DOW INDUSTRIALS TESTS NOVEMBER LOW -- DOW TRANSPORTS BREAKS NOVEMBER LOW -- MARKET BREADTH DETERIORATES -- VIX AND VXN BREAK ABOVE 50-DAY LINES -- A NEW VOLATILITY BASED ETN -- MOSAIC AND POTASH FORM RISING WEDGES -- MONSANTO TESTS SUPPORT

DOW THEORY REMAINS BEARISH... Today's Market Message was written by Arthur Hill. - Editor

Dow Theory remains on a sell signal as the Dow Transports broke below its late November low. Before moving on to the charts, let's review some Dow Theory basics. A Dow Theory sell signal is registered when both Averages record lower lows (exceed the prior reaction low). Conversely, a buy signal is triggered when both Averages record higher highs. When only one Average records a lower low (or lower high), a state of non-confirmation exists, which is not enough to reverse the prior signal. Both Averages must confirm to trigger a robust signal. Defining reaction highs and reaction lows is somewhat subjective. In general, I look for moves that exceed 5% in price change and one month in duration. Shorter moves are often just noise.

Chart 1

Dow Theory is not perfect, but staying on the right side of Dow Theory signals can improve returns and reduce risk. Chart 1 shows close-only prices for the Dow Industrials and Dow Transports over the last 12 months. These close-only charts filter out the intraday volatility to help clarify signals. Working from left to right on the chart, five developments were identified. The Dow Industrials broke support in June to forge a lower low, but the Dow Transports held above its prior low to forge a higher low (1). The lower low in the Dow Industrials was not confirmed by the Dow Transports. Both Averages then formed lower highs in August (2) and broke support on the subsequent decline to trigger a Dow Theory sell signal in late September (support break). The decline resulted in a lower low in late November (3). The subsequent rally forged a lower high in January for both Averages (4). In January 2009, the Dow Transports closed below its November low, but the Dow Industrials has yet to confirm (5). It is close though. The Dow Industrials closed at 7552.29 on 20 Nov and a close below this level would confirm the new reaction low in the Dow Transports. This would refresh the Dow Theory sell signal.

BREADTH REMAINS WEAK... The vast majority of stocks remain in long-term downtrends. Chart 2 shows the percentage of Nasdaq stocks above their 200-day moving averages. After plunging below 15% in October, this market indicator worked its way higher the last few months. However, it still remains below 15% and at low levels overall. A sustainable rally is hardly likely with the vast majority of Nasdaq stocks still below their 200-day moving averages. Chart 3 shows that the situation is even worse on the NYSE. After plunging below 15% in October, its indicator worked its way back to around 10% this year. However, it cannot even break above the 10% threshold.

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PERCENTAGE OF STOCKS ABOVE 50-DAY... For a shorter perspective, we can look at the percentage of stocks above their 50-day moving averages. Chart 4 shows this indicator for the NYSE. There was a breakout in late November and the indicator moved higher until early January. Over 80% of the stocks on the NYSE were above their 50-day moving averages in early January. This improvement did not last as the indicator plunged below 50% in mid January. The indicator formed lower highs in late January and early February. With the latest decline, the indicator broke below its January low and breadth remains bearish. At the very least, a break above 50% is needed to turn positive on this indicator again. Chart 5 shows the percentage of Nasdaq stocks above their 50-day moving average. The overall pattern is similar to the NYSE version. Breadth has been deteriorating since early January. However, notice that the Nasdaq indicator is holding up better than the NYSE indicator. The Nasdaq version remains above the January low and above 30%. In contrast, the NYSE version broke below its January low and below 30%. NYSE breadth is weaker than Nasdaq breadth.

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VIX BREAKS ABOVE 50-DAY LINE... Last week I featured the S&P 500 Volatility Index ($VIX) and the Nasdaq Volatility Index ($VXN) as both consolidated just below their 50-day moving averages. With Tuesday's sharp decline in the stock market, both volatility indicators gapped up and broke above their 50-day moving averages. Charts 6 and 7 show both meeting some resistance around 50 today, but the gaps and breakouts are holding. Rising volatility is negative for the stock market because it reflects an increase in the fear factor. Fear begets selling. As volatility surged this week, the S&P 500 broke its January lows and the Nasdaq broke its November trend line. Rising volatility is associated with falling stock prices. These volatility indices need to fill their gaps and break below their rising 200-day moving averages to reverse this bearish development.

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VIX POPULARITY AND A NEW ETF... As an aside, I was a bit surprised to see the VIX as one of the most requested symbols this afternoon. Chart 8 shows Ticker Rain from 2:30 to 4:05 this afternoon. $VIX was the second most requested symbol (behind SPY). Perhaps this has something to do with the new volatility ETN, the iPath S&P 500 VIX Short-Term Futures ETN (VXX). Now there's a mouthful. The ETN has been trading less than three weeks. VXX sports a gap up on Tuesday and this gap is holding. A close below 102 would fill the gap and break the trend line extending up from last week.

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POT AND MOS FORGE RISING WEDGES... Looking at the most popular stocks in Ticker Rain this afternoon, Mosaic (MOS) and Potash (POT) jumped out. These two are part of the Agricultural Chemical group that includes Monsanto (MON). Relative to the S&P 500, Potash and Mosaic have been performing quite well. Both are trading above their rising 50-day moving averages and both exceeded their January highs this month. However, both are trading well below their falling 200-day moving averages and the pattern at work looks like a rising wedge, which is typical for counter-trend rallies. Even though both firmed today with small gains, both also gapped down on Tuesday and have yet to recover from this gap. Further weakness below their 50-day moving averages would be quite negative.

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MONSANTO LAGS... Monsanto is the weakest of the three because it failed to exceed its January high this month. The stock formed a lower high in early February and declined to support this week. Tuesday's gap remains as the stock stalls right near the 50-day moving average and its Jan-Feb lows. Further weakness below this support level would be bearish.

Chart 12