Reply #21: Assessing the Quality of the Equity Rally from July 2006

[Ghost Dog]

http://www.gold-eagle.com/editorials_05/mchugh101306.html
October 13 th, 2006
Robert McHugh, Ph.D.
(Please forgive if already published here Friday)

One of the things we do each night is evaluate the quality of each day's price move. We want to know whether a trend is genuine, with broad-based participation, implying a longer shelf life, or whether it is the result of panic buying or selling, which suggests high risk of termination, and reversal. When directional volume, issues, and points are near, or over 90 percent, that is an indication of fear being the motivating factor for the price move, not a solid sustainable trend. Selling panics are an indication of selling exhaustion, often leading to strong reversal rallies. But the reverse is true, which is important when we are in what appears to be a strong price rally, since Bear markets can wipe out months and years of gains from Bull markets in short order, in a matter of weeks. So, we want to know if a multi-month rally has occurred from solid, broad-based buying, or whether it was intervention short-covering induced.



Most autumns we see a significant decline. This attracts shorts. Bears take aggressive short positions where they buy puts, or agree to sell shares in the future at today's prices but do not yet own those shares. They are gambling prices will decline. Interventionists feed off of shorts. The rally since July has been almost entirely short-covering. We get one big move, about once a week, on buying panic, then no follow-up, with slightly down to sideways price action until the next week. What has been missing has been supply. Sellers have noticed these out of the blue short-covering rallies, so have disappeared. The interventionists have succeeded in muting supply pressure. This type of rally can continue for quite some time, and drive prices quite high, as we have seen. But it is a death trap. It is artificial. It will end as soon as some trigger event sends fear into markets, the kind that catches shorts on the sidelines, buyers exhausted, and interventionists helpless to play their game. We believe a Democrat victory in the coming election could be such an event.

Get this: All of the progress of this three month summer/autumn rally, all of it, occurred in only 9 days of trading, and all but one of the nine was a short-covering rally. In other words, without intervention induced short-covering, the Dow Industrials would be exactly where they stood in mid July, at the start of this rally. Other than those 9 trading days out of 63 since July 14th, the other 54 days of trading produced only 4 percent of the upside progress, and zero since July 19th. Zero. In 8 of the 9 trading days where upside progress was made, evidence of short-covering was present. That evidence included a larger rise in Demand Power than the decline in Supply Pressure, suggestive that shorts joined the buying. That evidence also included either upside volume, advancing issues, or upside points coming in at or very near a buying panic 90 percent. In each instance, a sharp up move started early in the day, followed by buying panic as shorts felt compelled to cover, pushing the rally higher throughout the day. There was only next-day follow-through to the upside one time, on August 16th, after a short-covering rally on the 15th, but it too showed evidence of short-covering. No days other than August 15th showed strong upside follow-through. Solid rallies see follow-through. This rally has been manufactured.

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The point of examining whether the quality of this rally is broad-based or is from short-covering, is critical as to the risk that it will end badly. Clearly the rally from July has not been broad-based, is not sustainable on its own, is not a classic "Bull" market, but has occurred from a lack of supply and a ton of buying and price pushing from those most pessimistic about the market, not from optimists. There was no net progress in 52 of the past 60 trading days. Think about that. All this market requires to tank is a reason to sell. The buying isn't there. Overall, the decline in Supply Pressure since July 19th was 25 points, more than the rise in Demand Power, which was 21 points. This is not what we should see in a solid bona fide rally. Sustainable rallies require a stronger rise in Buying Power with a corresponding decline in Selling Pressure. We have the opposite condition here, a weak rise with the decrease in Supply exceeding the increase in Demand. Can prices rise further from here? Sure. Figure another intervention short-covering rally or two before the election, and maybe another 200 points? But, it will stop when an event sends fear into Wall Street, and end badly.

Genuine rallies occur typically with 2 to 1 upside volume, advancing issues, and upside points, with the Demand Power rise about equal to the Supply Pressure decline each day, and we see follow through several days in a row. We don't see once a week hundred point gains, and then sideways action for four or five days. If buyers are excited about the future, we should see strong steady buying on a daily basis, with periodic profit-taking selling. That is not what has happened since July.

The motive? The November elections. Wall Street loves Republican control. The means? Hidden M-3, and the lawful actions of the Working Group and their surrogates as established by President Reagan in 1988.

/continues...