Storm Clouds on the Horizon?
February 22, 2004
marketfn.com
I REALLY hate it when this happens. Just as I was feeling ever-so-clever last week for tying in Paul McCartney’s “Let it Be” with the Stock Market’s Big Picture, it occurred to me that Ms. Market may not be particularly pleased with such a pronouncement. And about the time I was clicking on the “send” button, the mighty Ms. Market must have sent out an alert to her minions to remind me of how the game is played. To review, the game goes like this: at the exact moment you are absolutely certain that you have things figured out – something changes, and you’d better be prepared.
As I was finishing the report last week, my “market angels” did their best to try and help me. Those little voices in the back of my head kept pestering me with thoughts like, “Very cute Dave, but there ARE “issues” in the market right now.” And then there was the subtle, “Are you sure you want to send a report with that type of title?” Next it was, “Remember, wise-guy, this is NOT 1982 revisited – you’ve said it yourself over and over again – we don’t have a Secular Bull on our hands.” Then the voices got a little louder, “You’re telling everyone to just ‘Let It Be’ when you REALLY ought to be keeping an eye out for topping signs.” And finally they got downright insistent, “Can you honestly call yourself a Risk Manager with that kind of advice? You might as well just chuck your career and join the mutual fund industry’s buy-and-hope parade!”
So while I enjoyed writing the report and I’m fairly sure that the Big Picture is still in good shape, we did make an extra effort this week with our models and indicators. We were really searching for the answer to the question: “are there any storm clouds on the horizon to be concerned about?”
Cumulonimbus Sighted
Sure enough, just as everyone (including me, apparently) had settled into a nice, comfortable (i.e. complacent) position, a subtle and somewhat disturbing shift in the leadership of the market appears to be taking place. Do you own any Microsoft? How about Cisco? Is there any Dell in your Portfolio? Does Intel show up in your list of positions? If you answered, "yes" to any of these questions (we own all 4 issues) then you know EXACTLY what I’m talking about.
These are the poster-boys for Tech and the NASDAQ. But if you pull up the charts of the “Four Horsemen,” you can quickly see that these “leaders” are, well... to put it nicely – lagging (the phrase “sucking air” was my first choice). To be more accurate, the action in these stocks is simply awful relative to the market. While the S&P and Dow are just a tad off of their recent highs, these stocks are in the midst of full-fledged corrections. Intel has dropped -14.7% from its recent high while Cisco has fallen -22.3%. Microsoft is off -8.3% and Dell has seen a decline of -12.2%. As a result, the NASDAQ, which has led this Bull Market Cycle, is now playing second fiddle and is -5.4% lower than the peak in January.
While “negative divergences” like this can resolve themselves over time, the Volume storm clouds on the NASDAQ are actually more disturbing. In general, Volume is a great indicator to watch because, while it is simplistic, upside volume represents demand and downside volume represents supply. (One thing that I’ve learned over the years is that indicators don’t have to be sophisticated to be effective.)
We like to watch several different indicators in the Volume category. One of the best shorter-term indicators is the relationship of volume on up days versus down days. In addition, the relationship of NASDAQ Volume to NYSE volume and Overall Total Volume both give you a nice indication of the underlying health of a market. Unfortunately for the staunch Tech Bulls, both volume relationships and our Overall Volume indicators have all turned negative recently. While these are not Bull Market killer types of indicators, it is important to note that historically, the NASDAQ’s performance has been either negative, or slightly negative when these conditions present themselves.
Winter Storm Warning?
A great indicator to pay attention to is called a “Volume Thrust”. To calculate this indicator, you look at the cumulative total of advancing volume versus declining volume over a 10-day period. Studies have shown that an excellent Buy Signal occurs when the 10-day ratio hits 1.87 and above (demonstrating almost twice as much volume on advancing stocks as decliners). It doesn’t happen often – just 26 times in the last 23 years on the NASDAQ - but on average, the index gains +2.4% in the ensuing 2 weeks, +5% a month after the signal, +8.3% three months later, and the NASDAQ is up +12.3% six months after a Volume Thrust Buy Signal.
Not surprisingly, the signal also works in reverse. While the “Sell Signals” aren’t as profitable as the “Buys,” the results are worth paying attention to. For example, when the 10-day ratio is just 0.65, a “Volume Thrust Sell Signal” is given. Ten days later, the NASDAQ experienced a decline of -2.5% on average. History shows a stalled-out market a month after the Sell signal, with the NASDAQ still down -2.4%. And after 3 months, the decline total is -5%.
Unfortunately, a Volume Thrust Sell Signal occurred in the past week. This doesn’t mean it’s the end of the world - unless your portfolio is heavily overweighted in Technology. If this is the case, it might be a good idea to move toward a more “normal” weighting in Technology. This would also be a good time to begin diversifying into some areas such as health care, financials, and energy (areas that have also proven to perform well in election years).
Please understand that we are not saying this the time to “dump Tech” or all of your NASDAQ positions. It is a known fact that the market’s “Leaders” historically correct harder than the overall market and, in turn, tend to rebound strongly as well. Thus, it will be very important to see the how the NASDAQ, and specifically big-cap Tech, rebounds during the next rally attempt. Our major point is that this represents a change in the landscape and is something that needs to be watched very closely.
Best wishes for a safe and successful week.
David D. Moenning |
