Lots of Concerns Abound

For the past 5 weeks I have often written about the elusive stock market pullback and the reasons why we shouldn’t be surprised to see it occur.  We had seasonal headwinds post-September. We had strength into earnings season. We had overly bullish sentiment. Nothing really mattered for more than a day. And just because stocks are seeing some weakness here, I am not beating my chest with “I told ya so”. Being early still equals being wrong.

Over the past two weeks, we have seen some other negative behavior in the Dow, S&P 500 and NASDAQ 100. Essentially, as each index hit new highs the number of stocks declining outpaced the advancing stocks. That’s not exactly healthy, especially when it’s happening over and over again.

Additionally, as I will write about in the next Street$marts, take a look at the two charts below. In the healthiest of markets, the Dow Industrials and Transports make new highs at or around the same time. Last month, the transports peaked and began to correct as the industrials continued higher. That’s a warning sign. Furthermore, this week we see the industrials score a fresh all-time high, but the transports are making a 30 day low. Again, that’s not exactly the behavior you see in strong markets.

I could continue on and talk about the banks or high yield bond warning or NYSE A/D Line, but I will leave that until next week. For now, these are all short-term concerns of mine and I continue to believe that the bull market remains alive, but a little less well than it had been. Dow 25,000 is next.

Enjoy the weekend! I am just back from Chicago and New Orleans where I was sick in both places. There’s is nothing fun about traveling when you’re under the weather. The night before I left was the first time since the 1990s where I had a fever. Happy to be home in my own bed and hope to shake this thing soon!

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Dow Theory Warnings Continue

Several months ago, I wrote back to back articles about the Dow Theory trend change. You can view them below.

http://www.investfortomorrow.com/newsletter/CurrentStreet$marts20141103.pdf

Simply put, this analysis holds that the Dow Jones Industrials and Transports should move in lock step to confirm each intermediate-term move in the stock market. When one index see a relative new high, so should the other. The opposite is true at lows. When one index diverges from the other, it is a possible sign of a trend change. When both indices closes below a previous significant low that is considered confirmed change of trend.

Let’s look at the two charts below for some real life, recent examples. At the far lower left of both charts you can see the Ebola October lows where both indices closed below previous significant lows. By early December, they both went right back to new highs where the party began to fizzle.

Since early December, the transports have seen a progression of peaks that were each lower than the previous one where the industrials saw a clear trend of higher highs through February. With one index lagging the other, this is called a non-confirmation or divergence and warns that all is not perfect healthy. Of course, if and when the lagging index rallies to confirm the leader, this Dow Theory warning completely goes away. Right now, we have a series of caution flags since late 2014 without much in the way of price weakness.

Beyond the Dow Theory non-confirmation discussed above, the more serious warning is the Dow Theory trend change. This occurs when both indices close below previous significant or above previous significant highs. On the left side of the chart in October, both indices saw Dow Theory trend changes to the downside that were immediately reversed. In other words, the October warning failed.Today, the transports are getting close and should breach the low points seen from December through February. The industrials have another 600 points to go, but don’t dismiss that as out of the question. I do believe, however, that if the industrials fall much more to signal a negative Dow Theory trend change, it will be short-lived like we saw in October.
Although the Dow Industrials and Transports are not and have not been perfectly in sync for many months, the broad stock market has been acting okay and lacking most of major signs that the bull market is ending. More than likely, any weakness this quarter will be of the ending nature, completing the divergence seen in the two major indices as the Dow Industrials prepare an assault on 20,000.
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Dow Theory Trend Change

Dow Theory has been around for decades and it’s not something I discuss very often. You can Google it to find newsletters and blogs and opinions on its value. As the stock market gets closer and closer to the final bull market peak, I think it’s something we should watch.

Dow Theory works in a couple of ways and I am going to focus on one piece here, primary trend change. Dow Theory Primary Trend Change occurs when BOTH the Dow Jones Industrials and Transports close above or below a previous secondary high or low. In essence, the trend of the market is said to have changed when lower lows are made during an uptrend or higher highs during a downtrend.

Earlier this month as you can see below, both the Industrials and Transports closed below their previous secondary lows from August. At that point, Dow Theory says the trend changed from up to down. Of course, that was also the stock market bottom I called in real time to contradict Dow Theory. Anyway, today, Dow Theory is still in a downtrend until both the Industrials and Transport make new highs which the latter did today. With my own upside target still 18,000, I would be surprised if the Industrials do not see all time highs and another Dow Theory Trend Change and whipsaw.

What would cause me much greater concern is if the Transports saw new highs, but the Industrials do not. That is called a Dow Theory divergence or non confirmation and often warns of a larger decline possibly unfolding.

