DOW JONES COMPOSITE AVERAGE CLOSES BELOW ITS 200-DAY LINE AS THE DOW INDUSTRIALS ENDS BELOW 50-DAY LINE -- THE DOW INDUSTRIALS ARE SHOWING NEGATIVE DIVERGENCES OF THEIR OWN -- INDUSTRIALS SPDR APPEARS TO BE FORMING HEAD AND SHOULDERS TOP
DOW JONES COMPOSITE AVERAGE CLOSES BELOW 200-DAY AVERAGE ... I've been writing about the growing negative divergence between the transportation and industrial stocks which has gotten even worse. The Dow Transports fell -2.1% during the week and ended at the lowest level in seven months. It was just a matter of time before that started to weight on the Dow Industrials which lost -1.2%. The Dow Utilities (aided by a late week bounce in bond prices) lost only -0.20%. Losses in all three Dow Averages caused the Dow Jones Composite Average ($DJA) to end the week below its 200-day average for the first time since last October (Chart 1). [The transports and utilities are both below their 200-day lines]. The DJA is now threatening its spring lows formed in late March and early May. A drop below those support levels would be an even more negative sign. It's doubtful that the Dow Industrials could withstand that type of weakness. The Dow Industrials themselves have some negative divergences to worry about.
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Chart 1
NEGATIVE DIVERGENCES ON THE DOW... Chart 2 shows the Dow Industrials ending the week a shade below its 50-day average, on the heaviest trading of the month. That's not a good combination. Neither is the negative divergence between the Dow and the 14-day RSI line that has existed all year. The red line in Chart 2 shows the 14-day RSI line peaking in early December which led to a January selloff. The Dow's record highs in early March and mid-May, however, produced lower RSI peaks (down arrows). In a healthy uptrend, the RSI line usually rises along with the price bars. That hasn't been the case since the start of the year, and suggests that the Dow is losing momentum. That's not all. Chart 3 shows a similar negative divergence between the Dow and its MACD lines (top of chart). That's another negative warning that the Dow is starting to weaken. With its two sister Dow Averages trading below their 200-day averages (and the DJA falling below its 200-day line), a drop by the Dow Industrials to their 200-day line wouldn't be surprising.
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Chart 2
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Chart 3
POTENTIAL HEAD AND SHOULDERS FORMING ON INDUSTRIALS SPDR... The negative interplay between the Dow Industrials and Transports shows up in another way, and the message there isn't encouraging either. Chart 4 shows the Industrials Sector SPDR (XLI) in the latter stages of a potential "head and shoulders" topping pattern. [The H&S top is identified by three peaks, with the two surrounding "shoulders" lower than the middle "head". A "neckline" is a trendline drawn along the lows of the formation. A decisive close below the neckline is a bearish sign]. Chart 4 shows the XLI nearing a test of its neckline (and its 200-day average), and on rising volume. Despite its name, the XLI includes both industrial and transportation stocks. And most of its recent weakness is coming from the latter. The XLI was the market's weakest sector over the last month (and the second weakest this week). The three weakest XLI groups over the last month were rails (-13%), truckers (-10%), and airlines (-9%). Volume also plays an important role in the formation of a H&S top. The red line in Chart 5 overlays On Balance Volume (OBV) on the XLI price bars. [OBV is a running cumulative line that adds volume on up days and subtracts it on down days. It's an easy way to see whether there's more upside or downside volume]. Notice that the red OBV line peaked in December and has shown lower peaks since then. As of Friday, the OBV line has fallen to the lowest level in four months. That's sign of weakness and increases the odds for an XLI downturn.
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Chart 4
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Chart 5
WEEKLY DOW CHARTS ALSO SHOWS NEGATIVE DIVERGENCE... As you've noticed by now, I'm starting to turn more cautious on the stock market. In addition to some of the short-term bearish signs shown above, there are a number of negative divergences showing up on weekly stock charts. Let's stick with the Dow. The red line in Chart 6 plots a 14-week RSI line compared to a weekly chart of the Dow Industrials going back five years. Normally, the RSI line rises with the Dow. When it diverges from rising prices, that often leads to price pullbacks or consolidations. I'm not quite sure what to make of the current negative divergence that's formed this year, but it's not encouraging. While the Dow has risen to a new record, the 14-week RSI line has continued to drop (falling red trendline). That's a classic negative divergence, and a warning sign. I could show a lot more negative divergences on weekly charts. There are certainly enough to warrant a more cautious stance on the stock market. With May having just ended, the market is also now in a seasonally weaker period which can last well into the summer months.
