Dow Theory Affirms Market Uptrend

This past October, the Dow reached a new high but the Transportation index lagged, as seen on the chart below.  This raised suspicions that the uptrend in the Dow (and S&P 500 for that matter), was on soft footing.  Dow Theory looks for consistency in technical patterns between the Dow and the Transportation Index.

When the indices diverge, for example, a vote of non-confidence is given to the Dow trend. When they agree, especially as they stair-step higher, a vote of confidence in the uptrend is affirmed.

In December, the Transportation Index broke out of a consolidating pattern and has head toward a new high. The Dow reached a high in September/October as the chart below shows, and is beginning to challenge that high in January.

For a primary trend buy or sell signal to be valid, both the Industrial Average and the Transportation Index must confirm each other. If one average records a new high or new low, then the other must soon follow for a Dow Theory signal to be considered valid.  See below a depiction of Dow Theory signals from StockCharts.com.

There are some criticism of Dow Theory, such as the fact that the Transportation Index and the Dow Industrials today are comprised of quite different components than the original industrials and railroad stocks. Dow Theory, however, should be used as a part of the market technician's toolkit.

At Baseline Analytics TrendFlex, several indicators like this are scored to determine the risk to the current trend.  Learn more about our indicators and subscribe to our weekly signal updates at Baseline Analytics.

- Baseline Analytics

Market Breadth Heading to New Highs

Along with the positive momentum of the major indices, market breadth has take a decidedly positive path, reinforcing the strength of this uptrend.

The chart below combines our favorite breadth indicators discussed on this blog in the past.  Note that the NYSE Advance/Decline ratio stretched to a new high today (December 18, 2012).

Similarly, Up vs. Down Volume has leaped higher, closing in on peaks previously reached in April and September 2012. 

Market Breadth indicators such as these are indispensable tools in the technician's arsenal, providing insight into the internal strength of equities and confirming the market trend.

Visit Baseline Analytics TrendFlex to learn more about the key indicators we use to assess the strength and staying power of the current trend.









Small Cap Leading Indicator

An interesting market relationship formed recently with the highs in the S&P500 reached just prior to Election Day 2012. Each week, Baseline Analytics reviews a series of charts depicting the technical condition of the major indices plus relationships between various market sectors.

Reviewing weekly charts, we note below that the Dow Jones US Small Cap Index peaked in April 2006.  We then measured how long it took for the S&P500 to peak.  That timeframe was 18 months, as shown on the left side of the chart below:

Fast forward to 2011 when the Small Cap index peaked in July.  Measuring 18 months from that peak would suggest a peak in the S&P500 in the November 2012 timeframe, right on target with the 18-month timeframe.  The S&P500's recent peak was on October 17 at 1461.

This may simply be coincidence and a lucky repeat of a historic relationship.  Nevertheless, patterns such as this are part and parcel of a technician's tools, especially with regards to setting price targets and evaluating cycles.

At Baseline Analytics TrendFlex, there are many such market sector relationships that comprise our review of the financial markets and the assessment of the current trend.  Click here to learn more about Baseline Analytics TrendFlex.



Using VIX and Put/Call to Identify Trend Change

Market sentiment can be measured in many ways.  These include Investor's Intelligence surveys, the Daily Sentiment Index (DSI), as well as readily-available VIX and Put/Call ratio indicators.

Baseline Analytics TrendFlex uses VIX and Put/Call ratios as an indicator to assess the risk of the current trend changing.

For example, see the chart below.  The S&P500 is plotted on the main chart with VIX (pink line) behind it, and the Put/Call ratio below.  Each indicator is compared to its 34-day exponential moving average.



You will note the ovals drawn at various points on the VIX chart as well as circles drawn on the Put/Call ratio chart.  These indicate extreme points vs. the indicator's 34-day exponential moving average.  VIX and Put/Call indicators and their "gap" from the moving average are treated as contrary indicators.  In calculating part of its TrendFlex Score, Baseline Analytics treats an extreme high in VIX or Put/Call, considered "extreme fear," as a contrary indicator.  This signals a potential bullish trend change.  Note the extreme points marked at the start of June 2012.  That point effectively signaled a shift in the S&P500 from a downtrend to an uptrend.

Although this signal is not 100% effective on its own, traders and investors are encouraged to use this tool alongside other technical indicators to assess the risk of change in the current trend. Click here to learn more about Baseline Analytics TrendFlex indicators and our TrendFlex Score designed to measure the risk of a trend change.

