Making a Case for a Bear Market, pt. 2

In part 1, we looked at fundamental reasons why the stock market can become a bear. Here, we will look at technical reasons. We will look at the Dow Jones Industrial Average and its relation to the transportation sector of the economy.

Background
The Dow Jones Industrial Average (DJI) and the transportation average (TRAN) should be correlated. This is from the Dow theory. The Dow theory states that a strong economy would be shown through the TRAN and the DJI. This is because the industrials need to get their products to places where they can be sold. If transportation companies are being used, then companies are shipping products to places where they are sold. In theory, if the TRAN were to go bear before the DJI, then it represents less sales, and less profits.

DJI

Here you can see the DJI peaked in mid-June and has been down since.

TRAN

The Transportation average began to fall in mid-March, about three months before DJI began its descent. You would expect DJI to follow. 

However, the TRAN is made up of different types of shipping methods. We can take a look at individual sectors and see what is happening, and what it implies.

DJUSTK

This is the trucking sector. It has a bearish pattern, a double top and it has fallen around 17.5%. The trucking sector will give tell you about domestic shipping. It will tell you about shipping from factories or ports. The lowering price implicates the outlook of the trucking sector will fall, which means products are not going to be shipped.

DJUSRR

The railroad sector has fallen at a very rapid rate. This is correlated with domestic shipping as well. The sector has fallen about 35%, starting in March.

DJUSAF

The delivery services has fallen about 17% from peak to trough. The falling prices in this sector imply that people are not shipping goods, or ordering goods to be shipped. This is more correlated with consumers, not so much industries.

DJUSMT

This is the marine transport index, and this has fallen 48% since mid-October. This index will tell you about imports and exports internationally. With this index you can see that global production has slowed.

DJUSAR

The graph here does not look like much has happened, but the index has actually fallen about 26%. This is actually counter-intuitive to what you would be expecting. With falling gas prices, airlines should be generating more profits. However, we can read this as people are choosing not to fly as much anymore. Which would mean people are starting to save money. When people decide to save, the economy gets weaker. Less spending means less GDP.

Conclusion

As you can see, the transportation sector tells a different story of the economy than the DJI does. Imports and exports have fallen, showing that global producers are not selling as many products internationally. The domestic shipping industries are not transporting as many products within the US, which signals a slowdown in the domestic economy. 

A global slowdown in shipping can signal a global economy slowdown. As you read stock charts, it is important to look for these types of connections. Technical analysis assumes that the market discounts all available information. This means that when a sector falls, it can have other implications, rather than just the transports are going down. Making these connections will allow you to read into the economy. Rather than waiting every quarter to run the fundamentals of each company, you can look at sector price action, and gauge things for yourself, before the fundamentals come out. 

Making a Case for a Bear Market, pt. 1

Alright, so the market did some crazy things this last week, but it had a strong couple of days Wednesday and Thursday. However, I am not too sure we are out of the woods yet, so let's look at some reasons why.

China
The Chinese economy is in a transitional phase right now. They are moving from a manufacturing economy to an economy based on services and consumption. This should and will, cause a shake up in the world's economies. This means that all those things you used to get that said "Made in China," will no longer be made in China. So, what does that mean?
A manufacturing economy means that most people produce goods, while a consumption economy means most people sell goods. China became such a strong economy because they had cheap labor. In fact, they kept their labor cheap by controlling their currency. China is still a communist country, so they would control their currency in order to make their exports cheap, so people would keep using their labor to manufacture products then ship them to other countries.
Now that they are moving to an economy that models the US, their labor has gone up. Since labor has gone up, companies that have been using their labor are looking to move to other poorer countries, such as Cambodia or Laos. That way they can spend less per product, and generate more profit. Now, before companies have a chance to move, they need to pay for the more expensive labor, which will drive down profits, which should drive down stock prices.
The other problem with China, is that their economy is not doing too hot; they are spending less. This means that lots of companies that have made a lot of sales from China, are not going to have such strong numbers. This leads to less profits, and lower stock prices.
The reason for the slowing economy is probably most attributed to uncertainty. As the transition from a manufacturing based economy to a consumption based one, jobs and government action become uncertain. People can lose their jobs, or the government could do something that hurts the economy, so the people become savers, and spend less and less. As before, less spending means less profits and lower stock prices.

The Fed
The Fed is still not clear about when to raise rates, and some Fed officials are even saying we should begin easing again. I think that would be a terrible idea, but I also believe it to be highly unlikely. The problem is that the economy is running in emergency mode, at the moment. It is supposed to try and get the economy in the right direction, but I think it will eventually cause problems, especially if it is held out longer. Lower risk means bad investments, and if too many bad investments occur, eventually a bubble will pop.
However, if they turn off the emergency burners, they will cause some volatility in the market, because nobody knows what is really supposed to happen after rates lift off. At least they do not know what will happen in the stock/financial markets. This can all be a reason for a bear market. People may begin to sell with a rate hike and a slowing Chinese economy, and these two things will not be fixed in a quarter or two. I think we are looking at a bear that will last at least a year.

What Happens to Stocks Now?

