We will begin this analysis by looking at the most basic Dow
Theory component, which is the transports must confirm the industrials. Take a
look at the Transportation average below,
You can see that the transports are in a bear market. They
did have a great bounce off the February low, with 22% gain. However, the trend
is still pointing down.
Now, let’s take a look at the industrial average,
As you can see, there are quite a few differences in these
charts. First off, the peak of the transports was near the end of 2014, while
the peak in the industrials was around May 2015. Also, after the peak, the
transports have had a bearish trend downwards, while the industrials have
stayed pretty flat. Since the transports are in a bearish trend, we will wait
to see if the industrials follow.
Next, we move on to the S&P 500, and the NASDAQ
Composite Index.
A lot like the industrials,
the S&P 500 is also moving sideways. There is a support just above 1,800,
and resistance around 2,100. Right now, the S&P is testing that resistance,
so it will be important to see what happens in the near future. If we can get a
significant breakout, we can see the S&P to new highs. However, the breadth
of the market does not show such strength.
In this chart, we have three
indicators under the price. They are the MACD on top, the S&P High-Low
Index in the middle, and the number of stocks above their 50 day simple moving
average. All three indicators show bearish divergences.
The vertical blue line shows
where the peak of the MACD was, across all indicators. We can see that the MACD
has diverged from the price action. This is a bearish sign that the rally
should be reversing. The recent peak and subsequent fall, illustrate the predictability
of the MACD. Now that the MACD is back to 0 (the middle line), we will need to
see where the index goes next. As we can see, the price is starting to move up
again. However, this is not showing the breadth we would like to see in a
rally, in fact the other two indicators are implying a reversal is on the way.
When an index moves in a
bullish or bearish trend, you want to see the underlying stocks moving up as
well. That is what the two lower indicators are designed to do. The High-Low
Index shows whether or not stocks are making new highs or new lows. When the
indicator moves up, it shows there are more stocks making new highs, than
making new lows. When it moves down, there are more stocks making new lows,
than there are making new highs. The number of stocks above the 50 day moving
average is self explanatory.
You want to see these
indicators following the market, but because the indicators are moving down it
shows underlying weakness in the index. This is true for the other two major
indexes. The NASDAQ Composite and the Dow Jones Industrial Average. These
charts show weakness in the market, and that the recent rally is not likely to
break to new highs.
Lastly, lets leave the US and
take a look at the MSCI EAFE, and the MSCI EM charts.
This is a 10 year chart of
the MSCI EAFE. Most recently, you can see a nice double top. This is a bearish
formation, and implies a reversal. As you can see, the index fell 15% from the
highs, and have fallen to the blue support line. I think this support line is just
supporting prices for now, but when the US indices break downwards, this index
will as well.
This emerging markets index
is also on a 10 year chart, and shows a massive symmetrical triangle. This
formation doesn’t tell you whether the move should be up, or down. What it
does tell you is when price breaks out of the formation, the trend is most
likely to go in the same direction. Based off of this chart, we would look to
see the index continue to move lower.
In conclusion, it looks like
the recently rallies are not sustainable. The weakness in market breadth is the
major concern with these rallies. The underlying stocks are not showing the
same strength that the index is showing, which is a problem. It means the
indexes are relying on fewer and fewer stocks to push the index higher, and the
recent rallies are not sustainable. Weakness in the EAFE and emerging markets
indices also show that there is weakness around the world.
