When a big decline occurs on a single day it’s a good time to step back and look at how much damage was done to the intermediate and long term time frames. Yesterday’s market action was pretty horrific for a single day. It was enough to cause all of my core indicator categories to go negative. As you know, I wait until Friday before making any portfolio allocation changes, but the damage done yesterday will be hard to overcome. That means it is likely that the intermediate term trend is down (or that we could see another month or so of decline). The long term trend, however, is still in question. Here are a few charts that show both good an bad signs for the longer term trend.
First is a chart of the Dow Jones Industrial and Transportation averages (DJIA and DJTA). While the transports have clearly broken down and signaled a Dow Theory non-confirmation, the industrials are still well within the bounds of a “normal” consolidation of the rally out of the August low. DJIA has only retraced 35% of the rally. The current decline could carry as low as 16500 and last into early February and still be considered long term bull market action. The fact that the transports have broken down is what puts doubt into the picture.
The S&P 500 index (SPX) is painting a pattern similar to DJIA. Yesterday’s carnage didn’t change that picture. It is still painting a bullish flag that generally resolves to the upside. This pattern is a way of shaking out weak stock holders, which removes overhead resistance and allows the market to break higher.
What puts the bull flag pattern in doubt is that although it looks OK as an intermediate term pattern, longer term market momentum is starting to fail. Monthly MACD looks like this decline is the start of something larger. I like to see confirmation from momentum before getting too bearish. That hasn’t happened yet, but it’s getting more precarious by the day.
Finally, another sign that the market needs to rally soon comes from the number of bullish stocks on the Twitter stream. Yesterday’s market action had a big psychological effect on traders and investors who tweet. The pattern being painted is starting to look like what happened from late June to early July where the bullish count fell sharply after a mild decline. What we want to see is any new rally accompanied by a large increase in bullish stocks. A weak response from bullish stocks and an increase in the bearish count would be very dangerous for the market. You can see the daily chart updates here.
The market needs a swift and sure rally or the intermediate term trend is likely down. The long term trend still shows signs of health, but is weakening every day. Bull markets die hard…and this one still has some signs of life so keep an open mind about the possibility of higher prices. As always, I just try to align my portfolio with the health of the various indicators I follow.