July 21, 2006

(Updated Commentary Bolded and Underlined)

Today is the 27th anniversary of the Volume Reversal Survey, d/b/a VRTrader.com. It is an appropriate time to post our 'mid-year' Annual Forecast Model update. Next report will be published, at least in part, in January, 2007.

Thank you once again for subscribing to the VRTrader.com Annual Forecast Model. In our opinion, you have in your hands one of the most unique market investment/trading tools in existence. Since you've already paid for it, you know that this is not sales hype, it is fact! While no indicator is perfect, especially the AFM, its uncanny record in calling significant turning points and overall trend for the stock market is, in my experience, unparalleled, especially since it is published early in the year and looks out 12 months in advance. The VR Forecaster (Annual Forecast Model) has been quietly published since the early 1980s.

The AFM list includes: The Dow Industrials, the S&P 500, the Nasdaq Composite, the XAU Gold and Silver Index, the Dollar Index, the 30-year Treasury, and Crude Oil. Remember, past performance does not guarantee future success!

We also ask that you keep this Model in strict confidence. The more eyes that see it, the less reliable it will ultimately become. We reserve the right to show pieces of the AFM on national television for promotional purposes, especially historical results, but are less inclined to show future projections. I am, of course, referring to the Nightly Business Report on PBS where you may have occasionally seen pieces of the AFM broadcast.

For those of you new to the AFM's construction and guidelines, let me lay some ground rules. First, the AFM's construction is fairly simple. The vertical axis denotes direction and the horizontal axis denotes time. A chart zig-zagging lower is a bear market pattern, but a chart zig-zagging higher is a bull market pattern. Secondly, please note the AFM does NOT attempt to predict amplitude, but only predicts direction! In other words, the attempt is made to forecast the TIME when high and low points in the stock market may occur. Peaks and troughs can be at any level. It basically comes down to a question of relativity. In other words, even though the chart may show a high point or a low point, there is no specific numerical value associated with that point, i.e., Dow Industrials 13,000 or 9,000. The AFM formula simply does not generate such values. In addition, new relative highs or lows in the AFM does not necessarily suggest higher market highs or lower market lows. These points could turn out to be relative highs or lows and nothing more. Thirdly, the AFM is presented in good faith as a general guide for the future. Though we make no modifications during the course of the year, we are always paying close attention to other technical, cyclical and sentiment indicators to help 'fine tune' what is unfolding in the marketplace. As we have all learned in the past, placing too much weight on any one indicator (including the AFM) may not be the best decision.

The dates presented may or may not turn out to be accurate representations of high or low points in the market. There have been occasions when a date is coincident (a bull's eye) with a market peak or trough. More frequently, however, the actual market peak or trough is skewed either side of the predicted date. What we are looking for is the GENERAL PATTERN of the AFM in any given period. Is the pattern bullish or bearish, is the pattern rising or falling dramatically or modestly? The bearish pattern displayed in the 2000 AFM when it was published February 1, 2000 certainly presented clear warning of what may lay ahead. The low point predicted for the end of March, 2001 dramatically presented the power of the AFM to predict an excellent near-term buying opportunity. The high point predicted for the end of March, 2002 or the low point in July, 2002 also turned out to be deadly accurate presaging a multi-month correction to the downside for the former and a sharp rally for the latter. The AFM for 2003 predicted a low point in March (specifically, March 26 which was ten days off - doesn't that sound familiar? - Same thing happened in July, 2002).

The Dow Industrials, S&P 500 and Nasdaq Composite projected a low point due in late March or April and that prediction came to fruition on April 18 when, e.g., the Dow Industrials traded at 9961.52 intra-day. An April/May bounce carried into June with the top occurring on June 17 at 10710.38, but it is fair to note that this high was within 100 points of the highest level seen during the previous few weeks. The predicted mid-June low was delayed until July 7, but the market was down from June 24 to that date. The predicted rally into July or early August worked out nicely with the precise top coming on July 28 at 10,745. The market zigged and zagged its way into the also widely predicted September/October bottom occurring this year on October 18 at 10,098, frankly much higher than we would have expected. The year-end rally forecast then began to unfold and the rest is history!

