Stock Market - Fall 2007 Update
By Frank Barbera CMT. October 25, 2007
At the present time, the S&P 500 is somewhat mildly oversold near term, and could be near another short term low. The 9 day RSI for the S&P reached down to a low value, below +30 earlier this week with the S&P holding support near the 50 day moving average and the 20 day lower Bollinger Band (1503). That said, it is important to remember that in emerging Bear Markets, Rule #1 is that surprises come to the downside. Now, we know that there are those who would disagree with our assessment that the S&P is in a bear market. A bull could still point out that the 200 day moving average is still rising, and therefore, that the primary trend of the market is still higher. They would be right, as at the moment, the evidence within the stock market really points to a grand transition phase and the presence of an emerging stealth bear market. In our experience, these types of conditions are usually the hallmark of a stock market that is moving into a full on bear, but the proof of that still waits to be seen in the weeks and months ahead.
For now, all we can do is point out some of the more glaring bearish indications, and let readers judge for themselves the health of the stock market. In the chart below, we show our own version of the DJIA along with its Daily Advance-Decline Line. The daily A/D Line is a cumulative summation of the daily NET of advances less declines within the DJIA. In the top chart, we re-compute the DJIA using our own Unweighted Formula so that instead of a Divisor and arithmetic computation, which favors high priced stocks over low priced stocks, using a logarithmic calculation, all stocks are are weighted equally. The value of our DJIA is arbitrary, and could be set to trade at 500, or 5,000 or 50,000.
So the scaling on the chart is not important. What is important, is that the Unweighted DJIA is not at decisive new all time highs to anything like the degree seen in the widely reported DJIA. Re-computing the DJIA, we find the DJIA to be right back to the vicinity of its former January 2000 highs, and running into a lot of price resistance in that zone. Next, let's compare the A/D Line with its 2000 highs, nowhere close is the answer on that one despite a good performance in the last few months. On the positive side, we can also point out that the strong bias toward large cap stocks has been producing a robust undertone within the DJIA, which has been reflected in a strong A/D Line moving to new higher highs in recent weeks. Next, let's look at the Dow Jones Transports. Notice that unlike the DJIA, neither the traditional Transportation Average, nor the GST Unweighted Transportation Average were anywhere close to confirming the new ‘all time’ highs in the DJIA. On a Dow Theory basis, this is the kind of bearish divergence that often signals a major market peak.
In his fine efforts at “Cycles News and Views”, market analyst, Tim Wood notes that going back to 1896, there have been 27 four year cycle tops, with the current cycle potentially marking the 28th four year cycle top. During the prior 27 four year cycles, a bearish divergence between the Dow Transports and the Dow Jones Industrials marked 81% of those prior tops. Over the course of the last two to three months, that type of action is exactly what is taking place, with the Advance-Decline Line for the Dow Jones Transportation Average presently very close to a major breakdown below support.
Above: the Unweighted DJ-65 Composite, could be finishing off the ‘right shoulder’ of a major peak.
Above: the Unweighted DJ-65 (upper), the Unweight DJIA, then the Transports and Utilities (lower). Only the DJIA made new highs in Sept, with the other averages failing to confirm.
In addition to the obvious bearish divergences between the averages, we can also point out that with even the Dow Jones Industrial Average, overall participation in the advance has been thinning. For example, when the Dow went to new all time highs in July, nearly 86% of the DJIA 30 stocks were above their own 200 day moving averages. Flash forward to September and the latest round of new highs on the DJIA, and only 73% of the stocks were above the 200 day average. Looking at the other two averages, the Transports and the Utilities through this lens, we see that with DJIA hitting new all time highs in September, LESS than 50% of the DJTA average stocks were even above the 200 day average. Ditto the 15 DJ Utility stocks where more then half the list was below the 200 day average. We don't know if that degree of failure has ever been seen before, but it certainly suggests that the market notwithstanding the CNBC Bobble-head cheerleading is not in good shape technically.
Above: the Transports with Percent of Stocks above the 200 day average, less then 50% at the recent all time high in the DJIA, and Below: same thing for the Utility Index. These later two indices often lead, and that cannot be a good message for the market.
As a result, we continue to suspect that the stock market is not far away from serious trouble, as looking at the four Dow Averages, the DJ-65 Composite, the Industrials, the Transports and the Utilities, ONLY the DJIA made new all time highs in September, and now, with prices reversing sharply lower, the odds are growing that the September high may have been a final exhaustion peak for the major indices.
Elsewhere, we also want to point out that over the last two years, the US Railroad Industry has thrived as a result of US-China Trade. Over this time, railroads were seen as the extension of the ports, which they are, and move to P/E multiples not seen in years. In many ways, the rise in China as measured by the surging Shanghai exchange has been paralleled by the recovery in US Railroad fortunes. If demand is dropping off in the US as a result of a consumer led recession, then perhaps the recent downturn in the Transports, and especially the Rails, is an ominous sign for the fortunes of the Chinese Stock market, as the US Consumer has been a key source of aggregate demand. In addition, the Shanghai Stock Exchange, which has unquestionably held up longer than we ever imagined, appears to have completed its five wave advancing pattern, but to be sure, we need to see another three to four percent decline. The momentum profile on Shanghai looks very bearish in our view, and a break in the Asian stock markets where we have seen a speculative mania would be a very big negative for other global markets, including the US.
As another foot note, we also note that European stock markets like the DAX, CAC and FTSE, really lagged the US, perhaps a strong Euro biting into market share, with European ministers pointing the anti-free trade finger at China over the last few days. Protectionism and negative sentiment is rising against China, with the US and Europe now joining in against low priced Chinese goods and an undervalued Yuan. If there ever was a case of “be careful what you ask for” pushing the Chinese to revalue the Yuan has to be it. Attention Wal-Mart shoppers, everything in the store is about to get a lot more expensive once the Yuan revalues.
Above: Shanghai with US Railroads.
Above: the Shanghai Composite with a very clear five wave pattern, the final high looks to be in place and with a few more percentage points on the downside, we can start to make a bear case for China.
Above: A double failure pattern on the medium term RSI for Shanghai, this can’tbe good. Momentum peaked back in late 2006, and then made a first failing high in April – May 2007, and now a second failing high in Sept - October 2007.
To date, Asian stock markets have held up longer than we expected, but the roll over in RSI in recent days smacks of something more serious afoot. While some of the Hong Kong ‘H’ Shares still appear as though they could hold up and make token new highs over the next two to three weeks, overall, the vertical nature of the move appears to be very late in the cycle. In our view, a break in the Asian stock markets – perhaps in November or early December would be very serious and could accelerate the outcome to the downside for the US Equity and other International markets leaving us with a mindful approach to investment risk at this late date in the cycle. That's all for now,
© 2007 Frank Barbera