Market participants are anxious to know what will come of the FOMC meeting on November 2-3 and how much quantitative easing will be announced. That anxiety is starting to show in the market with identifiable distribution and fewer buyers. As the major market indices sit near or just under the April highs, that anxiety is understandable. After nearly 1,500 up in the Dow Jones Industrial Average and 145 points up on the S&P 500 since this summer, it’s time to dip the technical thermometer into the market’s mouth to gauge its temperature.
Identifying a price level in the market that introduced supply in the past—as a potential roadblock now—is a simple matter. If I told you, “we’re at the April highs,” I would bet that uneasiness sets in, as many remember the gut-retching Flash Crash and the 13.5% drop in the Dow Jones Industrial Average from April to July. Well, the current chart in October, looks strangely familiar to the chart in April this year. I’ll show you what I mean.
Here’s a chart of the Dow Jones Industrial Average this year, from November to April 26. Notable features on the chart are:
- the large red volume day on April 16th when the SEC charged Goldman Sachs with fraud
- the divergence in momentum (lower) as the market price rose to new highs on April 26th
- and finally, the long, 55-day run higher for that leg in the bull market
And here’s the chart of the Dow Jones Industrial Average this year, from July to October 25th.
They look a lot alike, don’t they? Could this time be different? The outcome could be different, but both pictures, I believe, are telling the same tale: that this market is tired and overbought. The wicks above the candlesticks over the last week or so (as the market isn’t able to maintain the high levels on the day) tell me that suppliers of shares are entering the market. Now, that could mean churning and distribution, both of which signal either a consolidation or a correction is likely in the stock market.
The “risk on” trade looks tired as the Australian dollar, euro, and copper have stalled recently. Gold and the Canadian dollar have already begun a short-term correction. Much of it stems from a firming dollar. On the daily chart of the dollar, it looks to me like a bottom or triangle (continuation pattern) is just beginning to be formed. The key is 77.36, or Wednesday’s high last week. To determine if a dollar rally is at hand, the U.S. dollar index would need to break above 77.36 to confirm a reversal; otherwise, the dollar is consolidating its oversold condition.
Other indicators I’m watching are breadth and sentiment indicators. Looking at participation and demand versus supply, bullish momentum looks to be waning. The last time the bulls had a strong day was on October 5th, on a breakout above 1150 on the S&P 500. It was a strong showing for the bulls with 2460 of the NYSE stocks advancing and only 589 declining. The last big day on the NYSE was Tuesday, October 19th, with 2509 declining issues and 539 advancing issues. The bulls have yet to answer Tuesday’s selloff with the same fervor.
Another breadth indicator I follow is the percentage of stocks above the 50 and 200-day moving average. Once the percentage begins to fall and cross below 80%, it’s a sell signal. Previously, the indicator crossed below 80% on April 27th, well before the May 6th flash crash, warning of a correction. The percentage of stocks in the S&P 500 above the 50-day moving average is currently 86%, well overbought and starting to roll over. The percentage of stocks, in the S&P 500, above the 200-day moving average is not quite in the overbought region above 80%. More importantly, however, is if the indicator is rolling over. It did so Tuesday morning, but recovered most of the drop on into the close of the trading day to remain above 70%. The Percentage of stocks above the 200-DMA didn’t quite signal a sell based on a drop below 80% in April before the May 6th Flash Crash, but it was already dropping long before that with a clear trend reversal on a break below 85% (see chart below).
The final indicator to discuss is sentiment. The idea is, if everybody’s bullish there’s nobody left to buy. One sentiment indicator is the the volatility index (VIX) a.k.a. the “fear index”. In the past, levels below 20, combined with a stronger dollar, warned of likely corrections in the stock market. Once the VIX broke above 20 and trend, it has been a fairly good indication that a correction is at hand.
Final Comments
The U.S. dollar began a consolidation last week. As of yet, it is too soon to declare a reversal of the downtrend until we break above 78.36. Momentum in the stock market is waning, as it did late April. That alone doesn’t signal that investors should sell their stocks and hide in a bunker. It means to stay alert and there is hightened risk on new purchases. This market is trending, and overbought indicators aren’t a reason to sell, but they are a warning.
My overall feeling on the market is that no matter what size of Quantative Easing 2.0 we see on November 3rd, it is designed to get people further out on the risk curve. We just had our annual, client-only meeting on Sunday and one of the most common statements I got from clients was, “I have some CDs that came due and I’m looking for other alternatives.” Bernanke is getting what he wants, i.e. getting people into the financial markets. Americans are also refinancing their office buildings and homes if they have equity.
