FOREIGN STOCK MARKETS LOOK EVEN WEAKER THAN THE U.S. -- IF THAT'S THE CASE, HOW ARE THEY GOING TO SUPPORT THE U.S. MARKET -- COMPARISON OF 2007 AND 1998 SUMMER PEAKS -- DETERMINING HOW LONG A RIGHT SHOULDER SHOULD LAST
MAYBE GLOBAL GROWTH ISN'T THAT STRONG ... One of the mantras we keep hearing on TV is that strong global markets and economies will prevent the U.S. economy (and stock market) from suffering a serious slowdown. Since I happen to be of the belief that stock markets are leading indicators of economies, I thought it would be useful to see how foreign markets have held up during the recent downturn. Unfortunately, the picture isn't that encouraging. Chart 1 shows a picture that most of us are familiar with. It shows the MSCI World ex USA Index (blue line) rising much faster than the S&P 500 (black line) since 2003. That's reflective of stronger foreign stocks and economies. Chart 1 also shows both lines dropping since mid-July. Chart 2 is a different version of the same chart but covers only the period from 2005. Chart 2 plots the S&P 500 as the zero line (flat back line). That shows us what the MSCI Index (blue line) is doing "relative" to the S&P 500 (which is another way of showing the MSCI/S&P relative strength ratio). Chart 2 shows that foreign stocks have actually dropped much more than the US over the last month. [Since mid-July, Emerging Market iShares have fallen -13%, EAFE iShares -10%, and the S&P 500 -6%]. Chart 2 shows something else. The foreign/US ratio has broken the uptrend going back to mid-2005. That suggests that this downturn is much more serious than those that took place in mid-2006 and mid-2005. So here's my question. If foreign stocks are falling faster than US stocks, and if foreign stocks are leading indicators of foreign economies, how can they be expected to bolster the U.S. economy and stock market? Just thought I'd ask.
Chart 1
Chart 2
FOREIGN STOCKS LOOK TOPPY... The next three charts show the MSCI World (Ex USA) Index over three different time periods (plotted through Friday). Chart 3 doesn't look that different from the S&P 500. The MSWorld ex USA Index is trading well below its 200-day average (red line) and is near chart support at its March low. [Foreign markets bounced today, especially those in Asia that were closed on Friday when other markets rallied]. The relative strength ratio below Chart 3 shows that foreign stocks have fallen more than US stocks on a percentage basis. The weekly line in Chart 4 also carries some negative information. It shows that foreign stocks have broken the 40-week (200-day average) by the biggest margin in four years. It also shows the 14-week RSI (top of Chart 4) falling to the lowest level since the spring of 2003. Neither of those is a good sign. The weekly MACD lines (below chart) have turned down. That's not that bad. The MACD lines in Chart 5 are.
Chart 3
Chart 4
Chart 5
FOREIGN STOCKS IN DANGER OF MAJOR SELL SIGNAL... Chart 5 is a monthly version of the MS World (Ex USA) Index. There are two indicators on the chart. The top one is a 14-month RSI line. The RSI is falling from overbought territory over 70 to the lowest level in three years. That shows the major uptrend losing momentum. Much more troubling are the monthly MACD lines (which are overlaid on the price bars). First of all, the monthly MACD lines are turning down from the same level as their 2000 peak. Secondly (and more important) they've just crossed into negative territory (the faster black line is trading below the slower red line). That negative crossing can be seen more clearing on the histogram bars which measure the spread between the two MACD lines. The last monthly histogram bar is below the zero line for the first time in four years. Since that's a "monthly" indicator, the bear signal is only "tentative". An "official" signal can't occur until the end of the month. But it's something to keep an eye on. Which brings us back to my original question. If foreign markets are in danger of slipping into bear markets, how are they going to prevent the U.S. market from doing the same?
COMPARISON WITH 1998 H&S TOP... One of our readers asked me to compare the current possible "head and shoulders" top I wrote about on Friday to the one that occurred during the same time frame in 1998. He (or she) suggested than instead of a bear market, a great buying opportunity presented itself in October. Actually, that's only half right. A new uptrend started in October 1998, but only after the S&P fulfilled its downside bear market objective of 20% (22% to be more exact). Actually, the 1998 chart is similar to the present one. The major decline started in mid-July. A small "right shoulder" formed during August right around the "neckline" drawn under the spring low (more on that later). It resumed the downtrend in late August and bottomed in October. The initial drop from 1190 to 1074 was 116 points (or 10%). The second downleg matched that and ended 22% from its July peak. My Friday analysis suggested that an additional 10% drop below the recent low would fulfill the 20% bear market requirement -- just like in 1998. I also recently wrote about the market's tendency to drop during August and bottom in October.
Chart 6
WHAT ABOUT RIGHT SHOULDER TIME SYMMETRY ... I remarked on Friday that, if the market were currently forming a "right shoulder", that rally could move back up to the peak formed on the "left shoulder". That creates a form of "price symmetry". One of our readers asked about the "time symmetry" of a right shoulder. A glance at the 1998 chart shows no apparent time symmetry between the left shoulder (three months) and the right shoulder (less than three weeks). But there is another form of "time target" that I often use for market bounces. It has to do with the number of days in the previous decline versus the rebound, which brings to a form of cycle analysis known as "time translation". The idea is that, in a downtrend, a market bounce shouldn't last longer than the previous downturn. A quick count shows that the first downleg in 1998 lasted thirteen trading days. The sideways movement during August also lasted thirteen days before turning down. That's "time translation" at work. Let's go back to the current chart and see what we see.
TIME TRANSLATION ON CURRENT REBOUND... Here's my current version of "time translation". I count twenty trading days (or four weeks) from the July peak (first arrow) to last Thursday's bottom. That means that any rebound shouldn't last more than four weeks. Assuming this bounce is a "right shoulder", that would put the outside time target for another downturn to start by mid-September (or September 14). But there's more. In price terms, we often talk about percentage retracements. We can do the same thing in "time" terms. In other words, price bounces often last a third to a half of the time spent in the previous downturn. Using the 20-day decline, that would suggest a possible rally lasting anywhere from six to ten trading days. Starting from last Thursday (August 16), that would suggest a possible "time target" for another downturn to start by August 24 (one third) or August 31 (one half). In my experience, price targets are more reliable than time targets. When they work together, however, they're a good combination. Whether or not they work this time will be determined by whether or not the market is actually forming a "head and shoulders" top. In the meantime, I'll be counting the days until we find out one way or the other.
Chart 7
