Stock Market Update, End of May 2016

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.