Has the Stock Market Topped?Oct 24, 2012
Chad Karnes, CMT
Stocks are down around 4% from their September highs. There are some reasons to be very cautious, but also some reasons to keep your cool as a few other things need to occur before bears should get too excited.
Two times this past week the Dow has declined tripled digits. Is this the top the bears have been waiting for?
Friday 10/19’s selloff was the largest decline since mid-June, when the market was in the midst of a trend change and building a rally base.
Tuesday 10/22’s selloff was even larger, with the Dow Industrials (NYSEARCA:DIA) down over 200 points. Chemical and material (NYSEARCA:XLB) companies, such as Dupont (NYSE:DD) and 3M (NYSE:MMM), were the latest culprits in a quarter filled with lowered guidance and missed earnings.
Are these two large declines a sign that a trend change is occurring? Have stocks topped?
Speaking of Fundamentals
On 10/9 with the S&P 500 (NYSEARCA:SPY) near its yearly highs I wrote an article on the cyclicality of earnings and margins and why investors should be cautious of the market’s lofty levels.
The chart below accompanied that report and helps explain why investors should be cautious with such lofty earnings expectations.
To summarize: earnings are cyclical, do not go up forever, and invite competition when margins get too high.
Besides the more recent earnings misses, the Transports rang that warning bell even earlier, when FedEx (NYSE:FDX) and other Transports warned about 2012 and 2013 expectations.
Dow Theory, a popular technical analysis tool, has warned us for over a year that the Transports (NYSEARCA:IYT) were not as healthy as most assumed.
On 8/31 we published an article on the hints Dow Theory was providing us. Those warnings are playing out now as the Transports woes reverberate into other sectors. Also see our Dow Theory YouTube video here.
Speaking of Technicals
In our recently publishedProfit Strategy Newsletter, on 9/21 and again on 10/19, we identified the importance of 1430 and why if it fails the top is likely in. “We will be waiting for prices to drop back below the Fed low of 1430 to give us a signal that the top is likely in”. In the 10/19 ETF Profit Strategy Newsletter we alerted readers, “We are waiting for prices to maintain below the Fed Support Zone @ 1430 to give us a signal an intermediate top is likely in”.
On Tuesday, 10/23, prices breached that level as well as 1420 leaving only one intermediate term support level remaining for bulls.
What we are Watching Now
Seasonally the markets are entering their strongest period of the year. November and December typically spark the "Santa Clause Rally" . Similarly, the uncertainty around the presidential election also may trigger a rally into year end as statistically the final seven months of a Presidential election year have only finished negatively in 2 out of the last 15 elections. The bulls certainly have seasonality and statistics on their side.
The rally since the June lows has been led by the Energy (NYSERCA:XLE), Financial (NYSEARCA:XLF), and Technology (NYSEARCA:XLK) sectors. On 8/17 and on 9/26 I showed how these markets have been the leaders since the June lows and until they start to become laggards - the market likely would not top. They have led the market up ever since.
However, technology has already broken down and is leading the market lower. We are now watching the financial and energy sectors closely for their confirmed breakdowns and added weight that a market top is likely occurring.
The latest ETF Profit Strategy Newsletter includes a detailed analysis of various market forecasting tools, along with a short, mid, and long-term outlook for the US stock market and a target range for the ultimate bottom. Although the market is only down 4% from its September highs and the bulls have seasonality and statistics on their side, there are warning signs that could turn this decline into something much nastier.
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