 level in this bear market, a minimum duration of three years is implied. Should this turn out to be the case, a bona fide bull market in stocks would not begin until the latter part of 2003. In comparison, the 1929 bear lasted 33 months and the 1972 bear lasted 24 months.

Our long term model is still recommending a maximum of 70 percent stocks, while the intermediate model moved to a maximum of 20 percent stocks on March 12. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. Please try it out -- you won't be disappointed.

Be sure to join us next month when we dissect the recently popular investment strategies of "Buy and Hold" and "Buy the Dips". Learn why these seemingly sensible approaches to making money are on the way out and why "Market Timing" will soon replace them as the favored strategy.

Market Statistics
DJIA 9785.35	S&P500 1153.29
DJTA 2765.08	Nasdaq 1854.13
DJUA 372.84	30 YR BOND 5.46%

28-February-2001

Long Term Model asset allocation:
stocks	bonds	cash	gold stocks
70%	30%

Intermediate Model asset allocation:
stocks	bonds	cash	gold stocks
45%	30%	25%

Regular readers of the Market Insights newsletter should not have been surprised to learn that the S&P 500 Composite index was officially declared in a bear market last week. Our indicators allowed us to speculate back in May 2000 that "Our expectation is that a double top will form sometime in the fall, followed by a bear market." Later that year in October we proclaimed "...we are convinced that all the major indices have now entered a bear market..."

From its all-time high of 1553.11 last March to its intraday low of 1215.44 last Friday, the S&P 500 is now down nearly 22 percent -- by generally accepted definition a bear market is one that has fallen a minimum of 20 percent. Both the Nasdaq and S&P are back to levels not seen for two years -- since February 1999 -- wiping out all the gains acquired in the blow off phase of the mania that began in 1995. That mania, we believe, marks the end of the great bull market that began in 1982. When the bear has completed its mauling of stocks, we believe the major indices will find themselves in the neighborhood of their 1994 levels. That could take years to unfold.

In the near term, we believe stocks are putting in a bottom here. While today's price action was not encouraging, particularly in the Nasdaq, a positive close tomorrow in the S&P 500 would trigger a short term BUY signal in our model. Should the market continue lower from here, we are closely watching the 10300 level on the Dow Jones Industrial Average and the 611.4 level in the NYSE Composite. The NYSE is retesting the 611.4 intraday low set back in October. The Dow is challenging the lower support line of a rare diamond formation. If this level holds, we anticipate a final run to the upper resistance line. This would complete a Wave 5 by our count that would be followed by a decline and ultimate breakout of the formation on the downside.

While that is going on in the Dow, we expect the S&P 500 to unfold in the following Elliot Wave interpretation of the S&P weekly chart. The force behind the anticipated counter trend rally in stocks is expanding liquidity. The latest reading of our proprietary RPCM2 indicator showed another increase for the month of January (view the RPCM2 chart by clicking on the link at the top of the page). We don't expect to see another serious decline in stocks before RPCM2 starts a decline that should take it below its seven-year moving average.

There has been a lot of focus on the Fed in recent weeks as investors look to Greenspan & Company to bail out both the economy and the stock market. Signs of impending recession are all around us. Consumer confidence, factory capacity utilization, and the year-over-year change in initial unemployment claims are all at levels not seen since the 1990-92 recession period. GDP growth is clearly slowing, the National Association of Purchasing Manager's manufacturing index is now at a ten year low, and the CEO Business Confidence Index hit a twenty year low!

In spite of all this, the Fed is not likely to lower rates before their March 20 meeting. That's because consumer spending has not yet shown a significant decline and both PPI and CPI inflation data popped up higher than expected in January. It's only one month's data but if inflation continues to rise, Greenspan will find himself in a shrinking box with limited options. Postponing the rate cut is bad news for stocks because our proprietary Discount Rate Model indicates that short term rates must fall at least 50 basis points (1/2 %) to significantly propel stocks upward.

While a recession appears imminent, our own boom/bust indicator has yet to move into the danger zone. This indicator compares the S&P 500 Composite dividend yield (currently around 1.3%) with the three month treasury bill yield (around 5.0%). It is telling us that either stock values or short term rates (or both) will fall further before real trouble arrives in the economy.

Increased liquidity like the Fed is adding would normally pull the economy out of its tailspin. It only works, however, if it translates into greater borrowing and spending by businesses and consumers. With confidence falling, debt levels high, the personal savings rate near 60 year lows, and the stock market either flat (if you're in large caps) or down significantly (if you're in technology), our suspicion is that the extra liquidity will find its way into retirement savings and debt reduction. The Fed could find itself pushing on the proverbial rope, much as it did back in 1990-92.

There has been much discussion in recent years of the impact demographics has on the economy and the market. The rate of human procreation appears to move in a rhythmic pattern, rising in number for roughly twenty years and falling for another twenty. In theory, this birth bulge translates into a surge in consumer spending and investment some 47 years later when people on average are reaching their peak earning years. This so-called Spending Wave forms the basis of some market forecasting models, most notably that of futurist Harry S. Dent, Jr.

Dent has directly correlated the performance of the S&P 500 Composite index step for step with the Spending Wave. The conclusion that one must draw from his model is that the bull market in stocks still has a way to go and will not end for another four to eight years. Perhaps more importantly, the chart provides a convenient explanation and validation of today's record setting stock market by the sheer size of the Baby Boom wave (peaking in the 2000s) compared with the prior wave (peaking in the 1960s).

