After a very rough January, the U.S. stock market has rebounded sharply thus far in February. Is the foundation for a rebound solid?
A telling indicator for the strength of the January decline was a proprietary indicator suggesting a market decline on a short-term basis. This short-term correction implied a fall in the hundreds of points and a duration of 2-4 weeks. What actually transpired? The Dow fell approximately eleven hundred points in about 28 calendar days. This was well within my expectation.
The day after I wrote this article, the market made a low and started a fairly rapid ascent. On Valentine's Day, the Dow closed at 16,154, a close not yet eclipsed though intraday highs have ascended beyond that level. How convincing is this move? In the enclosed chart, I exaggerate the volume indicators to illustrate the strength, or lack thereof, in the February rise. This chart reflects market increases and volume decreases in the color red. The green color represents market decreases and volume increases. To understand this better, I direct your attention to December's action. While the market was making new highs, the volume fell dramatically. A retort to this will be that volume tends to fall in the holiday period and this is true. That said, I would not expect the light trading volume to move the market up as much as it did. In January, as the market fell, what did volume do? It increased! Conversely, during the market's February rise, trading volume decreased. For the market increases to be more convincing, I would expect volume to move along with it. The opposite is occurring suggesting something other than market strength.
My intermediate-term price level was not breached. I noted that this indicator had not demonstrated corrective action since the summer of 2011. This is important. When the price level dictated by the intermediate indicator held firm, it suggested that a rise was indeed forthcoming. The problem with the rise is its lack of conviction. The long-term indicator was not in danger of breach and this would occur after the intermediate-term indicator flashed.
Sentiment indicators still remain in extreme bullish territory. Dividend yields are at levels more indicative of a market top than bottom. There are deep bullish feelings among professional investment advisers. Even public companies are exhibiting signs of overly bullish behavior. I developed a special report for 2014 identifying business and investment trends. Here is an excerpt from the section on the stock market.
In fact publicly traded companies are betting on The Wizards. They have taken unprecedented
steps to buy back their own shares often times with borrowed money. Why would a
company borrow money in order to buy its own shares? Answer...for the benefit of their shareholders. Rather than investing in their future, they are paying off shareholders. Statistically,
it also appears as if these firms are holding large amounts of cash, but they also hold large
amounts of debt.
The stock market dodged a major bullet in February by narrowly missing my intermediate-term price level, which would have implied a much larger decline. That could have set the stage for breaching the longer-term price level that would have signaled the end of this rally from 2009. On a short-term basis, this February move looks very weak. For now, we will have to wait and evaluate market action to make the next call.
Jim Mosquera is the author of Escaping Oz: Protecting your wealth during the financial crisis and has recently published two special reports on 2014 trends available at The Sentinel web site.