Monday's Falling Dominos May Be Enough to Tip the Short-term Trend to the Downside

Many internal short-term indicators are overextended and starting to look vulnerable, but need some kind of a push to tip the near-term technical balance to the bearish side. That push may have been delivered with Monday's action, as several indexes gave the appearance of some selected short-term buyer exhaustion.

Signs of Short-Term Exhaustion

Take the MSCI World Stock ETF (ACWI), for example. It touched a marginal new all-time high on Friday, but Monday's action unveiled a bearish engulfing pattern, as shown in Chart 1.

Chart 2 shows that the 9-day RSI failed for a second time to confirm a new high in the ACWI. In addition, the daily KST has already gone negative. Tuesday's penetration of the November/May up trendline is confirming this weakening momentum.

When it comes to the US, the NYSE Composite experienced a shooting star on Monday. These one-day patterns are only expected to adversely affect prices for 5-10 days.

However, the NYSE is precariously balanced on its bull market trendline, as you can see from Chart 4, so the bearish action suggested by the shooting star could easily morph into a decisive trendline violation, the effects of which would likely spill over into other indicators.

Short-Term Indicators on the Verge of Going Negative

The Dow has been one of the strongest sectors of the market recently. One fairly consistent series that has identified short-term setbacks has been my Dow Diffusion Indicator, as plotted in Chart 5. In that respect, the red arrows appearing in the chart flag downside reversals from above the overstretched red dashed horizontal line. The vast majority of situations were followed by a downward or sideways correction. Another sell signal was unleashed at the end of April, but nothing negative happened and the indicator has since started to rise again.

This sort of secondary rally has happened on three occasions since 2015. The dashed blue arrows tell us that each was followed by a correction of some kind. Until it reverses direction, this series is not warning of trouble. However, the weak action suggested by Monday's World Index (ACWI) and NYSE Composite ($NYA) suggest that it may have trouble in maintaining its upward trajectory. Please note that the indicator was not updated for Tuesday's sell-off as we went to press.

Too much optimism often foreshadows a decline. The thinner arrows in Chart 6 show when a correction in the S&P Composite was accompanied by a reversal in the 4-week MA of AAII bulls. The problem is that some are triggered when the indicator peaks from the dashed overstretched line. On the other hand, the 2018 and 2019 declines developed from a much lower level of optimism. Still others, as flagged by the dashed arrows, were not followed by any negative response whatsoever. One thing we can say is that reversals from at or above the thick solid red line at 52% have been  consistently followed by a market correction. These examples have been flagged by the smaller thick arrows placed just above the Index. A fifth such signal since 2006 has just been triggered.

The daily KST of the VIX is another indicator on the verge of going negative. It is featured in Chart 7, where the shaded areas approximate those periods when it is above zero for an extended period. Those instances reflected a trend of greater volatility and fear. There was only one period, at the end of 2017, when a positive reading above zero failed to trigger a correction. At Tuesday's close, the indicator looked to be on the threshold of crossing above its equilibrium point for another negative signal.

Conclusion

Monday's exhaustion action, experienced by a few major indexes, suggests that some corrective action will extend over the course of the next 5-10 sessions. That in and of itself will probably cause several reliable short-term indicators to turn bearish, thereby hinting at the first meaningful correction since last fall. There is nothing at this point, though, to suggest that any weakness will threaten the underlying bullish trend, as the vast majority of the primary trend indicators I follow remain in the bullish camp.

Good luck and good charting,

Martin J. Pring