Our position on this concept is that it is valid in its fundamental assumption. Clearly the Spending Wave has to make an impact on the economy. It is the magnitude of that impact that we take issue with. If you think about it, it isn't the absolute number of people in a cohort group but the size of that group relative to the size of the entire economy that is important. A "quick and dirty" way of normalizing the data is to divide births lagged 47 years by total current population. The result is what we refer to as the Demographic Wave.

It should be obvious from the two charts that the Demographic Wave could not have the same impact on the economy and stock market as the Spending Wave is presumed to have. Using the same logic that is applied to the Spending Wave, the Demographic Wave should have produced in the 1950s a bull market more powerful than today's Greatest Bull Market of All Time. We see the Demographic Wave as one of several important cyclical effects that drive the market -- certainly not by itself enough to avert the hangover that will surely follow the great stock market party of the last five years.

Our long term model is still recommending a maximum of 70 percent stocks, while the intermediate model is still at a maximum of 45 percent stocks. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. Please try it out -- you won't be disappointed.

Special Note: In last month's newsletter we discussed Fed rate moves today in comparison with those in 1929-30. We were quoting rate hikes and drops by the Minneapolis Fed. Prior to WWII, the various Fed districts functioned independently of each other. Fed actions in Minneapolis tended to be more measured than those by the New York Fed, for example, neither rising as high nor falling as low.

Market Statistics
DJIA 10495.28	S&P500 1239.94
DJTA 2925.04	Nasdaq 2151.83
DJUA 386.22	30 YR BOND 5.34%

28-January-2001

Long Term Model asset allocation:
stocks	bonds	cash	gold stocks
70%	30%

Intermediate Model asset allocation:
stocks	bonds	cash	gold stocks
45%	30%	25%

Last month we promised to discuss a phenomenon we call the Demographic Wave (a.k.a., the Spending Wave) in this month's newsletter. Because of Fed chairman Alan Greenspan's "January Surprise", we felt it more fitting to spend time discussing the historical effect of discount rate reductions on the stock market. We will shelve the Demographic Wave topic until next month.

As we noted last month, discount rate reductions are generally positive for equity valuations. Since 1915, the S&P 500 Composite index appreciated an average of 15 percent in the year following a discount rate cut. Compare that with a -2 percent return following a tightening move by the Fed. (For both calculations, returns were adjusted for inflation and ignore cash dividends).

There are exceptions, however. We make the case in our Turning Point article that the U.S. equity markets have been in a mania the past five years, similar to those that peaked in 1835 and 1929. The Federal Reserve was created in 1913, so there is no discount rate for comparison in 1835. Looking at 1929, however, history suggests that we should treat rate cuts with great care.

In May of 1929, following six years of mania, the Fed raised the discount rate from 4.5% to 5.0%. Four months later the party ended. The Fed did not lower rates in reaction to the dramatic fall in equity values that followed but instead waited until February of 1930 when the economy showed signs of slowing. Stocks continued the rally that began the prior November. Investors undoubtedly took solace in the Fed's supportive action.

The next discount rate reduction came in April 1930 dropping it to 4.0%. Almost immediately real long term interest rates began to rise and stocks fell. By the end of the year real long rates had jumped from under 3.0% to close to 10.0% while stocks lost 40 percent of their value. As these long bond and stock index comparisons demonstrate, there are eerie similarities between then and now.

Why should lowering short term interest rates cause long term rates to rise and stocks to tank? Our discount rate model indicates that a reduction in the discount rate to 4.5% at the current time would be enough to end the bear market in equities and launch a new bull market -- assuming that real long rates stay below 4.0%.

The problem is that we may not be able to get there from here. Much of the current mania was financed from overseas. In particular, foreigners own a subtantial stake in long term fixed income securities. A slowing economy coupled with falling short term rates will weaken the dollar relative to other currencies, eating into the fixed returns that foreign investors can earn.

The risk is that lowering short term interest rates too much will convince overseas holders of bonds to liquidate their positions, driving long term real rates upward and equity share values downward. The financial panics following both the 1835 and 1929 manias were accompanied by real long term rates well into double digits.

In the shorter term, the January Effect shifted money out of big cap stocks (the Dow Industrials in particular) and into small cap stocks (including those in the Nasdaq Composite) just as we had anticipated last month. All the major indices have been searching for an intermediate bottom since late December. The surprise Fed move on January 3 locked it in.

Our money variable indicator, RPCM2, confirms that we are in a counter trend rally. Liquidity exploded upward in December, driving RPCM2 further above its seven-year moving average line. When it falls below its average again the majority of the stock market decline will follow, but that could be months away. Check out the updated RPCM2 chart by selecting the link at the top of the page.

Looking at a chart of the S&P 500 index, it appears at this point that the market decline from September through December is the first of three down legs in this bear market. How long might the current counter trend rally last? In 1929 the first down leg lasted only two months while the counter trend rally lasted five months but retraced just 50 percent of the decline.

If a discount rate cut is to be the catalyst, then the current rally could end as early as February 1 when Greenspan & Co. are expected to lower rates again. Although we find ourselves in an intermediate term rally, stocks have yet to clear the resistance levels we laid out last month. Our hunch, however, is that February is too soon for a continuation of the bear market decline. We will be watching the situation very closely in our new newsletter, Weekly Insights, which is offered on a subscription basis with email updates as market conditions warrant.

Our long term model is still recommending a maximum of 70 percent stocks, while the intermediate model moved up to a maximum of 45 percent stocks after the Fed rate cut. These maximums are for more aggressive investors and should be modified by the results of our FREE proprietary HIPPO program. Please try it out -- you won't be disappointed.

Market Statistics
DJIA 10659.98	S&P500 1354.95
DJTA 2956.19	Nasdaq 2781.30
DJUA 375.65	30 YR BOND 5.64%