NO DOW THEORY BUY SIGNAL YET -- TRANSPORTS HAVEN'T CLEARED AUGUST HIGH -- SMALL CAPS HAVEN'T BROKEN OUT EITHER -- S&P 500 RETESTS NECKLINE SUPPORT -- FALLING US RATES HURT DOLLAR
DOW TRANSPORTS HAVEN'T BROKEN... A lot has been written about the recent upside breakout in several market indexes. Unfortunately, the upside breakout took place on relatively light volume and hasn't shown much follow-through. I suspect that part of the reason for the lack of bullish follow-through is that some key groups still haven't broken out. One example is the Dow Transports. One of the basic tenets of Dow Theory is that any breakout by Industrials or Transports must be confirmed by a similar breakout in the other (in either direction). My last article on the Dow Theory (August 24) warned that both Dow Averages were in danger of triggering a Dow Theory sell signal which would occur if both closed below their mid-July intra-day lows. Although the Industrials did that by a slight margin, the Transports didn't (red circle in Chart 2). Hence, no sell signal was triggered and the market rallied from there. Over the last week, the Industrials closed above their August high as shown in Chart 1. However, Chart 2 shows the Dow Transports still testing its summer highs. Hence, no Dow Theory buy signal has been triggered. For that to happen, both Dow Averages must close above their August highs. Another divergence is showing up in small cap stocks.
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Chart 1
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Chart 2
SMALL CAPS HAVEN'T BROKEN OUT YET... Three Thursdays ago (September 2), I wrote that the S&P 500 appeared to be forming a "head and shoulders" bottom which would be confirmed by a breakout through its August peak on higher volume. I also wrote that the Russell 2000 Small Cap Index appeared to be forming a bullish "double bottom" pattern which would also be confirmed by a breakout over its summer high. The S&P 500 Large Cap Index did exceed its August high (and neckline) as shown in Chart 4 (although on disappointing volume). The RUT, however, has yet to confirm that upside breakout by large (and midcap) stocks. Chart 3 shows the RUT still testing its July high at 672. In my view, a close above that important resistance barrier is needed to confirm the upside breakout in larger cap stocks. I still lean toward the view that the stock market is headed to higher levels between now and yearend. I also believe, however, that some of the lagging groups (like transports and small caps) have to break out as well to confirm some of the bullish breakouts that have already taken place. Chart 4 shows the S&P 500 retesting its August peak near 1129 and the "neckline" drawn over its June/July peaks. Its 200-day average isn't far below that. If the recent upside breakout is for real, the S&P 500 should find support along its "neckline".
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Chart 3
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Chart 4
SILVER AND GDX CHALLENGE OLD HIGHS... Money continues to pour into precious metals owing primarily to a weaker U.S. Dollar and a Fed commitment to lower U.S. interest rates. Gold thrives in that environment (partially because it implies that the Fed is devaluing the dollar in hopes of "reflating" the economy). Although gold has reached a new record (in nominal terms), silver is close to a new thirty-year high. Chart 4 shows Silver Trust Shares (SLV) challenging its early 2008 peak at 20.73. That would put silver at the highest level since 1980. Precious metal stocks are nearing an important test of their own. Chart 6 shows the Market Vectors Gold Miners ETF (GDX) nearing a test of its early 2008 high at 56.73. Although rising metals have attracted a lot of media attention (which always makes me nervous), the group hasn't yet reached a dangerous overbought level as measured by the Gold Miners Bullish Percent Index ($BPGDM). On September 7, I warned that the BPGDM (which measures the % of mining stocks in p&f uptrends) was on the verge of a new buy signal at 68. It has since reached 80. I also warned, however, that I would start getting more cautious when it reached its old highs near 86%. It's not there yet, but it's getting close (see Chart 7).
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Chart 5
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Chart 6
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Chart 7
IMPLICATIONS OF A WEAKER DOLLAR ... One of the factors driving the direction of currency markets is interest rates. With the Fed declaring war on deflation, U.S. interest rates continue to fall. Chart 8 shows the 2-Year Yield (green line) falling to a record low. That, and the Fed's warning that it may create more dollars by buying more bonds, is bearish for the dollar. Not surprisingly, the Dollar Index has tumbled to the lowest level in eight months. That's not necessarily a bad thing. For one thing, it's helpful to bond prices which rise when yields fall. A weaker dollar is also bullish for most foreign currencies (like the Euro, Aussie, and Canadian Dollars). It's also good for commodities (like gold) and stocks tied to commodities. Last Thursday's message showed that a weaker dollar has given a boost to basic material stocks. A weaker dollar is also good for foreign shares which have been much stronger than the U.S. of late. Chart 9 shows a relative strength ratio of the EAFE iShares (a benchmark for foreign stocks) divided by the S&P 500 (red line) compared to the Dollar Index since the start of 2009. The two lines travel in opposite directions. The chart shows that foreign shares have risen faster than the U.S. since June when the dollar started to drop (see arrows). That's another way to play a weaker dollar. Another potentially positive message is that stronger foreign shares have already exceeded their summer highs and are pulling U.S. shares higher.
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Chart 8
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Chart 9
WEEKLY MACD LINES HAVE TURNED BULLISH ... Last Thursday's market message showed that weekly MACD lines turning bullish for the first time since April. That's important because weekly signals are more infrequent than daily signals but carry greater weight. It's true that the U.S. stock market looks a bit over-extended (and is now getting a lot of competition from bond prices which are climbing again). The fact that weekly MACD lines have turned positive encourages the view that the market is still headed higher between now and yearend. It still has to get through the dangerous seasonal period that usually lasts into October. After that, however, seasonal trends turn more positve for the following three to six months. That stronger trend, however, still needs upside breakouts by small caps and transportation stocks which have yet to exceed their August highs.
