Recent Commentary and Analysis
Dow Theory applies the principle of confirmation to confirm primary trends. Charles Dow used the Dow Industrials and Dow Transports to confirm the primary trend for the broader market. The primary trend is up, and confirmed, when the Industrials and Transports both
The stock market is extended and strong. While the extended nature of the advance argues for a correction at some point, current strength could extend because stocks can become overbought and remain overbought.
The principle of confirmation stems from classic Dow Theory, which used the Dow Industrials and Dow Transports to confirm price movements. The bull market was in good shape as long as both recorded higher highs by exceeding their prior peaks.
There are lot of new highs already this week and lots of flag breakouts. However, these new highs and fresh breakouts are still overshadowed by an overextended stock market (SPY). Yes, the odds of a corrective period remain high. The flag breakouts and gaps from early February
Amazon is by far the biggest component in the Consumer Discretionary SPDR and its recent breakout bodes well for the ETF. The new highs in XLY and AMZN this month, however, did not carry over to the Equal-weight Consumer Discretionary ETF (RCD).
There are three ETFs covering the defense and aerospace group and all three recorded new highs. Even though these ETFs cover the same industry group and have similar price charts, they are quite different when we look under the hood and one is seriously underperforming the other two.
Stocks are still looking overextended and ripe for a rest. SPY formed three outsized weekly candles, the tallest since the advance began, over the last five weeks. In addition, the weekly gain/loss was well above average for three of the last five weeks.
The Aerospace & Defense ETF broke out to new highs with leadership coming from Lockheed Martin (LMT), United Technologies (UTX) and L3 Harris (LHX). This shows broad strength in the industry group so I looked through the components of the Aerospace & Defense ETF (XAR).
The S&P 500 SPDR and Nasdaq 100 ETF led the market by surging to new highs. After a bashing at the end of January, these two came roaring out of the gates and answered with big moves in the first week of February. As the chart below shows, SPY held its early January low during the dip and showed relative strength in late January (less weakness).
My, that was quick. A few days ago, Friday January 31st, to be exact, the S&P 500 SPDR and Russell 2000 ETF were down year-to-date. The S&P 500 had just suffered its worst weekly decline since late July (-2.14%) and the small-cap Russell fell 2.94%. In addition, seven of the twelve sector SPDRs were down year-to-date on January 31st
Selling pressure was extremely broad in Friday with all sectors declining and more than ninety percent of stocks in the S&P 500, S&P MidCap 400 and S&P SmallCap 600 declining. While this kind of broad selling pressure creates a short-term oversold condition, it also reflects a change in market dynamics and points to a corrective period ahead.
The stock market took a hit this week as money rotated into safe-have assets, such as bonds. Gold also moved higher and hit a 52-week high on Friday. It looks like a correction has started in the stock market as SPY confirmed its weekly harami and the short-term indicators trigger bearish.
The bears fired their first shot across the bow this week with sharp declines on Friday and Monday. The bulls were not in the mood to allow even a modest pullback and quickly stepped back into the market. Short-term, an oversold bounce after a 2.5% decline (Friday-Monday) is pretty normal stuff and does not change my overall thesis.
The defensive names further improved this week, while the number of ETFs showing real weakness expanded. ETFs related to bonds, precious metals (sans silver), utilities and REITs remain strong. We saw the 20+ Yr Treasury Bond ETF, Aggregate Bond ETF and Gold SPDR extend further on their falling wedge breakouts. The Utilities SPDR is the leading sector here in January with a 6.24% gain.
Signs of a correction were building for some time and it now appears that the long awaited corrective period is here. The S&P 500, in particular, is following the script from January 2018 quite closely.
The pickings are slim today for two reasons. First, we are in the middle of earnings season and I typically avoid stocks that are reporting earnings soon. Thus, today’s setups do not report until the latter part of February or later.