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WHILE MARKET INTERNALS CRUMBLE, IS PRICE NEXT?

There are countless ways of describing the deterioration of stock market internals, yet internals are only internals until they become the signs of a crumbling stock market. For most people, this occurs only in hindsight. For those using internals to look forward there is the pitfall of saying (with feeling) “Ah-Ha, this crumbling ‘internal’ is a sign of a stock market doomed to failure!” While this may now be true, the time frame for failure may be longer than most folks expect. The bullish predisposition of today’s market and preponderance of hope in the market is typified by the action of General Motors (GM) common stock. A stock market that can be led by a company sporting GM’s current (lack of) fundamentals is capable of doing practically anything in the intermediate term. These were my thoughts and suspicions going into this week, and they were further solidified by this lucid article.

To summarize my thoughts, this is a market containing crumbling internals which is capable of doing almost anything in the intermediate term. From a trading perspective, this requires great care, risk management, and patience. If the internals are signaling a new intermediate bearish trend, I’d want to be following the young trend; yet prudence requires care of entry and exit points because recent experience has shown that any stock or sector is capable of becoming the next GM, even homebuilders.

Bullish Percent, a deteriorating market internal, is described in Stockcharts.com:

“The Bullish Percent Index (BPI) is a popular market breadth indicator that is calculated by dividing the number of stocks in a given group (an exchange, an industry, etc.) that are currently trading with Point and Figure buy signals, by the total number of stocks in that group. Bullish Percent levels that are above 70% are considered overbought, whereas levels below 30% are considered oversold. Strong buy signals occur when the Bullish Percent Index falls below 30% and then reverses up by at least 6%. Conversely, promising sell signals occur when it goes above 70%, and then reverses down by at least 6%. The most popular version of this chart is the NYSE Bullish Percent ($BPNYA) which is mentioned prominently in Thomas Dorsey's book, Point & Figure Charting however it is important to remember that the Bullish Percent index can be calculated for any grouping of stocks.”

Below is a 5-year line chart of the NYSE Composite bullish percent. When the stock market bull was confirmed in the Spring of 2003, it was confirmed with a higher low in the NYSE bullish percent. However, although the NYSE bullish percent index apparently topped in the winter of 2004, the NYSE composite made continual higher highs until early May of this year when the NYSE may have finally made its bull market top. In this case, this “internal” was deteriorating for over 2 years before an apparent stock market top was seen. And was the May 2006 top the actual bull market top?

A closer look at the NYSE composite chart is warranted. Below is a 5 year daily chart showing that, in spite of deteriorating internals, the price action still looks healthy as indicated by the pattern of higher lows and higher highs. A former potential ending diagonal has been invalidated.

The 6-month daily chart shows that the NYSE composite is lacking in intermediate term direction as it is in the midst of a complicated and tricky corrective pattern. This is in spite of the deteriorating internals described above.

However, more ominous than the NYSE is the Nasdaq composite. In this case, the market internals of the Nasdaq (in terms of bullish percent trends) do not look significantly different than the NYSE composite. However, whereas the current bullish percent of the NYSE composite is currently 53%, the Nasdaq composite bullish percent is only 39% (and the Nasdaq 100 bullish percent is about 25%).

Unlike the NYSE composite, the price action of the Nasdaq composite has made a significant lower low.

A shorter term look at the Nasdaq composite shows a more bearish picture of consistently lower highs and lower lows:

Whereas the NYSE is in a complicated corrective pattern, the Nasdaq composite is in a clear and definable (down) trend. Unlike the NYSE composite, the Nasdaq’s deteriorating “internals” are being confirmed by price action. A future higher high or higher low would negate this conclusion; but for now with both deteriorating internals and price action, the prognosis for the Nasdaq appears bearish in the intermediate term.

We could be in the midst of a role reversal. In the late 1990’s bull market, the NYSE practically topped in the first quarter of 1999, and then it traded in a range, while the Nasdaq composite didn’t put in its top until a full year later. It appears that the roles have been reversed in recent market action.

Today’s Market

There’s more internals to discuss that pertain to today’s action. Whereas the Nasdaq composite traded higher on significantly lower volume than yesterday, the NYSE composite traded about even on significantly higher volume than yesterday. That shows another (small) sign of deteriorating market internals. But until the internals are confirmed by price action, they are only “internals.” Today’s leading indices included transportation, technology and perhaps the next General Motors – homebuilders. The point is that the recent lagging indices led the market higher today. The bear-market laden Dow Jones US homebuilder index was up over 5%.

If I had to make an intermediate term call on the direction of the US stock market and could have only 2 charts in which to do it, the following would be the two charts I would use. The important semiconductor sector, as represented by the semiconductor I-Shares, is near the technically important level of 55. A close below the recent low of about 51 would strongly suggest resumption of the secular bear market. A whipsaw of the 55 level would confirm the still-intact bullish predisposition of the US stock market.

Similarly within a shorter term timeframe, the transportation index, as represented by the Dow Transport I-shares, closed today’s trading at 79.63, just below the technically important level of 80. Failure to reclaim 80 would strongly suggest the resumption of the secular bear market. A whipsaw of 80, would suggest more of the same trading range-bound market.

Worth watching the next few days until after the Fed talk next week is the 10-year note yield that sits at a key intermediate term technical support level.

FYI. There is a relatively new homebuilder ETF (Symbol: ITB), designed to track the Dow Jones US Home Construction index. It is a homebuilder pure play ETF.

Have a great evening.

Martin Goldberg

Copyright © 2006 All rights reserved. Martin F. Goldberg, MS, P.E. Market Analyst Expert Page Commentary Archive Email

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