Look Up Not Down

• More corrective activity to come?
• Are we there yet with Dow Theory?
• Does the correction matter?

The market has been moving sideways for the last 2 months, thereby frustrating bull and bear alike. Chart 1 shows that the technical position, so far as breadth is concerned, has been improving. That is because the NYSE A/D line, and that constructed from common stocks only were both at new highs earlier in the week.

Chart 1

The vertical lines, in Chart 2, show that at the time of major peaks in the NASDAQ Composite, the record high NASDAQ indicator, or rather its 10-week MA, is close to dropping through the 60 level on its way to an oversold condition. A downside penetration of that blue line has not been a sufficient condition to signal a major decline. However, it does appear to be a necessary one. In other words, if a move below 60 takes place a correction does not necessarily follow, but by the same token, a top cannot occur without such action. At least that’s been the case in the last 30 years or so.

Chart 2

More corrective activity to come?

I am not saying that more ranging action or some actual downside price erosion will not occur. Indeed, there are signs that it is not yet over. The KST for the S&P Composite, in Chart 3 for instance, is by no means oversold and is certainly not showing signs of an upside reversal at present. Seasonally, September is the weakest month of the year, so this rolling over action may provide some downside fireworks.

Chart 3

Furthermore, Charts 4, 5 and 6 feature the KSTs for the major sectors. Most are in a declining mode, which means that the predominant near-term pressure is on the downside, notwithstanding an oversold utility and telecom and slightly positive staples, industrials, energy, and transports.

Chart 4

Chart 5

Chart 6

Chart 7 compares the $VIX to its KST, or rather the inverted VIX. The arrows show that when this momentum indicator starts to peak out from an extreme level a correction of some kind typically follows, as volatility increases. Please note that a declining VIX means an increase in volatility since this series has been plotted inversely to correspond with price movements in the S&P.

Chart 7

Are we there yet with Dow Theory?

Chart 8 compares the Dow Industrials to the Transports. The red and blue waves flag moves in excess of 7.5%. In order for the Dow Theory to go bullish, we need to see a series of rising intermediate peaks and troughs in both series. What classifies as “intermediate” is open to debate, but in order to be as objective as possible, I am using these 7.5% waves as my intermediate demarcation points. In a strict sense, the series of declining bottoms for the Industrials is still intact. That’s because the February low was very fractionally under that of August 2015. However, for all intents and purposes they were at the same level, so common sense says that the price action formed a double bottom. In other words, this common sense interpretation says that the Industrial part of the theory is bullish.

That’s not yet true for the Transports, though. We can conclude that they are experiencing a series of rising bottoms since the July low formed above that for February.

Chart 8

However, the declining peaks are still intact and require a break above that July closing high around 8015, better still above the April, 8100 high, as such action would decisively penetrate the 2015-16 down trendline featured in Chart 9. At this point, KST action is mildly positive as the indicator is slightly above its MA. That suggests that a test of that green trendline may well take place in the immediate future. Let’s see what happens.

Chart 9

Does the correction matter?

In most situations during the course of a primary bull market, those looking for a sharp correction in order to buy are usually disappointed, because such counter-cyclical corrections are pretty rare affairs. That’s why, having been caught myself many times in this way, I prefer to focus on the bigger picture. Charts 10 and 11 complete the picture because they strongly suggest that, whatever may happen in the immediate future, prices are ultimately headed much higher.

First, Chart 10 shows that one of the most favorable setups for equities is for a corrective period to be associated with a decline in bond yields, as a trend of lower rates typically stimulates the economy. Since equities look forward to an expansion in business activity the anticipation of such an event triggers a rally. This triggering point appears to take place when the 12-month ROC drops to its oversold zone. You can see this by observing price action following the vertical lines. Seven such signals can be observed since 1995. All resulted in a major advance in the S&P Composite. I’ll take those odds any day!

Chart 10

Second, Chart 10 features my Financial Velocity Index, which is a composite momentum series calculated from stocks, bonds and commodity indexes. When it reverses from at or below the green dashed horizontal line, a major rally for inflation adjusted stocks materializes. That’s because it is signaling that enough liquidity has been pumped into the system to be consistent with rising equity prices. Since 1918 there have been 20 signals, only three of which can be said to have failed. These have been highlighted with the red vertical lines. The subsequent rallies have not been without their corrections, but the big picture certainly suggests greater success will befall those following the major trend than those looking for a correction that may or may not ever come.

Chart 11

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.