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Key Sectors Sending Up Bearish Warning Signs

Last week, in Major Indices Issue Warning, I discussed how the strength in the Dow and S&P 500 were masking weakness in the other major indices and how a warning sign was given. Today, I go a step further and dive into the key sectors of the stock market.

We begin this section with the S&P 400, Russell 2000 and NASDAQ 100 all showing relative weakness, a clear red flag. Below is the first key stock market sector and also one of the two components of Dow Theory.

The Dow Transports should confirm all highs in the Dow Industrials and vice versa. When one doesn’t, a non confirmation or divergence develops. At the most recent all-time high in the Dow Industrials, the Dow Transports did NOT make an all-time high, clearly a warning although one that can be rectified quickly and easily.

The banks are below and you can see a much bigger problem as they are nowhere near their 2014 highs and in a clear pattern of lower highs and lower lows. This issue can’t be easily fixed.

The semiconductors are next with a pattern of lower highs but higher lows. There is a clear warning sign as the last all-time in the Dow is definitely not confirming or even close. This is also a red flag for the NASDAQ which is a red flag for the major indices.

 

One of the important bright spots of the market is the New York Stock Exchange Advance/Decline line which is continuing to score all-time highs. Almost without precedent, bull markets do not end until the NYSE A/D line fails to confirm the final high in the Dow Industrials and S&P 500. That’s definitely not the case today.

 

Finally, the high yield (junk) bond market is one of the best canaries in the coal mine to gauge the health and strength of a bull market. Left for dead almost a year ago, junk bonds did a 180 and remain in a very solid position, another positive for the bull market.

All in all, we have two big picture indicators that remain bullish, but a host of others flashing the warning sign. My conclusion is that the bull market remains alive, but is building towards an intermediate-term correction, especially if the Dow and/or S&P 500 see all-time highs this quarter.

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Canaries Quiet

canary-720x350

Thanks to my friend and business colleague/partner Dave Moenning (stateofthemarkets.com) for the canary pic.

It’s been a while since I last updated this column, but it’s not because I am lazy! There simply haven’t been enough changes in the data to warrant an update. The rally through year-end was very powerful and almost all areas we in gear to the upside. And even today, while there may be a few warnings, we don’t have bull market ending conditions in place. That potential climate seems to be months, if not quarters, or more away.

Let’s start with the indices and the Dow. All was well right into year-end and then something began to go wrong in a small way. The Dow has now given back all of the gains achieved since the last Fed meeting in mid December.

dow

The S&P 500 is next and you can see it was a touch stronger than the Dow to begin 2014.

sp

Turning to the S&P 400 Mid Cap below, a very different picture emerges as all time highs were seen last week.

mid

Next is the Russell 2000 Small Cap and just like the S&P 400 above, this index hit all time highs last week unlike the Dow and S&P 500.

rusFinally, the Nasdaq 100 is below and it looks very similar to the previous two indices except that it’s all time still remains from the Dotcom Bubble in March 2000.

naz

Looking at all of the major indices, we have two small warning signs from the large cap space.

Moving to the key stock market sectors, we can see the Dow Jones Transports and its recent all time high last week. On the surface, that is very good action, but traditional Dow Theory would call a non-confirmation or divergence since the Dow Jones Industrials did not also see all time highs. While this can easily be corrected on a subsequent rally, it is nonetheless a warning sign now.

tran

The semiconductors are below and they look very similar to most of the other charts with the last major high seen last week. This group is so crucial to the health of a bull market because historically, as go the semis so goes technology. And as goes tech so goes the market.

semis

Banks are last in the sector space and they have really kicked it into high gear since the October bottom. It’s hard to argue with their leadership or that of the semis.

banks

Another way to graphically see the underlying strength in the stock market is through the New York Stock Exchange Cumulative Advance/Decline Line which simply tallies the number the stocks going up and down on a given day and adds them to the previous day’s total. As you can see below, the NYSE A/D Line just recently made another all time high, which is not something we typically see at major market peaks.

NYAD

Lastly, let’s turn to the high yield (junk) bond sector, which is one of the primary canaries we watch. Junk bonds are among the riskiest and most volatile in the fixed income area and are definitely among the most sensitive to ripples in the liquidity stream. After being left for dead during the second quarter of 2013, they did a complete 180 and slowly and steadily marched back to all time highs, surprising many people, including me! It’s going to take another mini cycle before high yield warns again.

PHYDX

Summing it all up, the bull market is old, but alive and basically well. We have a few yellow lights from the Dow Jones Industrials lagging, but that can and may be corrected during the first few months of 2014.