The market had a selloff these last couple of days, and the indices have dropped around 4%, so what can we expect to happen? Well first we can take a look at a few reasons why the market has finally given up on the lower supports.
First there is China. All the signs are pointing to a slowing economy in China. The stock market is plummeting, manufacturing is slowing. Commodity prices are slumping, and the Chinese government is doing everything in its power to prop the economy up. Second, there is the rest of the world. The rest of the world's economies are slumping as well. Interest rates are low everywhere, and the economies just aren't picking up. Third, the strong dollar is lowering international profits, and making US exports more expensive, drawing down demand for US products. Lastly, interest rates are looking to rise soon, so it may be smart to exit some stocks now, take as much profit as possible, and have cash ready to enter the bond market.
Fundamentally what does all this mean? Well, the US economy is going rather strong, compared to the rest of the world. Most international companies are taking hits because of all the reasons mentioned above. So, what you can look for are companies that are more closely tied to the US economy. Look for companies that are not affected too much by the dollar, and that do not have many international ties. Those are the companies I would expect to take smaller hits in this downturn. However, most stocks will probably take some sort of hit. When a downturn in the broad market occurs, people get scared and will exit their positions. So you will want to look at the technicals of the stock and wait for a clear sign that the price won't continue to fall.
Now lets take a look at the technicals of the market as a whole. We'll take a look at the S&P 500, the Dow, the Nasdaq Composite and the Russell 2000.

S&P 500

The S&P traveled sideways and ended the range with a symmetrical triangle and a subsequent drop. Normally, a symmetrical triangle is a continuation pattern of a trend. In fact, by definition, there is supposed to be a clear trend before the triangle forms in order for it to be considered this pattern. However, this was just to perfect of a setup to not pay attention to, and a lot of insight can be made from its formation. 

The blue lines are where the supports are. These are the levels where we would expect the price to fight a little before bouncing back up, or continuing the fall. So the price is right around a support at the moment, so we need to watch to see what the price will do. I think that the price will fall through this level and head towards the 1810 mark. 

The Dow

From this screen shot, you can see that the Dow has broken through a few supports and still has some room to keep going down before the next one. I think the index will keep falling into the 1600 area, before the price starts to fight the bears. This is partly because the same formations exist on the S&P 500, and both indexes have a support there.

Nasdaq Composite

The Nasdaq Composite does not  have many supports to, well, support it. If the price falls passed the 4550 level, were looking at a drop towards 4000. The Nasdaq Composite has diverged from the other two indices from the beginning of the year. If all the indices were to align again, we would be looking at a fall to around the 4200 mark.

Russell 2000

The Russell 2000 is a small cap index, that is very different from the other three indices. This one barely traded above it's two year range, and has now fallen back into it. Unfortunately we cannot see the volume for this index, but it almost looks like the RUT has topped out with a head and shoulders pattern. The head and shoulders is one of the most recognizable pattern, where there are three peaks. Two peaks are roughly the same height, the shoulders, and a middle taller peak, the head. This almost always leads to a reversal in trend, and it looks like it is doing that here. The RUT looks like it will fall to 1090, and once it gets there it will probably show some support. However, from there it could keep going down, or bounce back up, 

The Russell 2000 is full of small cap stocks, and these are the ones that we would expect to take less of a hit. However, after looking at the technicals, it does not look like they will be spared the selloff.
Conclusion
The stock market has finally done something exciting this year. The amount of volume that has been generated shows people trying to take their profits before price falls more. We can hope this will only be a correction, and not a full blown bear. However, as prices fall, it makes these companies cheap again. So now it is time to watch, wait for a bottom, and buy the climb back up.

Disclaimer: (http://http//brandonrossta.blogspot.com/2015/07/disclaimer.html)

Why a Stock Market Correction is Due

The last six years has been one of the longest bull runs in the history of the stock market. This alone marks that a correction should occur, but let's take a look why.

When the housing bubble burst, the stock market crashed. People were losing jobs and equity in there homes, so they sold their stock. They wanted to save their money. The Federal Reserved realized this, so they began a program called Quantitative Easing (QE). They did three rounds of QE that were meant to make cash cheaper, and to spur investment. The idea was to keep interest rates low, and make money cheap. This should increase investments because it is cheaper to borrow from the bank, so loans are made and things are bought. See, what most people do not realize is that in order for the economy to be "good", it requires people to buy stuff. Every individual is part of the economy, and if everybody wants to save, the economy is not going to get better.

Now people have cash, but where do they put it? Stocks? Bonds? Venture capital? Remember, interest rates are low, so bonds are not the answer. That leaves stocks and venture investments. Because of this, you can see how stock prices have gone up, and why there is all these startups. People put there money somewhere, because the opportunity cost of keeping their cash in a savings account is high. People want to put their money in stocks, because most people do not have the cash to fund a startup. This raises prices because the demand for stock goes up.

Now, the Fed knew this would happen, its why they did it. When people make good investments, they feel a wealth effect. They feel they have made more money, and they spend more. They have those stocks to sell if they need to. That was the Fed's plan the whole time; prop up stock prices, create a wealth effect, increase spending. So what is the problem then? The economy is getting stronger. More people are getting jobs.

