The Stock Market Broke on Wednesday
Classic Technical Analysis Suggests Additional Drop In Key Indices, and Even Lower Interest Rates
by Martin Goldberg CMT. March 11, 2004
Key index technical chart patterns were formed recently and have been broken this week. These important events all indicate that the US stock market is now weak from a technical perspective. The Nasdaq and the 10-year Treasury note (as measured by the interest rate) have both formed descending triangles that have been broken. Price objectives from technical analysis principles suggest that the Nasdaq is likely to go to 1,860 or less, and the 10-year Note interest rate will reach 3.3% or less. The Dow Transport index has formed a symmetric triangle, which has been broken decisively to the downside, thereby indicating that the longer-term trend of the Transports is down. Similarly, the Dow Industrials have violated their 50-day moving average. With almost everyone playing "technical analyst" during this rally, this is likely to spell trouble for the overall stock market. In short, this is a momentum market that has lost its momentum. In this article, I will illustrate and describe these technical events.
The Nasdaq is showing a lot of technical weakness. The 40-trading day chart below shows a descending triangle with the horizontal line at 2,000. The Nasdaq broke decisively below 2000 on Wednesday. Although it could reclaim 2000, this appears doubtful. The measuring objective suggested by Pring in Technical Analysis Explained, The Successful Investor's Guide to Spotting Investment Trends and Turning Points, 4th edition (page 96), results in a price objective of 1,860 as a minimum drop. (Of course based on fundamentals such as P/E and dividends, the Nasdaq could go a lot lower than that.)
Note the negative trends shown by the 14-day Relative Strength Indicator (RSI) and 12-day Rate of Change (ROC). I also noted the "hanging man" Japanese candlestick pattern on the chart. It illustrates how useful the candlestick patterns can be to identify for short-term trades (see).
More technical weakness in the Nasdaq is apparent with the number of recent "distribution days", and the very distinct head-and-shoulders pattern in the relative strength index. A "distribution day" is a trading day in which the index finishes down and trades a higher number of shares than the preceding day. The chart below indicates that the Nasdaq has been peppered with distribution days over the last six months.
Dow Jones Transportation Average
After dropping off of a high and then recovering some of the loss, the Dow Jones Transport Average has formed a symmetric triangle. The symmetric triangle shown below was decisively broken on Monday and confirmed on Tuesday and Wednesday. This indicates that the symmetric triangle (or "pennant") that was broken was a "continuation pattern" of the downtrend, and not a reversal pattern. The trend is still down.
10-year Treasury Note - Descending Right Triangle Broken Suggests Even Lower Rates
Below is a chart of the 10-Year Treasury note yield showing a descending right triangle that has been broken. This suggests that the yield will trend lower. The measuring objective suggested by Pring in Technical Analysis Explained, 4th edition, results in an interest rate objective of about 3.3%, or less. This is the distance indicated as the distance from the base of the right triangle to the first rally (the length of the red arrow-line on the chart). The anticipated drop in interest rates suggested by technical analysis of the 10-year Treasury note is probably fueling the "final fourth" uptrend in the homebuilder stocks (see next Thursday's Market Wrap Up).
Dow 50 Day Moving Average Broken (With Everyone Watching)
Below is a one-year daily chart of the Dow Jones Industrial Average (DJIA) with several popular technical momentum trend indicators and annotations. The indicators suggest underlying weakness in the Dow. However, these indictors are only secondary to actual price trends. The most important trend indicator below is the 50-day moving average (MA). As you can see from the chart below, the line served as support for the DJIA uptrend since April of 2003. It appears that the 50-day moving average was penetrated decisively on Wednesday. In my view, the Dow 50-day moving average is likely to now become resistance, and signal the end of the DJIA's uptrend. As with Nasdaq index level of 2000, the 50-day MA is a very "watched", and therefore important, technical level. If it is not reclaimed soon and decisively, it will indicate definite technical weakness; especially with the Transports confirming a market downtrend. (See "Today's Market", below.)
The stock market opened lower today, apparently impacted by the horrible and tragic terrorist act in Madrid, Spain. The market largely recovered by mid-day, but sold off by the close to finish lower. The Dow finished down over 1.6%, and the S&P 500 closed down 1.5%. The Nasdaq finished down 1%, but price action was especially weak at the close. This is not a good sign. As indicated in the chart above, this was the fifth (5th) consecutive "distribution day". I doubt if the hot guru, Investor's Business Daily (IBD), will be able to split any hairs today in describing whether today's action "felt" like a distribution day. If they are true to their technical philosophy, they will advise their readers to move to cash except for stocks that are acting particularly well. Today's edition stated, "Corrections are normal for bull markets, which typically last much longer than a year". You would have to consider after an unprecedented bubble that topped in March of 2000, there would be a secondary bull correction of unprecedented duration.
Gold finished up $2.30 to finish at $402.5 per ounce, and silver closed up a nickel to finish the day at $7.19 per ounce. The gold indices (XAU, and HUI) each finished up about 1.2%. This was one of the few places to hide in today's market. Another place to hide was in the restaurant stocks. Homebuilders have also held up very well of late. It makes one wonder just how sustainable this is.
The 10-year note finished down for the day, but closed strong. Not much of downward correction considering the magnitude of the recent rally.
The dollar was down today against the euro. Here is a chart of the dollar. The long-term trend is down. Buffett says the trend is down also. I'm certainly no currency genius. But you would have to argue pretty hard to make me believe that the dollar is going to go significantly up any time soon.
As I finish this article CNBC is on in the background, and there is an analyst describing how "healthy" this correction is. There was nothing healthy about the hype-driven rally; and there is nothing healthy about this "correction". Look at the charts above, folks! This stuff is right from the textbook. You may get a head fake rally; but the trend is down in my view. If this continues, Wall Street may begin looking at P/E's.
Have a great evening.
© 2004 Martin Goldberg