Rising Risk in Stocks as Dow Walks Alone
By Joe Duarte on August 6, 2017
We are in the early days of what could be a major technical divergence
in the stock market.
It’s a term used rarely now, but some of us old timers still remember
the “solitary walk,” a technical analysis expression which describes
a time in the stock market when the Dow Jones Industrial Average rallies
alone as the rest of the stock market is either flat or falling. Well,
guess what? Even though it takes an ancient geezer like me to bring
it up, it’s happening right now and unless the situation is corrected,
it’s more of a when than if moment for the next very meaningful decline
for the stock market.
I hate the fact that it’s happening because the rally off of the
November 2016 bottom has been very profitable. But it should be clear,
even to the casual observer than when the 30 stock Dow Industrials
rise nine days in a row, and as I will show below, the rest of the
market falls asleep, it’s just not a healthy environment for the stock
market. And to make matters worse, the lack of follow through in the
major indexes has now been confirmed, by the one single indicator whose
faltering has preceded every major decline in the stock market since
the 1987 crash.
When Being Alone Isn’t Good
We all want a little time for ourselves. But, unfortunately, the
personal time dynamic is not applicable to the stock market, where
big gains over long periods of time are achieved when the majority
of stocks rise closely together. So, why am I so worried? I could just
tell you, but I’d rather show you.
First, let’s look at the Dow Jones Industrial Average (INDU), a
group of thirty very large and very influential blue chip stocks with
global businesses. As the chart clearly shows, the Dow has been knocking
it out of the ballpark for nearly the past two weeks. More specifically,
as of the close on August 4, the industrials have risen over 500 points.
Moreover, the Dow has risen over 22% since the November bottom.
But now, the index is well overbought. First, its close on August
4 was above the upper Bollinger Band (upper green line). This is an
indication that prices have risen well above the normal range of the
short term trend as measured by the 20-day moving average (dotted green
line). As a result, under normal operating procedure, the odds favor
some type of price reversal in the Dow within the next few days and
a return to the mean, in this case the 20-day average. Next, consider
that volume is starting to shrink on the rally, and that ROC, a measure
of momentum did not confirm the last high in the Dow. These two factors
are early, but clear indications that the Dow is due for some time
of pause or perhaps a pullback.
Finally, although the Accumulation Distribution (ADI) indicator for
the Dow is very positive, the On Balance Volume Indicator (OBV) is
less robust. Plainly stated, the investors that are buying into the
Dow are very motivated. The down side is that there are not that many
of them that are willing to buy at these prices compared to those who
are electing to watch or to sell. So even if the few buyers are motivated,
they are outnumbered by those who don’t share their enthusiasm. Either
way, there seem to be more people that aren’t going to buy stocks at
these prices, which means that at some point, the path of least resistance
will be down.
Breadth and Broad Market Falter
The Dow Jones Industrial Average is due for a breather, but the rest
of the market has already begun its own pullback. This is best illustrated
by the flattening of NYSE Advance Decline line (NYAD) and the stealthy
decline in the S & P Midcap Index (MID).
Last week I noted the NYAD was starting to wobble, and this week,
it’s a little bit worse. For one thing, the Dow Industrials made a
series of new highs while NYAD was flat. This is a sign that fewer
and fewer stocks are participating in each new upward thrust, a sign
that investors are losing their appetite for stocks.
It’s important to know where the weakness in the
market is coming from, which is why the stunning chart of the S & P
Midcap Index is worthy of a detailed analysis. First, compare the MID
chart to the INDU chart. The former has rallied nine days in a row,
while the latter has lost 2% of its value. And while a 2% loss may
be a tolerable short term paper loss, consider the following. The midcap
index is an area of the market where both growth and value players
converge, thus its current weakness is sending a clear message: investors
don’t think growth is all that strong at the moment, and value players
seem to think that it’s hard to find cheap stocks.
Technically, the midcaps are in a potentially serious down trend
which could accelerate. This is supported by the ROC indicator falling
below the zero line, illustrating a lack of momentum while prices are
starting to trace a lower high and lower low trajectory. This loss
of momentum is confirmed by the falling ADI and OBV indicators for
MID. So unless this is reversed, it’s safe to day that midcap stocks
maybe in the early stages of a potentially meaningful correction.
More Bad that Good
While a month ago there was positive momentum in stocks, the current
scenario shows a weakening of the midcap sector which is being reflected
in the flattening of the New York Stock Exchange Advance Decline line.
When the broad market is weak and the Dow Jones Industrial Average
rallies by itself – the solitary walk - there are two likely possibilities
for the future of stock prices; the Dow will fall or the broad market
will rally and catch up. Either one is possible at the moment. Yet,
given the degree of weakness in the broad market, it’s safe to say
that this remains a good time to be very selective and very prudent
in where we put our money. If the mid cap stocks break further below
their 50-day moving average and the selling picks up steam, it is likely
to be a sign that there is more trouble ahead.
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