Market Breadth Reinforces Uptrend

As the S&P500 settles down from its recent highs, it is reassuring (for Bulls) to note that market breadth remains healthy.

The chart below has been a regular feature of the Baseline Analytics blog.  It depicts the following market breadth indicators:

1. Advance/Decline ratio of the New York Stock Exchange (NYSE).
2. NYSE Up Volume vs. Down Volume
3. Stocks reaching New Highs vs. New Lows
4. Ratio of New Highs vs. New Lows.

As can be seen by the behavior of these indicators, market breadth has been positive and remains in an uptrend. Baseline Analytics TrendFlex weights these indicators to develop a market breadth score.  On a scale of 1-3, 1 being Bullish and 3 being Bearish, this week's Market Breadth score is at 1.75.  This is better than Neutral (2.0) but not an overly-bullish 1.0 reading.

The S&P500 is depicted on the top chart as the orange/brown line.  Note how SPX diverged from the A/D line in mid-October as the index corrected almost 4% from its peak.  The firmness of market breadth indicators, however, suggest internal strength. 

There is no doubt that, from a weekly perspective, the S&P500 remains in an uptrend. Its recent consolidation as seen on the daily charts is just that; nothing more than a corrective move amidst the larger uptrend.

We would turn negative on the S&P500 should market breadth start to roll over.  That would manifest itself in a downtrend in the A/D line and/or negative readings in Up vs. Down volume activity (following recent highs in the index, it will take a lot of effort to push the New Highs vs. New Lows figure into negative territory).

Market breadth indicators should be a part of an investor's toolkit in assessing the strength of the stock market trend.  Click here to learn more about Baseline Analytics TrendFlex and our market indicators.

Copper-30-Yr Treasury Bond Ratio: Bullish Indications

At Baseline Analytics TrendFlex, one of our economic strength indicators is the ratio of the price of copper vs. the price of the 30-year Treasury bond.  A rising ratio indicates an increase in the price of copper, considered a key industrial metal and a bullish macro-economic indicator when rising.  A decline in the Treasury bond price (and hence an increase in interest rates), is another reinforcement of economic growth.  See the chart below:

Being such a significant industrial metal, copper is used in many facets of the industrial economy, such as housing.  The ratio has recently stretched above its 200-day moving average (see note on right of chart).  At the same time, bond prices appear to have peaked (see the blue line at red arrow) as the price of copper turns upward (green line).

Note the surge of this ratio above its moving average in May 2009. That move followed the bottoming of the S&P500 two months earlier. Fast-forward to today: although the breakout above the 200-day moving average is not yet convincing, the RSI of the breakout peaked above 70, indicating a potentially bullish trend change in the ratio.   That may be an indicator of how overbought bonds are today, as well as an early indicator of the industrial metal's strength and hence potential economic strength.

The Copper/30-Year Treasury Bond ratio is one of many indicators that comprise the Baseline Analytics TrendFlex Score.  Click here to learn more.

Bob Palmerton

Leading Indicator to a Market Top?

An interesting pattern has emerged in the ratio of Small Cap stocks vs. Large Cap stocks.  The Small Cap/Large Cap ratio is comprised of the Dow Jones US Small Cap Index divided by the Dow Jones Large Cap Index.  In March 2006, this ratio of Small Caps vs. Large Caps reached an intermediate term top, as noted below by the black arrow on the far left.  Notice that the ratio peaked 18 months before the S&P500 peaked, in September 2007. 

 

 

Now, fast forward to June 2011.  The Small Cap/Large Cap ratio peaked at that time, as preference for more conservative, dividend-paying large caps exceeded interest in small caps. Today, the ratio sits near support denoted by bottoms in April 2012 and July 2011.  The noteworthy observation in the above chart is that 18 months following the June 2011 peak, is November 2012.

 

Will November 2012 represent a possible intermediate-term top for the S&P500? The S&P500 remains in a clear uptrend, and faces potential resistance near the 1430 area last reached at the aforementioned peak in September 2007.  This is an interesting technical coincidence and is worth watching. 

 

At Baseline Analytics, we are trend-followers and rarely resort to picking targets on the indices.  Our models however assess the risk to the current trend and its probability to change. Although there is growing bullishness as the "risk-on" trade prevails, investors are counseled to remain suspect and protective of their capital.

 

Click here to learn more about how Baseline Analytics TrendFlex can help keep you on the right side of the market.