With stocks near a record high, is a change of fortune just around the corner?
The U.S. stock market has exhibited a less bullish tone since hitting an all-time high March 1. Could a change in a major trend be imminent?
Most stock market timers I track certainly think so. Consider the average recommended equity exposure among a subset of timers who focus on the Nasdaq stock market. It has dropped more than 55 percentage points in the past week alone, and is a total of 71 percentage points below its early-March high.
If all we knew was the magnitude of those declines, we’d guess that there must have been a huge amount of stock market carnage. In fact, there has been only a minor pullback. The Nasdaq Composite Index (COMP) is only a little more than 1% below its all-time closing high, for example, and the S&P 500 (SPX) is down only slightly more than 2% from its high.
For guidance when other market timers are running around with their heads cut off, I find it helpful to turn to the oldest stock market timing system that remains in widespread use: the Dow Theory, which was created a century ago by William Peter Hamilton, who at the time was editor of the Wall Street Journal.
For the moment, it says that all you Nervous Nellies can relax: All three of the Dow Theorists who I monitor on a regular basis believe the major trend remains up.
What would it take for a Dow Theory “sell” signal to be generated? Though each of these market timers may quibble on how to put the Dow Theory into practice in each situation, there is broad agreement on what it would take:
At least some Dow Theorists believe that step No. 1 has been satisfied by the declines registered since March 1. To be sure, the Dow Industrials have suffered only a minor pullback: At its lowest closing low since the beginning of March, it was just 2.7% below its all-time high. But the Dow Transports have been weaker: At its lowest closing low since March 1, it was 6.9% below its early March high. (See chart.)
Richard Moroney, editor of Dow Theory Forecasts, summarizes what this means for the current stock market: “A rebound above the March 1 closing all-time highs … would reconfirm the bullish primary trend under the Dow Theory. If one or both averages fail to rebound to fresh highs … the stage would be set for a bear-market signal.”
This means that while we should remain ever alert to potential trouble on the horizon, we shouldn’t jump the gun.
Since the Dow Transports are the furthest below their March 1 high, our primary focus in coming weeks should probably be on them: Specifically, they need to better their all-time closing high of 9,593.95 in order for the Dow Theory to remain bullish.
A worrisome omen in this regard is the latest reading of the Freight Transportation Services Index, which was created by the Bureau of Transportation Statistics in the U.S. Department of Transportation to measure the movement of freight in the U.S. The bureau’s researchers found that this index over the past three decades “led slowdowns in the economy by an average of four to five months.”
This index reached a high last July, and is currently 1.6% below it.
But potential trouble is always on the horizon, and most of the time that trouble is resolved before it turns the major trend negative. One of the geniuses of the Dow Theory is that it counsels against overreacting to every cloud on that horizon.
That’s why, as Jack Schannep, editor of TheDowTheory.com, reminds us, the “current trend is assumed to continue intact until it is proven otherwise.”
And for the moment, that means the judgment of the Dow Theory is that the bull market remains intact.
Courtesy of MarketWatch