UPDATE: Dow traveling light into Fed news is a warning
Ken Odeluga December 16, 2015 10:29 PM
<p>Updated at 1818 GMT DJIA recovers from last week’s sell-off, but Dow Transport fails to follow Wide spread may be bearish signal DJIA/DJT hit widest divergence […]</p>
Updated at 1818 GMT
- DJIA recovers from last week’s sell-off, but Dow Transport fails to follow
- Wide spread may be bearish signal
- DJIA/DJT hit widest divergence of the year
- It could be nothing; what could possibly go wrong?
Was last Friday’s global stock market sell-off a false alarm?
That’s one possible conclusion to draw from how global equities have performed since.
By the middle of this week, the world’s major stock indices had all recovered losses and extended gains well beyond Friday’s near-rout, and a 26% spike in Chicago Board Options Exchange’s ‘fear gauge’, the VIX, had fizzled.
Elsewhere, ‘safe-haven’ US 10-year government bond yields resumed their ascent from October lows, inverse to demand.
To be sure, extreme market stress heading into the most important economic event of the year in the shape of the Federal Reserve’s probable interest rate rise on Wednesday was still evident.
But it was largely limited to the least ‘lit’, often illiquid corners of the global asset markets, namely ultra-high-risk ‘junk’ bonds.
That said US equity markets still had cautionary fingerprints.
One possible indication was continued widening in the spread between the Dow Jones Industrial Average and the Dow Jones Transport Average Index.
Whilst relatively narrow gauges, and therefore not great benchmarks, historically, the spread between the pair has often heralded important market shifts, if not trend changes proper.
We don’t need to go too far back to find instances in which the spread—an implied component of Dow Theory—warned of potential instability, either by marked narrowing or widening.
Theory to practice
For example, the spread on a monthly closing basis (which some Dow theorists insist is an essential refinement) gave advance warning of instability before the 2000-2002 and 2007-2009 bear markets.
On Tuesday the intraday peak set a new high for the year above 9970, having touched 10,000 during the session.
That trounced its previous widest extent for the year at 9710.93 points, in May.
After 2015’s prior apex, DJIA retreated a net 2640 points (about 15%) before the year’s bottom on 24th August.
DJIA/DOW TRANSPORT DAILY CHART AND SPREAD
Please click image to enlarge
The Transports in turn lost a net c. 850 points (about 10%) between the end of May and the bottom on the same date in August.
The spread itself fell to 8499 points by the end-of-September, reaching a 14-month low, before the market rallied for about a fortnight.
To date, DJIA has recouped all of its early-to-late summer sell-off.
But by Tuesday, the spread’s sharply accelerating trend—well beyond the previous expanse of the year—matched new 2015 lows for DJT.
In fact, the select gauge of North American transportation stocks closed just 1% away from notional ‘bear market’ territory on Monday: 20% down from a 25th November 2014 top of 9202.84.
Of course, Charles Dow, after whom so-called ‘Dow Theory’ was named, would probably have agreed it is just that: an often arguable theory.
The same goes for the DJIA/DJT spread.
Another caution is that the spread is ‘backward looking’, even tautological—neither cause nor effect can be assumed.
However, at the very least, market watchers may wish to add another layer of alertness when the spread hits an extreme such as the current one.
So what might DJIA/DJT spread be signalling now?
On the basis of parallels, we could simply look for corroboration of increased DJIA volatility, as per May-August.
The spread could either retreat from new annual highs or break even higher.
The latter move might be accompanied by an extension of DJIA’s current August trough-to-November peak rise of 21%.
Or instead, there could be a more severe correction than the late summer one.
Any resurgent helter-skelter price action is unlikely to be a reaction to tonight’s main interest rate decision itself.
The Federal Reserve’s all but inevitable raising by 25 basis points of its major rate is already baked-into asset prices.
No, it’s the trimmings.
These additional details seem to hold myriad possibilities to disappoint or exceed market expectations.
When a market is as out of whack as some signs suggest, the fallout might be proportionally crazier.
Wall Street poised at support
City Index traders of Wall Street Daily Funded Trade, which tracks the DJIA closely, had pared back bullish positions from Tuesday considerably by online time.
For comparison I have posted a four-hourly chart of the underlying index, underneath the Wall Street DFT one.
DJIA was still above a trend from August although testing the (light-blue) 100-period moving average.
Wall Street DFT’s 17525 short-term support had withstood a number of tests, even though trade had seeped below a rising line from Monday.
61.8% of Monday to Wednesday’s highs, where the index reversed, equates to 17485—the latter may offer additional support if required.
A relief rally tonight ought to match the previous high with potentially unleashed momentum, in view of Slow Stochastic lines which are currently crushed in oversold territory.
However, in view of contorted market conditions we outlined earlier, that might not be enough to prevent a wicked spike lower in the event of a disappointment.
This week’s 17140 low would be the first to be tested under a negative scenario in the near term, but possibly not the last.
WALL STREET DAILY FUNDED TRADE – HALF-HOURLY CHART
Please click image to enlarge
DJIA – FOUR-HOURLY CHART
Please click image to enlarge
GAIN Capital UK Limited (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.
No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.