The Dow Industrials, S&P 500 and Nasdaq Composite AFMs project overall market strength through May followed by a declining market in late Summer and Fall. Fine-tuning, one would be out of the market by early May, anticipating the advent of a correction. There appears to be a sizeable bit of volatility ahead in August, i.e., a big swing up and down or a big swing down then up. We do not like to compare apples to oranges, but the last time we saw such a long 'bar' on the graph was back during the Crash in 1987, though this 'bar' is far smaller. Following a Fall low point, the market rallies into year-end once again! The AFM portrays 2006 as being quite volatile, so we advise wearing your seat belts and crash helmets. We would not characterize the year as being bearish - simply tradeable! Remember, the highs and lows presented are 'cycle' points and not necessarily reflections of amplitude which could be far greater than herein portrayed. Also, please keep in mind that the widely expected four-year cycle low is due sometime in 2006 (the previous four-year cycle low came in July, 2002) and perhaps the low predicted for late Summer to early Fall will fulfill this fairly reliable cycle.

The Annual Forecast Model hit the nail on the head for a May top with the exact top day May 10 when the Dow Industrials traded at 11,670.19 intra-day. A Negative Volume Reversal ™ immediately followed and 'down she went'! The Model has done a terrific job and paid for itself a hundred times over with this one call! But, where do we go from here? Is the long 'down bar' in August an omen of a 'crash-type' scenario ahead, especially in August? Or, is the worst behind us with the market attempting to bottom at current levels? The other question is where is the four-year cycle low? There is some evidence we could have seen it when the Dow Industrials recently double-bottomed at the 10,600 level. The bottom line is that we remain bearish, but recognize that time is running out, i.e., between now and October for the formation of a bottom. To be safe you wait until the traditional October low (sometimes it comes in September) before jumping on the bullish bandwagon. The Dow Transports and the Nasdaq have been displaying relative weakness (more for Nasdaq) as of late, so let's wait for them to help confirm a bottom as well. If you've been reading my VR commentary, you know there are theoretical downside projections in the Dow Industrials as low as 9600. If we're not there by early October, then they are likely false projections.

The Dollar Index Forecast for 2005 was overall positive and except for a 'respite' from an August high into September, no significant decline was forecast. As you know, except for a dip into mid-March, the Dollar Index has been in a slow but steady uptrend all year - this despite continued negative press surrounding the Dollar's multi-year decline and the resulting negative impact on the U.S. economy and stock market. The Dollar Index posted its year high on at 92.63 on November 16 and though it settled back to 91.07 at year-end - the overall trend was positive and the AFM vindicated.

The Dollar Index Forecast starts out with a bang to the downside and appears to drift sideways with a little upward spike come May. A downward spike appears coincident with a decline in the overall stock market due in August followed by a year-end rally apparently also coming in sympathy with stocks. Overall, it appears where 2005 was a rally year for the Dollar, 2006 is more neutral.

The Dollar Index spiked up in June not May, as forecast, but has subsequently retreated. The Model points to further weakness later this year which, theoretically, is bullish for both stocks and gold. The overall pattern remains bearish for the Dollar according to the Model, so we're sticking to that forecast!

One of the keys to the continuation of this rally - a point rarely discussed in the financial press is the strength or weakness in the Dollar! You've got to recognize that the WALL STREET LOVES A WEAK DOLLAR, despite all the Washington rhetoric to the contrary. A weak dollar is desirable because we export our debt and pay off that debt with cheaper and cheaper dollars. A weak dollar is especially good for U.S. companies doing business overseas as it makes products more price competitive. The entire 2003 to date bull market was coincident with a weak dollar. Remember that! A weak dollar is also good for Gold!

In 2004 the XAU AFM called for a high in January to be followed by a huge sell-off which, indeed unfolded by mid-year. The AFM never really encouraged us (as a stand alone indicator) to jump back into the market except perhaps for trading purposes.. As you know, 2004 was not a good year for investors in gold shares, many of which got caught into perma-bull mentality. Our admonition that the dates presented in 2005 may or may not turn out to be accurate representations of high or low points in the various markets had particular meaning looking at this forecast. In fact, the dates presented were nearly perfectly INVERTED. As students of cycle theory for nearly 25 years, it is clear that cycles (and forecasts) can and do invert and the value of the 'change point' date is more important than whether a high or low was correctly forecast. We stated in our mid-year report last July that if the present inverse pattern persists, we can expect to see a low point in September followed by a year-end rally. Indeed, that is exactly what transpired! Obviously, we're not pleased when a forecast inverts, but recognizing that fact (a common fact in cycle analysis) and reporting it is our job!

