STOCK RALLY REMAINS STRETCHED -- AVERAGE DIRECTIONAL INDEX FOR THE DOW SIGNALS THAT RALLY IS VULNERABLE TO A SETBACK -- THE SAME IS TRUE FOR OTHER MARKET LEADERS -- THE 20,000 MILESTONE FOR THE DOW MAY BE PROMPTING SOME PROFIT-TAKING
ADX AND RSI LINES ISSUE WARNINGS... My last couple of messages have repeated the idea that the post-election stock rally looks stretched. Last Friday's message showed the stock/bond ratio, the value/growth ratio, and the transportation/utilities ratio also in overbought territory. Momentum and seasonal factors are helping to keep the rally going. But a lot of technical indicators are showing the market to be in a very overbought condition. Chart 1 shows the 14-day RSI for the Dow Industrials at an unusually elevated reading above 80. Here's another indicator flashing a short-term warning. The box above Chart 1 shows an indicator designed to do two things. First, it signals which direction the market is going. That's done by the two Directional Index (DI) lines. When the green (+DI) line is above the red (-DI) line, the trend is up. Those two lines turned positive during election week and remain so (see green circle). What's concerning is the fact that the Average Directional index (black line) has risen above the green line (black circle). That's usually a sign that the current trend is vulnerable to a setback. Any downturn in the ADX from that elevated level would be a more negative sign. [For the record, this system was developed by Welles Wilder who also invented the RSI system and is based on the same 14-day period. For a more in-depth explanation, please read the Average Directional Index (ADX) under ChartSchool]. The S&P 500 shows the same elevated ADX warning as do several of the leading market groups like financials, small caps, and transports. And some of the group ADX lines have started to slip. That's not necessarily bearish. But it suggests that investors may start taking some profits. And they may be using the approaching 20,000 milestone in the Dow to start doing that.
