It does appear that the Dow Jones Industrial is in trouble with a classic bearish head and shoulders chart pattern in the making. The broad Value Line Index is also echoing this same chart pattern. A fall of a mere 125 points on the Dow (1.5%) and 61pts on the Value Line (3.8%) would signal a bearish breakdown. So do we get bearish now? From a bullish perspective we do not like these chart formations……but, we think it is way too premature to get bearish, even if the Dow does break below support at 8200 over the coming days. In order for us to get bearish we need to see a broad based break down in the market (a close below 1600 on the Value Line would be the first piece of evidence of broad based break down). We believe things when we see them so for now it is a waiting game. However, there is more to it than that. We have to carefully analyze market internals.
While the narrow Dow Industrial is behaving badly, this bearish behavior is not being echoed by the broad market. Market internals remain positive and are certainly not behaving the way you would expect them to if this market was genuinely bearish. The classic market internal indicators, such as the NYSE Advance Decline Line, the 200 day moving average ratio and the New Highs – New Lows index are either at multi-week highs or just a few percent away from multi-week highs (as opposed to the Dow which is a few percent away from a multi-week low). The reluctance of the broad market to participate in the downside of the major market indices is a classic tell tale sign of an underlying bullish condition in the stock market.
Many commentators have been suggesting that the stock market is in an overbought condition. While that may have been so on June 1st with just over 90% of the stock listed on the NYSE trading above their 50 day moving average, that figure is now down to a more neutral 45%. If the Dow was to fall below “support” at 8200 to say 8000 this ratio would probably drop below 30% which would effectively push the market into a short term oversold condition. This would confirm our hypothesis that commentators have been too quick to get bearish. Reading through commentary we get the feeling that the average punter is behaving as if the Dow has already broken through support and is trading significantly below (somewhere below 8000)…….in the same manner that investment grade corporate bonds were priced for a depression rather than a recession in November last year.
We believe that equity markets turned bullish late last year, it was stealth because few could see it. However, as of early April the market made its intentions perfectly known……with broad based advances across all the major market indices in the US. However, markets do not move in straight lines. The weakness we are now experiencing in the Dow and Nasdaq was a little overdue. While market internals continue to resist following the major market indices down we continue to believe that this is just an attempt by the market to shake weak hands out of the market…..once the weak hands are out of the market (probably when we see the NYSE 50 Day Moving Average Ratio trade below 40%) then the market will resume its upward path. We continue to be buyers in weakness.
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