2006 should be bullish for the XAU , according to the AFM. It appears a temporary high point will occur by February 3 to be followed by trading tops around March 28 and June 23 and a big upside acceleration into the end of the year! The bottom line is that a picture is worth a thousand words!

A temporary high was posted on January 31 which was pretty darn close to a bullseye. However, tops predicted around March 28 and June 23 didn't materialize with a lows coming in on March 10 and June 13 instead. So far, the big high was posted on May 11. You may have already realized that gold itself has diverged somewhat from the XAU index with some days gold stronger than the shares. The overall pattern between the two are still very similar, but stocks are stocks and physical gold is physical gold. When stocks decline across the board, sellers tend to through the 'baby out with the bathwater'. The Model is still positive for the XAU and, remember, though we attempt to fine-tune specific dates, the overall intention of the Model is paint a picture of the general trend. In this regard, we have to remain bullish as an upward acceleration appears likely into year-end.

The Crude Oil AFM has been a super bullseye! Not only has it done a fabulous job of catching the swings points last year, but it clearly tracked the record uptrend which has propelled Crude Oil to all-time highs. We experienced a bit of inversion here as well with a predicted late August low actually turning out to be the high for the year at $70.85 and the mid-November predicted high point turned out to be a low ($55.40) before the market recovered into year-end. But, the overall pattern was bullish and, my friends, is the purpose of the AFM!

Crude Oil appears essentially sideways to slightly higher through mid-year, but then really accelerates to the upside during the summer months but peaks in the by Fall. Overall, this is a bullish chart much like 2005!

We're 'on-the-money' here, as the Model correctly predicted an upward price structure for 2006 which still very much appears to be intact with Crude Oil touching a new record high of $77.95 just last week (July 14). However, it appears that we're fast approaching a potential trading top due by early September. Could we have already seen the highs? No clear sign of that yet at this writing, but we suggest that further upside strength in the weeks ahead might cap the move for 2006 whether Crude Oil is $5 higher or $25.00 higher.

The Treasury Bond AFM forecast predicted in January a positive year for the Treasury Bonds, i.e.. lower long-term rates. Until June, the forecast was pretty much on track as bonds extended their rally much to the chagrin of 'Wall Street' who couldn't understand why short-term rates continued to rise (due to regular and well advertised Fed hikes) yet long rates held relatively steady to lower. The 30 Year Treasury Bonds were rallying for other reasons such as buying pressure from China and Japan as these countries continue to intervene in making their currencies competitive. One simple basis for that Bush boom is that China is recycling its US$100 billion-plus trade surplus with the US back into dollars. As you know, almost half of the US Treasury bonds are now owned in Asia. So the rally in Treasury bonds may be artificial. Awfully interesting, isn't it? However, that artificiality can keep mortgage rates low which in turn can continue to fuel a booming housing industry and amplifying the wealth of Americans who continue to hold a large portion of their assets in their homes. A forecasted mid-November low was pretty much on target following a sizeable two-month correction that began in early September. Though the correction was nasty it was nowhere near the downside amplitude forecast by the bears. All told, the bonds rallied into year-end characterizing the year as more positive than negative and, once again, vindicating the AFM.

It appears Treasury Bonds will be zig-zagging lower during 2006 (higher interest rates), though a mid-year spike to the upside suggests we could see a temporary reprieve (lower interest rates) . Following the tracks, a high point is due in early March followed by a sell-off into early May. Then, a rally carries the Bonds higher into early July which may be the high or relative high for the year! A general decline in Bonds follows into year-end.

The overall pattern calling for higher interest rates (declining bond prices) depicted in the Model has been accurate, so we're pleased with the general forecast. A rally in bonds (lower interest rates was predicted for June/July period and though the bonds have attempted to rally (bottoming formation?) the action has been a bit anemic. According the Model, a rally in bonds will only be temporary and lower bond prices by year-end are expected. The current rally phase could hold up until August or September if the Model is in sync.

Thank you for subscribing to the 2006 AFM. May I extend my very best wishes to you for a happy, healthy and prosperous year.

Mark Leibovit, Chief Market Strategist
February 2, 2006

and

July 21, 2006

Charts - Annual Forecaster Model