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This Tried and True Indicator Should Have you Worried Right Now

Aug 31, 2012
Chad Karnes, CMT

Over the last three months, the market has grinded higher. But, the S&P is now back below 1400 and given up almost an entire month of gains. There is indeed reason to be cautious.

The powerful rally since 6/4 has succeeded in “climbing the wall of worry”.  Now what? 

In August, news headlines like the ones below captured the general feeling around the market’s advance:

-S&P 500 Caps Longest Rally Since 2010 On Stimulus Bets – Bloomberg, 8/10 (S&P at 1402)

-Can the stock market rally last through the 2012 election? – Futures, 8/13 (S&P at 1403)

-Rally takes S&P to highest in four years – Financial Times, 8/21 (S&P at 1412)

Overall, the headlines were positive and showed optimism and an expectation of a continued advance.  But beneath the veneer, the S&P is now below 1400 and investors holding longs should be concerned.

One Tried and True Approach

In the September ETF Profit Strategy Newsletter published 8/17 we took a look at Dow Theory and showed the numerous times over the past 5 years where Dow Theory Non-Confirmations showed us that the market was in a danger zone of topping.  Every single time this signal occurred the broader market soon fell. 

With the Transportation Index trading at $5,142, the below chart displayed our feelings that before anyone should get excited about the recent Dow Jones Industrial Average rally (with price at $13,165), they should wait for the Transports to join in the rally.  We warned, “This current lagging of the Transports and non-confirmation is one of the reasons we remain skeptical of the rally since 6/4”.  Today the Transportation Index is below $5,000 and the Industrials (DJI:^DJI) are also down to $13,000.


What are the Transports Showing Us Now?

The transports have been down or flat 8 out of the last 8 trading days.  Incredible, I know!  Don’t believe me?  Check out the chart below of both the Transportation Average (DJI:^DJT) and its tradable counterpart, the iShares Dow Jones Transportation Average (NYSEARCA:IYT).

 

But you won’t hear any of the media talking about how bad of a sign this is for the overall markets.  Dow Theory continues to give us a major warning sign and investors should take note. 

On 8/13 I wrote an article warning of such a scenario as the Transports started showing weakness and lagging the Industrials in late-July.  One of the key takeaways I suggested was, “In a strong market, these two indices should be confirming one another, which is not occurring and a big warning sign”.

Fundamentals are Confirming

The fundamentals are also not confirming a recovery in the economy as revenues still are below 2007 levels.  Revenues would be even lower if adjusting out price increases (a majority of revenue gains have come at the expense of the consumer through price gains and not because of volume increases). 

We warned in the ETF Profit Strategy Newsletter, “This is backed up fundamentally by the recently released business sales and inventory data which show a sharp uptick in the inventories/sales ratio confirming the greater inventory being kept on the industrials’ books and/or lack of comparable sales.  The latest 1.29 inventories/sales ratio has not been seen since 2009”.

Until the Transportation Index and Industrials confirm each other, this market will likely have a hard time rallying.  If the Transportation Index continues to lag, then look out below for the Industrials (NYSEARCA:DIA).  An ETF available to short the Dow is the ProShares Short Dow 30 (NYSEARCA:DOG) or for more aggressive traders, the levered  UltraPro Short (NYSEARCA:SDOW).

The ETF Profit Strategy Newsletter and Technical Forecast provide out of the box analysis of the stock market along with actionable ETF profit strategies to keep our subscribers on the right side of the market.  Updates are provided a few times each week.  

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