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THURSDAY a.m.
January 30, 2003



The Neutral Zone
by David Nichols

Last Friday's opening hour was so shockingly bad that it's going to require convincing upward movement to prove the selling wave has subsided, and fear isn't still in control of market participants.



While some have been quick to jump on the strength over the last few days as a sign of a bottom, it just doesn't look that way to me. We all know by now what a true washout bottom looks like -- it's a dramatic bungee cord drop down and up, with accelerated moves in both directions. This one has so far only seen the acceleration to the downside.

The move up looks more like a routine, drifty move back to the underside of an important broken support line. The market is pausing in the selling, working off the extreme initial descent. It's very dangerous to assume otherwise.



Since the summer swoon in 2002, the markets have found a "neutral zone" where prices like to reside during uncertain periods. This neutral zone is between 875 and 910 on the S&P 500. It takes a lot of energy to break out of this neutral zone, both up and down, and so far none of the breaks above it have been able to hold for too long.



Now we've seen a decisive break of this zone to the downside. It happened last Friday, with continuation on Monday. Using the strength of this downside break as a guide -- and the fact that bear market sentiment patterns persist -- it's likely the breakdowns out of the neutral zone have more validity than the upside breakouts, and should be given the proper amount of respect.

If there is a decisive and clear move back above SPX 875 back into the neutral zone, then bearish positions should be reassessed. At that point it will be easy for the market to drift back and forth between 875 and 910, awaiting the next important geopolitical, corporate, or economic development.

Let's pull back a bit and look at the big, big picture. Among technicians, this next chart is a popular way of viewing the bear market. How could it not be? The SPX has been riding down a very clear channel for nearly 3 years.



The fact that this channel is widely recognized and followed is a good thing. This single chart is one of the reasons why the market has a chance to really move in one direction or another in 2003. If global tensions ease, and the recovery gets traction, the upside could be surprisingly robust. A confirmed break out of this channel should be embraced as a very, very bullish development, and we'll be more than happy to join the bullish festivities.

Yet a move back down to the bottom of the channel could be an epic wipeout.

The monthly SPX chart still has some serious problems. I like to look at the 12 month exponential moving average as an important gauge of the long-term trend -- this is the blue line on the chart. Glancing back you can see that this one average would have kept you on the right side of the market for a very long time.



January is not a bullish month on this chart, although there are still two days left. But with two days to go we can see a long "wick" up on the monthly candle -- stretching for the 12 month average -- yet utterly failing to hold. There is absolutely nothing in this chart that shows the bear market patterns have been vanquished.