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Getting Ready For The Next Bull Market

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

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

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

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

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

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

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

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

The International Securities Exchange (ISEE) Sentiment Index, which measures calls/puts, is also sending a very bullish intermediate-term signal for the market. The 15-day moving average of this ratio is currently at its lowest level in over two years, which shows that the public has been very heavily bearish on the market's prospects. Once again, from a contrarian standpoint this is bullish.

The S&P 500 index (SPX) closed at its highest level of the past four months Friday at just under the 1320 level. What's next for SPX in the next few days is anyone's guess but odds favor a corrective dip or "pause that refreshes." The downside potential on the market's next correction will likely be limited by the bearish investor sentiment backdrop and once this correction ends, as previously mentioned, we'll likely see the SPX breaking out above its May high and on to higher levels.

After breaking out above its 10-week consolidation pattern, the Broker/Dealer Index (XBD) has finally signaled that the bull market we're talking about should shortly begin. I'm hopeful that before long the Bank Index (BKX) will join the broker/dealers on the upside. The bullish signal generated in XBD will be difficult to ignore as many professional traders and institutions follow this extremely important leading index. When XBD breakout out on the topside and makes a new 10-week high the broad market indices nearly always follow suit.

So with the dust settling from the 8-year cycle, the pieces are being put in place for the next bull market in stocks that will take the Dow to its highest level in a while and finally lift the NASDAQ out the funk it has been in for a long time (as exemplified until recently by the NASDAQ advance-decline line). The tech stocks will finally resume its role as a leader as the baton is passed from the oil stocks to the techs and the Dow, which has been held back now from breaking out for over a year, will finally take off and running as we head into what should be a bullish 2007.

Clif Droke is the editor of the 3-times weekly Momentum Strategies Report, a technical forecast and analysis of several leading stock market sectors and individual stocks, which is available at www.clifdroke.com. He is also the author of several books, including "Turnaround Trading & Investing," also available at www.clifdroke.com.

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