Dog Days Arrive Early

A growing number of analysts expect directionless trading to persist.
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Did somebody say "woof"?

After three years of gut-wrenching declines followed by nine months of mind-blowing gains -- interrupted in the first-quarter by another sickening slide -- the market could use a rest. Certainly, most participants would embrace a period of relative tranquility. Traditionally, such a period occurred in late summer as investors fled the sticky confines of lower Manhattan for the Hamptons or Nantucket or other seaside destinations.

Modern communication capabilities and "fast" markets have often forestalled the arrival of these so-called dog days in recent years. But an increasing number of market participants are expecting them to arrive soon, if they haven't already. Most observers believe the rally from the mid-March lows has peaked, but they're looking for trendless, sideways action for the foreseeable future, as opposed to a big swoon.

Last night I mentioned Scott Bleier of HybridInvestors.com being so inclined. Rainsford Yang of Astrikos.com, a Web site dedicated to market-timing, offered a similar view Wednesday, appropriate on a day featuring dogged action.

Major averages overcame midday weakness to end higher and near intraday highs. But the day was pretty uneventful and final tallies modest. The

Dow Jones Industrial Average

closed up 0.4% to 9194.17; the

S&P 500

gained a fraction to 988.60; and the

Nasdaq Composite

rose 0.8% to 1719.15.

The Comp's outperformance was fostered by optimism about results from Internet names

Amazon.com

(AMZN) - Get Report

and

Ask Jeeves

(ASKJ)

, as well as biotech bellwether

Amgen

(AMGN) - Get Report

. Blue-chip proxies were restrained by notable weakness in

AOL Time Warner

(AOL)

.

Trading volume was solid, with over 1.3 billion shares on the

Big Board

and 1.8 billion over the counter, but market breadth favored advancers by a narrow margin in both.

Release the Hounds

Wednesday's gains notwithstanding, the market looks "vulnerable" in the short term, Yang declared, citing Tuesday's close of 20.98 by the CBOE Market Volatility Index. (The VIX fell another 2.6% to 20.44 Wednesday, its lowest close since May 23, 2002.)

Of 18 prior occurrences in the past four years when the VIX initially closed below 21, the S&P 500 was down 14 times a week later, with an average loss of 2.2%, he reported. Recent examples include April 19, after which the S&P fell 4.3% in the ensuing week, and May 23, after which it shed 2.7%. (Of the four occasions the index rallied, the average gain was 0.5%. But that average is skewed by a 1.1% advance in 1999.)

"Accordingly, Wednesday's session appears to be a good time to square up long positions and begin anticipating a likely selloff," Yang said.

On the other hand, the specialist short ratio -- the ratio of short-selling by New York Stock Exchange specialists to total short-selling -- was 32.6% in the past week, the sixth week in seven it's been below 35. The relatively low level indicates that specialists have been forced to buy stock as the public bets on the short side, he suggested. "Since the public is invariably wrong about the stock market's prospects, this long period of accumulation by specialists and selling by the public typically comes right before significant rallies."

Since 1970, the ratio has been below 35% for six out of seven weeks only eight times, he reported. The S&P was higher three months later in every case, with an average gain of 8.6%.

"The specialist short ratio argues against a meaningful selloff anytime soon, but other key long-term indicators, like the net position of commercial

hedgers in S&P futures, remain bearish, creating somewhat of a standoff," Yang concluded. "I'm expecting a difficult market for the next few months -- most likely a prolonged trading range around current levels."

In sum, dog days.

The Yellow and the Green

While equities were relatively sleepy, there was some drama in so-called other markets. Gold futures rose sharply, up $7.80, or 2.2%, to $358.50 per ounce, while the Philadelphia Stock Exchange Gold and Silver Index rose 5.4%. As is often the case, the dollar moved in opposition to gold, falling to 118.825 yen vs. 119.13 late Tuesday, while the euro rose to $1.1482 vs. $1.1330.

A

speech by

Federal Reserve

Governor Ben Bernanke was the precipitate catalyst for the moves.

"Even if the economy recovers smartly for the rest of this year and next, the ongoing slack in the economy may still lead to continuing disinflation," Bernanke declared. Core personal consumption expenditures inflation might fall from 1.2% currently to around 0.7% by year-end 2004, he said, assuming the Fed's forecast of a noticeable pickup in GDP in 2003's second half and between 3.75% and 4.75% in 2004 proves accurate. "If the recovery is significantly weaker than we hope ... the greater level and persistence of economic slack could intensify disinflationary pressures at an inopportune time," Bernanke warned.

Given such risks, he stressed that the Fed would cut the fed funds rate to zero and/or employ unusual policy methods to fight disinflationary/deflationary pressures.

As has been widely reported, Bernanke has played a crucial role in raising awareness within the Fed about Japanese-style deflation happening here, and in examining what actions the central bank can take to avert such an outcome.

On Wednesday the Fed governor reintroduced concerns about disinflation/deflation, concerns that had diminished in recent months as stocks and corporate bonds rallied. In doing so, and simultaneously reviving the possibility the Fed might "increase purchases of longer-term government bonds," Bernanke helped Treasuries advance. The price of the benchmark 10-year note rose 6/32 to 96 6/32, its yield dipping to 4.10%.

Conversely, his comments weighed on the dollar, as they renewed concerns about the economic recovery, as well as the yield differential between the greenback and other major currencies.

On

May 23, I predicted the dollar might reverse its prior weakness while gold was due for a setback. Heading into Wednesday's session, the dollar index had risen 3.6% since then, and the greenback was up more sharply vs. the euro. Meanwhile, gold had fallen from over $370 per ounce on May 27 to as low as $342.50 on July 17.

Action in the past week or so suggests this interruption in the longer-term trend of a weaker dollar and stronger gold prices is ending. Wednesday's action certainly did.