Back in Gear but for How Long?
THE STOCK MARKET WAS in a postelection funk as it eased lower late last week but gave no real technical signals it was ready to move up or down. The bears seized upon inaction by ratcheting up the put option buying. In other words, they were positioning themselves for a decline that surely would break the market's four-month rally.
But with many Dow Jones Industrial Average components turning out some pretty good earnings numbers in recent days, that index broke through resistance to set yet another new all-time high (see Chart 1). Whatever uncertainty there was earlier this month is gone, and that clears the way for a strong finish to the year.
We're not going to be so bold as to predict a big run from here but until proved otherwise, the bulls are in control. They have been favoring big stocks. Technology shares are leading the way and a reversal in the fortunes of the key semiconductor sector has turned a breakdown into a breakout (see Chart 2).
Another area with a reversal of fortune was the financial sector. Stocks of brokerage houses have been rallying well and the technical pattern that formed in the American Stock Exchange broker/dealer index (ticker: XBD) over the past two months was broken to the upside. What this means is that after a two-month stalemate, demand beat supply, thanks to the strength of the bigger stocks in the group.
However, despite the fact that the bank sector, as represented by the Keefe, Bruyette & Woods bank index (ticker: BKX), has not yet made its breakout move, it has done something that bodes quite well. It made a technical breakdown Nov. 2, but two days later rallied sharply (see Chart 3). This false signal suggests a rather significant change of heart on the part of investors, and now the index is knocking on the door of a technical breakout to the upside.
Let's recap for a moment. Technology stocks are back in favor and financial stocks are apparently transitioning from disliked to liked. And the most important factor since the summer start of the rally is that the bears are still in denial over the whole move.
That's two traditional bull-market leaders back in front and a big "wall of worry" for the market to climb. Even if we doubt the staying power of the rally we have to concede that these factors are pretty good.
I'd like to write about more interesting technical factors in the market or about an obscure indicator that has something earth-shaking to say, but the market today is a lot more mundane. The trend is up and there are plenty of doubters to provide additional market fuel when they can no longer stand the pain of missing out.
That's it. I'm not looking at market cycles now or wave formations. I'm not considering intermarket influences of energy prices that are a lot lower now than they were a few months ago. I'm simply looking at the most basic tool available to all chart watchers and nonchart watchers alike -- the trend.
The trend is up. For investors, that is good and no matter what should be happening, that is the reality.
But just because it is up this week does not mean it will stay up. Here's what I'll be watching over the next few weeks as a warning that the summer trend is over.
Trend break -- The most obvious signal available to chart watchers will be a move below the rising trendlines originating at the summer lows for each respective index. For the Dow, that would be a move below 12,100, in rough terms. The caveat is that because this is such an obvious signal everyone will know it. That makes it a little less reliable.
Capitulation -- When the bears finally throw in their collective towels by covering all their short positions and buying into the rally there theoretically will be nobody left to buy. Another way to look at it is that demand will be exhausted.
How will we know this? There are several ways but for starters, we can look at the put/call ratio data. If call volume starts to beat put volume, meaning that more bets are being made that stocks will go higher, then we will be able to spot the change.
Distribution -- This is another bit of jargon for the so-called smart money selling, or distributing, stock to the public. Given that the public is usually late to the party, when they step up to buy we can safely assume that the rally is not at its beginning.
We can spot distribution by looking at how much volume trades on days when the market goes up and on days when it goes down. If more stock changes hands on days when prices fall, we can consider that a distribution day. String enough of them together -- perhaps 10 of 15 days in a row and we get a warning that the smart money is getting out.
When we start to see breakdowns, capitulation and distribution, we'll know the end is near. These changes can come in a week, in a month or sometime next year, so all we can do is trade with what is actually happening now.
Clearly, it would not hurt to have a plan in place just in case they come sooner rather than later.
"Putting Stocks to the Technical Test," Nov 13.
Michael Kahn writes the daily "Quick Takes Pro" newsletter (you can get a free trial at www.quicktakespro.com). He is the author of two books on technical analysis, most recently Technical Analysis: Plain and Simple, and was Chief Technical Analyst for BridgeNews. He also is on the Board of Directors of the Market Technicians Association (www.mta.org).
THE STOCK MARKET WAS in a postelection funk as it eased lower late last week but gave no real technical signals it was ready to move up or down.