The problem is that this economy has been built upon artificial interest rates. The cheaper money has spurred more investment, but it has also spurred more risk. Investors have cheaper money, so they can take more risk when they make their investments. This will lead to bad investments, and when these investments fail, it will hurt the economy. The other problem is that when people feel this wealth effect, they technically do not have the cash in hand in case of an emergency. They still have to sell the stock to actually realize any profits. The savings they are relying on, are at risk. All it will take is something like a stronger US Dollar, or falling oil prices to make profit margins fall and force stock prices to fall. This will lower the wealth people have, and start to cause some worry. What can happen here is panic selling. Stock prices fall to a certain level, and everybody decides to sell at the same time. People late to the party can see the "savings" they were relying on in the stock prices fall quickly, and lose a lot of money.

Another problem is interest rates will go up, and it will be better for the bond market. Since people have gone out of the bond market and moved their cash to stocks, they will sell stock to put back into bonds. This will create a higher supply in the stock market, and that will cause the market to fall.

Lastly, and the hardest one to grasp, is how much higher can the stock market really go? Demand causes the prices to go up, but what happens when people simply run out of money to put into stocks? Is it realistic for the market to keep going up? Do people want to risk more money to keep the prices going up? Or has demand reached supply?

Buying the Dips?

I have read some articles that ask "Which stocks are you buying the dips?" Unfortunately, I do not think these are dips people should be looking to buy. Maybe some stocks will go up, but after seeing most of the indices going into a bear, you may want to hold off on buying. The bull has raged for the last six years, and earlier dips were great opportunities to buy. However, these dips do not have the same feel as the other ones. The last dip, in October 2014, was one that you could feel the market was going to brush off.

This time it is different. The market has been in a range and unsure of what to do. It is skittish. Any news related to finances or economies spooks investors, and sends the market up, then back down again. If this were a case of buying the dips, the market would have already gone back up. Let's take a look at AAPL:

You can see that AAPL has been in a range for most of the year, like the indices. You can also see that the price fell through the bottom of the range and fell a little more than 5%. The important thing to look at is volume. The volume in the red circle shows that a lot of stock changed hands that day. When that happens you can insinuate that a lot of people think the price will fall, and they are trying to take as much profit as possible. 

From its peak in mid-July, the price has fallen about 15%. By definition it has had a correction. I think what will happen from here is that the price will stay around the $115 region, fluctuating between $112 - $120. It will continue that for a while, maybe until September, after we know if interest rates rise or not.

Another stock that has corrected is DIS:

This stock, we can make a case for buying the dip. We see it has a pretty strong trend until the earnings report, there was something that investors did not like. Towards the end of the trend you can see that the price took a new angle and went up. This is actually a bearish sign that marks a correction or a trend reversal. This could be an opportune time to buy, however, I would wait. You would want to wait for a confirmation that this is just a correction and nothing more. 

As you can see there are two types of corrections, ones that can lead to a bull, and others that lead to a bull. AAPL has the formations that would lead you to assume that this may be more than just a correction; while the sudden fall from DIS can be a correction returning to a bull. Make sure you set your stops, and follow your rules.

Index Analysis August 3, 2015

 Index Analysis: August 3rd, 2015

The second quarter of earnings is coming to a close, and it has been lack-luster to say the least. It looks like businesses that have heavy sales in China did not do well, while producers of only American goods have had stellar quarters. This alone, leads you to believe that there is a strong US economy, while China is starting to slump. With the Greece Crisis contained, for now, and The Fed poised to raise rates in September, let’s take a look at the technicals of the major indices.

Dow Jones Industrial Average

The Dow has moved sideways all year. There is a lot of indecision going on, and the price swings back and forth from low to high. The pattern it has created is a pennant going into a widening formation.

The formation here looks to be a bearish one. The failure in the third upward swing looks like it will fall back down to confirm the reversal.

S&P 500

The S&P is also range bound, starting as a pennant then breaking down. However when it broke out of the pennant it hit some resistance around 2045. It also looks like a top has been created at its high. In the bigger picture, it looks like the S&P is in a sideways range, but in a closer inspection, it has the same formations as the Dow. It goes from an upwards pennant, do a downward broadening formation.

The MACD also has some divergences and shows a reversal. I think a bear is coming out of this one.

Nasdaq Composite

The Nasdaq Composite has continued to trend upwards, but has remained in a range. This is the only of the major indices that has an actual direction, however it did break the trend in early July. This break could have some significance, not particularly because of the graph, but because the other two indices are showing bears, while the Nasdaq keeps fighting through. So I think this break will eventually become part of a reversal.  

Russell 2000

The Russell 2000 was in a range for two years, before it broke out into a new range. It looked almost like the S&P, where it was in an upward range, but has broken down and formed a range. One good thing that the Russell 2000 has that the other indices do not have is tested support levels. The others have been going straight up, and have very little tested supports. So we may be able to use the RUT to determine where supports may be on the other indices.

Conclusion

In my opinion, we will be heading into a confirmed bear market in the next couple of months, with the beginning starting in mid-July. How long will the bear last? Well if you look at wave theory, it could be 15-20 years, but we will have to watch to see.