FOREIGN SELLING INCREASES ODDS FOR DOWNSIDE CORRECTION IN U.S -- EAFE ISHARES HAVE BROKEN 50-DAY LINE -- CANADIAN STOCKS HAVE ALSO TURNED DOWN -- S&P MIDCAP INDEX IS STALLED AT 2011 HIGHS -- NYSE COMPOSITE INDEX IS WEAKENING
EAFE ISHARES WEAKEN... It's dangerous to analyze the U.S. stock market without taking into consideration trends in foreign markets. That's because they are very highly correlated. In my view, odds for a downside correction in the U.S. have increased, due mainly to selling in foreign stocks. First, some perspective. Although several U.S. stock indexes have already exceeded their 2011 highs, foreign stocks have yet to do so. In fact, they're not even close. Chart 1 shows EAFE iShares (EFA) having regained 62% of their 2011 losses. That's the third upper line in the chart. A 62% retracement level often acts as a resistance barrier. And it has done so with the EAFE. Chart 1 shows the index having already fallen back below its 50-day moving average for the first time since mid-January. The correlation coefficient line along the bottom of the chart shows a positive correlation of .87 between EAFE iShares and the S&P 500. Weakness there could cause weakness here. EAFE stands for Europe Australasia and Far East stock markets. Its biggest weighting, however, is in Europe where recent problems have developed. EAFE doesn't include Canada.
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Chart 1
CANADIAN STOCKS WEAKEN... The chart of the Toronto Composite Index in Chart 2 also shows that market weakening. The TSX has fallen below a rising trendline drawn under its October/December lows and has fallen to the lowest level since December. The TSX has also fallen back below its November high, which negated the upside breakout that took place during February. It seems clear that the short-term trend in Canadian stocks has turned down. Given its close historical correlation with the U.S. stock market, that also increases the odds for more selling in the U.S.
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Chart 2
MIDCAPS STALL AT OLD HIGH -- NYSE WEAKENS... Although I generally look at the S&P 500 to get a feel for the market's trend, it's a good idea to see what other stock indexes are doing. Two of them are giving warning signals. Chart 3 shows the S&P 400 Mid Cap Index (MID) starting to meet resistance along its 2011 highs. That's a logical spot to expect some profit-taking to develop. Chart 4 shows the NYSE Composite Index which has also yet to clear its 2011 high. I suspect that's because of its heavier weight in commodity-related stocks which have been market laggards. Chart 4 shows the NYSE slipping below its 50-day average which is a sign of weakness (blue circle). Its RSI line (top of chart) and MACD lines (along bottom) have turned down. That's another warning sign.
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Chart 3
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Chart 4
MACD SELL SIGNAL FOR S&P 500... Arthur Hill recently wrote about the tendency for stocks to weaken during the six months after April ("sell in May and go away"). April ends the six-month period that has historically been the strongest half of the year. He also mentioned a timing device used to help determine an entry point near the start of that period (during October or November) and to time an exit point during April or May. That timing device is the MACD indicator. That's why I've overlaid the two MACD lines on a daily chart of the S&P 500 in Chart 5. The MACD lines show two disturbing trends. One is the "negative divergence" between the lines and the S&P 500 (see falling trendline). [That occurs when the S&P hits a new high and the MACD lines don't). The second disturbing trend is the fact that the lines have turned negative. Given where we are in the seasonal pattern, the fact that the U.S. market is overbought, and recent weakness in foreign markets, the odds for a downside correction in U.S. stocks now appear to be pretty high.
