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Long Day's Journey Into Down



Tony Dwyer made an interesting remark yesterday in his Random Thoughts piece. He wrote, "The argument of secular bull vs. bear isn't relevant to me. The S&P 500 (SPX) hasn't even moved above the last lower high in a clear downtrend of lower lows and lower highs, which defines a downtrend. To repeat - THE SPX HASN'T EVEN BROKEN THE DOWNTREND YET!!! And I am the resident bull."

Although Tony and I are both technicians, we have very different stylistic approaches. Occasionally, this difference in approach results in the kind of misperception Tony referred to when he called himself the "resident bull."

To sort things out and make sense of the journey we are all on, and make no mistake the journey differs for each if us, let's look at the market through a different lens.

Let's look at the market as a trip. Also, a journey. No, let's just look at it as a journey. Forget the trip part. Ok, each morning when the market opens millions of participants take another step along their journey. For some, the journey may be a simple walk around the block. For others, it's a subway ride from New Jersey into the city. For some it is a four-hour train ride from D.C. to New York. And for still others it is a trip across the country, perhaps originating in Los Angeles. The final destination is the same: making money. The maps involved for each trip are dramatically different.

Before you make your trip, it helps to accurately choose your map. A map showing the route from Los Angeles to New York is useless once you get within 15 minutes of the city. A city map showing downtown Manhattan is worthless for planning your journey from Los Angeles.

Let's look at some maps. Below are two "maps" of Yahoo!, Inc. (YHOO). I chose YHOO simply because they reported earnings last night, although I could have chosen any number of stocks across a wide array of sectors.

The first chart is a 1x3 scale of YHOO. I think of this as a detailed city map. YHOO has given only one sell signal since the initial breakout off the bottom last October. The most recent sell signal was a double bottom break at 29 in August, followed very quickly by a buy signal at 34 in September.

The second chart is a 2x3 scale of YHOO. Although these are charts of the same stock, the path they describe are dramatically different. On this chart YHOO gave its first buy signal, from the 2002 lows, in March of this year. But, as you can see, the road is only getting more difficult from here, not easier. The stock is now testing resistance from January 2001, and the primary down trend line remains very much intact.

My journey begins with an assessment, subjective of course, and a thesis, also subjective, about the easiest path to my destination, which is making money. From there, I use the indicators I follow to help me choose the safest roads. Sometimes a safer road takes me temporarily in the opposite direction of where I'm ultimately headed. But, as long as my thesis about the best path toward my final destination remains intact, I'll stay the course.

My thesis is that this is a powerful cyclical rally in a larger structural bear market. From my perspective, the less dangerous long-term path is the one that sides on the larger structural trend, which is down, because there is more margin for error when one participates with the primary trend.

However, and this is probably the most important point I want to make here today, my indicators occasionally tell me to take a course that does not intuitively correspond to the direction of my ultimate journey. My discipline forces me to make traveling decisions that sometimes fly in the face of my larger thesis.

If I just traveled on this journey according to my big picture thesis, I would be very much like someone who wants to go from Los Angeles to New York by way of the shortest distance between the two points without any regard for the obstacles that may be in the way. Consequently, I would find myself traveling through dense forests, treacherous ravines, up and down mountain ranges, across rivers and lakes, and who knows what else.

So, while my big picture view is decidedly bearish, my long-term indicators have remained stubbornly bullish since April, with several fluctuations in the short and intermediate term indicators along the way. From that standpoint, the value of outlining a big picture thesis is that I never lose sight of what the primary trend is since this primary trend, once the short and intermediate trends begin to turn around and reinforce it, is where I believe the big money lies.

My indicators allow me to participate in the counter-trend moves when risk levels are appropriate, albeit on a lesser scale than I would participate in a move that is "in trend". But the real money will be made when the indicators and the respective short, intermediate, and long-term trends line up.

From this discussion, hopefully you can begin to see that the perceived divide between Tony's views and my own, is not quite as wide as it may appear on the surface. Although I believe we do disagree as to the relevance of the structural bull vs. structural bear debate, there is simply no arguing that currently demand continues to have her way with the market. Every attempt by supply to gain control has been met with a counter-thrust by demand. This does not change the fact that risk is very high, but it does give powerful evidence that the short and intermediate trends are not quite ready to fall back in line with the longer-term structural trend. Every day we get closer, and risk gets higher, but what is, is. And right now, what is, is that demand is refusing to relinquish control.

No positions in stocks mentioned.

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