In my last article (July 20th) I mentioned that while the Dow recently made all-time, intraday highs, closing prices remained below the highs of May. I did not attach a high degree of significance to this condition but noted that if the market experienced a problem moving through those May highs, it warranted more attention. I will now comment on a series of slides discussing this further.
Slide 1 – The red line in this chart of the Dow Jones Industrial Average (DJIA) is drawn from the May highs across recent price action. To date only one day has actually closed above (and barely at that) that line. Other days’ closes are close to this line but have not penetrated it. This shows hesitation.
Slide 2 – A fairly simple tool in market forecasting is to use Fibonacci lines (drawn in slide) to represent possible retracement levels. In this chart of the Dow Jones Utilities (DJU), the common 61.8% retracement line shows how the DJU approached this level but has not exceeded it. This line represents 61.8% of the distance between the low and high on this chart. This line could signify a near-term market high.
Slide 3 – This slide shows the DJIA over the last 10 years. I will admit that I did not forecast the highs of 2007 to be exceeded. The fact the highs were exceeded makes for a very dangerous market.
Slide 4 – By contrast, the DJU chart of the last 10 years shows prices that have not exceeded the 2007 highs.
Slide 5 – This chart overlays the DJIA (red/right scale) and the DJU (blue/left scale) for the last 10 years. While the markets have not followed each other in perfect harmony, in general they tend to move in the same direction. Dow Theory proponents, however, see a bear lurking when a high in the DJIA, for example, is not confirmed by the DJU.
Slide 6 – This chart prices the DJIA in another currency, in this case the Euro. Unlike the DJIA priced in U.S. Dollars, this chart reveals a different pattern – the prices from 2007 have not been exceeded.
Another interesting view of the market is the DJIA priced in terms of gold. Unfortunately my charting software does not have this capability. If it did, you would see the DJIA making a high in the year 2000, yes 13 years ago, and the chart showing a persistent decline. Using a gold chart to price the DJIA eliminates some of the effects of credit inflation the likes of which have never been seen since the year 2000.
The stock market appears to be at an important juncture. The Fibonacci 61.8% line is not sacrosanct. Neither is the fact that the DJIA has not been able to close above the May highs. These are merely indicators of a patient in some distress. Whether that distress results in a full-blown infection remains to be seen. Measures of market optimism remain quite high which is usually a harbinger of a decline ahead. Market trading volume has actually been decreasing during the advance from 2009 – another bearish sign. As I also mentioned in the last column, there seems to be much less fuel (credit) in trading accounts to feed the stock market bull.
Jim is the author of Escaping Oz: Protecting your wealth during the financial crisis.