Strength on the Verge of Weakness

Since the day after Election Day 2016 the Dow Industrial Average has not touched its 200-day Moving Average.  Technically, the Dow has been above this important average since late-June 2016 (the present bull market began in 2009 under President Obama) - that's roughly 19 months, over 570 days ago.  I have not been able to discover what the Dow’s current record is for days above the 200-day MA, but we must be close to it.  (The record of the S&P 500 is over 600 days and dates from the mid-1950's.) I have watched the stock markets for over 30 years now and I have never seen anything like this.  The previous longest streaks for the Dow are in the area of 300-350 days.  The strength of this Bull Market is highly unusual. 

Here is what the last six months of the Dow Industrial Average looks like in a technical chart.  The Dow has moved from under 22,000 to over 26,000 during this time frame.  Incredible resilience! The red candlesticks represent down days. The white represent up days.  The longer the candlestick the more volatile the trading for that day.  As you can see, the Dow has experienced a steady rise over this period of time and has only become volatile recently.  The blue line represents the 50-day Moving Average.  The red is the 200-day MA.  Notice how the distance between the red line and the Dow was widening in early 2018.  This is setting up a possible "snapback" scenario as the market wandered farther and farther from the mean average. 

The graph above the chart is the Relative Strength Index (RSI).  The shaded area of the RSI shows strong upward strength (overbought conditions),  You can see the strength has tapered off  in the past week or so.  Below the chart are graphs for the MACD which have been elevated over the past six months as well and are now trending negative.  Below that is a graph for the slow stochastics which is useful for short-term market measurements.  As rule, anything above "80" reflects a hot upward trend.  Anything below "20" is a strong downward trend.  Technically, neither the RSI nor the MACD nor the slow stochastics are in what could be termed "oversold" territory, suggesting the downward trend might continue.

To review the past several years since the Great Recession, it is useful to keep in mind this summary: "On October 9, 2007, the Dow closed at its pre-recession all-time high of 14,164.43. But fourth-quarter gross domestic product growth contracted 1 percent, announcing the start of the recession. (It was later re-estimated at a positive 2.9 percent.) The Dow started declining gradually. After the failure of Bear Stearns in April 2008 and a negative GDP report in Q2 2008, the Dow dropped to 11,000. Many analysts felt that this 20 percent decline was the market bottom.

"But it wasn’t the bottom. On Monday, September 15, 2008, Lehman Brothers declared bankruptcy. On Wednesday, panicky bankers withdrew $144 billion from money market funds, almost causing a collapse.

"On September 29, 2008, the Dow fell 770 points. That was its most significant single-day point drop ever. Investors were stunned that the U.S. House of Representatives rejected a $700 billion bailout bill to save failing banks. The Senate reintroduced the bailout as TARP on October 3. Nevertheless, the Dow plummeted 13 percent in October. By November 20, 2008, it fell to 7,552.29, a new low.

"That was still not the real market bottom. The Dow climbed to 9,034.69 on January 2, 2009, before screeching down to 6,594.44 on March 5, 2009.

On July 24, 2009, the Dow finally reversed course. It beat its January high, rising to 9,093.24 by close of day."

The Dow at the close on Friday was at 24, 190.90.  More than 300% up from its 2008 low.  An astonishing bull market.  The Dow essentially doubled under President Obama.  Under Trump it has enjoyed roughly a robust 31% gain in much shorter span of time.  Now, entering its 8th year, it is prudent to ask is it overheated?  The Dow closed at 26,616 on January 26, 2018.  In terms of Dow Theory, that number now becomes the resistance that must be matched or exceeded in order to confirm the bull market's continuation.  Unlike in 2008, we don't seem to have any major issues among financial institutions themselves at this point in time.  The "real world" of economics seems solid.  So, maybe the bull will continue to romp upward once this (actually healthy) correction is complete.

Donald Trump has repeatedly referred to the market's bullishness as a KPI for his economic policy.  Well, "policy" might be overstating it.  Trump really has no policy of any kind.  He wants to kick immigrants out.  He wants to build a wall.  He hates Europe, loves Russia, Israel, and Saudi Arabia.  That's about it for the Trump idealism so far.  To be fair, however, the Bull Market he inherited loved him.  It loved him so much it rose in classic "irrational exuberance." But he was more of a cheerleader than a policy maker.  The recent massive tax cut, for example, was hammered out by the republicans in congress.  All Trump did was sign the final bill.

Which is ironic in a way.  Trump's party may have killed the very thing it was trying to drive onward and upward.  The economy was clicking right along when the republicans decided to "step on the gas" with the tax cut.  Trump wanted the economy to grow faster and much larger and tax cuts can (theoretically) add fuel to the fire.  Trouble is, the tax cut is an inflationary move.  Now the markets are skid-ish on inflation and downright terrified of the inevitable interest rate hikes associated with inflation.  Plus the tax cut will also add to the massive national debt of the country.  It all seems pretty pointless since things were zipping along just fine before the tax cut.

Now the stock markets have turned sour.  Trump is trying to distance himself from all those earlier statements in connection with the markets.  Suddenly they are no longer a KPI for his "policy," instead he is now all about "the fundamentals." Whatever.

The interesting thing for me currently is watching as the markets "snapback" again toward the 200-day MA.  It has been a very long time since the Dow touched the 200-day MA; too long actually.  This Bull Market was gathering too much steam.  It was becoming unnaturally parabolic like cryptocurrency.  Which is why the past week has been so violent.  Strong declines and surges intermingle like a great battle is being fought by the forces of economic equilibrium.  As Richard Russell used to proclaim (paraphrasing) "the further the market moves up or down away from the 200-day MA, the more violent the pullback to the mean."

This is how all the same technical indicators look in a two-year time frame.  The red circle denotes Election Day 2016.  You can clearly see how the Dow's momentum accelerated after that point in time.  You can also see the more variation in the various indicators, the RSI going wild after remaining range-bound in the months before the election, the MACD remaining high even before the election, and the slow stochastics recording short-term upward or downward strength.

So, now we are witnessing a snapback.  It will be interesting to see if it actually (finally) takes the Dow down to the 200-day MA or if it has already discounted higher interest rates, inflation, and the increased debt trajectory - all three at least partially related to the republican tax cut.  January 2018 was the Dow's best month since March 2016.  It was up on Friday in highly volatile trading.  Is the correction over? Let's watch and see what happens next.

The same chart and indicators going back to mid-March 2013.  Notice how the RSI remained pretty much in the middle of its scale, driving a healthy bull market upward throughout 2013-2014 under President Obama.  Volatility struck the Dow in the fall of 2015 and the early part of 2016 with two dips below the 200-day MA. Also notice how the Dow regularly touched the 200-day MA throughout this period.  This is typical market activity.  Nothing too extreme.  You can clearly see how out of whack things got looking at the MACD in the most recent weeks.  WAY above the norms.  The slow stochastics isn't that valuable at this scale, but it does provide a look at the "seismic" nature of that indicator.