I'm entering the fifth week of being contaminated by some kind of illness. This time, it's a nasty cold that developed last Thursday, and gave me a fever every day this past weekend, into Monday morning. That was accompanied by an incredibly sore throat, cough, and inordinate amounts of post-nasal drop. Not exactly the most fun way to spend a weekend, but thankfully it looks like things are turning a corner.
A handful of technical indicators on the Dow Jones Industrial Average are flashing warning signs that the market might be slightly distressed.
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| StockCharts.com |
Attached above is a picture of the Dow Jones Industrials over the last six months, with the Average Directional Index (ADX) posted below. The +DI (Positive Directional Index) and -DI (Negative Directional Index) are superimposed on the ADX. In a nutshell, an ADX value over 20 generally indicates the presence of a trend in the market. Using the ADX alone, one can't determine the direction of the trend without looking at the values of the stock or index. The Directional Indexes help out by separating the ADX into positive and negative components. When the ADX exceeds 20 and the +DI is greater than the -DI, the trend of the security is generally positive/upward. Likewise, when the ADX exceeds 20 and the -DI value is greater than the +DI value, the trend of the security is generally negative/downward. This is by no means foolproof, but can be a guide to identifying trends and momentum, to some degree.
The ADX has been stuck in a pretty tight range since middle September, eyeballing it says it's hovering between roughly a 22-27 value window. Although the index has stagnated, it remains above 20, and therefore it is plausible that a trend still exists in the market. How can there be a trend if the Dow is stuck in a sideways pattern, you ask? Well, that's the gist of it. The trend is for the sideways pattern to continue, it would appear, as has been the case since last month. When taking into account the Directional indexes, we get a different story. Since mid/late August, the -DI line has consistently been above the +DI line, save for a brief come-together in late September. This was not a red flag back in August and early/mid September, because the ADX was below that key 20 threshold. However, it's been about a full month that the ADX has been above the 20 mark, and the -DI line has exceeded the +DI line. This has bearish implications for the Dow, and while there's nothing from this particular index screaming "correction" in the very near future, this indicator is raising the possibility that a correction cannot be ruled out down the road. A sideways trend with -DI exceeding +DI isn't something I'm fond of.
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| StockCharts.com |
We now turn to another indicator, using the same 6-month timeframe as the ADX analysis. This time, we're looking at the Moving Average Convergence/Divergence Oscillator, or the MACD. This is a momentum oscillator, and will work in tandem with our ADX analysis above. The MACD, while a wonderful indicator, is also a rather complicated indicator to learn, given the number of crossover signals and such that can be learned. For this analysis, we will be focusing solely on the positivity or negativity of the MACD line itself (black line). In a nutshell, when the MACD value is positive, the momentum for a gain in the security is increasing. Taking this point further, a strongly positive MACD value can predict a strong upward breakout, whereas a weakly positive MACD value may anticipate weak gains or even stagnation. Similarly, when the MACD value is negative, the momentum for a loss in the security is increasing. A strongly negative MACD value may anticipate a large drop in the security's value, whereas a weakly negative MACD value may predict small losses or stagnation.
Something right off the bat that worries me is that the MACD has been negative since early September. This implies that there is more momentum for the index to lose value than to gain value. However, as we saw with the ADX, we are stuck in a rather small window, and in order for the MACD or ADX to succeed in anticipating this downward momentum, we need something to break out of the small window. Perhaps a series of worse-than-expected earnings, as we're in the thick of earnings season, or some other shock to the system. Those kinds of things can't really be anticipated, but when a breakout does occur, the MACD agrees that a downward movement is more likely than an upward movement.
Of course, we can't discuss stress in the market and not bring up everyone's favorite fear gauge.
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| StockCharts.com |
The CBOE's Volatility Index, or VIX, is Wall Street's 'fear gauge', measuring volatility in the markets. When investors get jittery and uncertainty over the future increases, the VIX goes up. When markets are calm and the economy's looking good, the VIX goes down. As of the day this post was written (Tuesday), the VIX closed at 13.46, about where it's been since this past spring. That's something that I find a bit concerning.
As we described above, when volatility is low and investors are calm, the VIX is down. When you take into account that the 52-week range of the VIX currently stands at a high of 32.09 and a low of 11.02, you don't need a financial analyst to tell you that investors are pretty complacent with economic conditions right now. In some aspects, this is good; stock markets generally stay up during calm periods, enabling a prolonged, slow appreciation of capital if this calm period were to extend into the longer term. In other aspects, this is not good; investors are a little too complacent right now. The Federal Reserve is well on its way to boosting interest rates, either in its November or December meetings (likely the latter), and while experts are pricing this likelihood in, I don't believe the stock markets are doing the same. To some degree, this is warranted, as the FOMC has lost some credibility in the last few meetings after building up the case for a rate hike and then keeping rates steady. Despite this, I believe a correction will occur at some point if/when the markets realize that interest rates could very well rise in December. It shouldn't be a big correction, but at least a few days in the red ought to accurately price in a rate hike.
Another thing to discuss concerning the VIX is the Relative Strength Indicator, or RSI, placed above the VIX price chart. The RSI is an indicator of whether a security is overbought or underbought. Values above that dashed line at 70 indicate a security is overbought and a pullback in value can be expected soon. Similarly, values below the dashed line at 30 indicate the security is underbought, and a rise in value can be expected in the near future. The 'neutral' line is at 50, so anything between 50 and 70 generally is accurately priced but perhaps a bit too pricey, while anything between 30 and 50 is generally accurately priced but perhaps a bit too cheap for its real value. The VIX stands at about 46 at Tuesday's close, below the neutral line of 50 but not below the 'underbought' line of 30. In other words, volatility is about where it should be based on recent history, but might be just a bit too low. The RSI isn't perfect of course, but it's one of the more accurate technical indicators. Using the RSI, the VIX should be watched for a slight short-term boost.
Lastly, we apply the ADX we discussed earlier to the VIX. I'll save you the trouble of re-explaining the ADX and +/-DI, as it's all explained at the beginning of this post, so we'll just analyze the chart. The +DI line has exceeded the -DI line ever since the first few days of September, up until the last couple of days before this writing. Over the last few days, we've seen the -DI and +DI switching back and forth, seemingly fighting over which is more dominant. In a situation like this, I would call it neutral. But it doesn't really matter too much because the ADX itself (black line) is below that key 20 threshold, indicating there isn't really a trend present for the -DI and +DI lines to anticipate momentum. The momentum recently has been negative, and while that momentum and the trend are currently neutral, it could very well return and place continued upward pressure on the VIX.
Lastly, adding on to this theme of losing momentum and being stuck in a sideways pattern, let's check out just how low volatility has been, using numbers.
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| TradingViews |
Shown above is the Dow Jones Industrials over the last year, with two price change windows on the right side of the chart. The larger window is where I measured the range in index values from highest close/open to lowest close/open. Since mid-August, a period of about 2 months, the Dow has varied by 626 points, or 3.36%. That's not much of a move at all, when looking at other 2-month periods over the last year. Applying the same method to the last month and a half, we get the Dow varying by 320 points, or 1.74%. These two price changes, particularly the window over the last month and a half, show this pattern we've been stuck in. The Dow Jones has been moving sideways on this chart, hence the 'sideways pattern' references. While there is downward pressure on stocks as we described above, until we get out of this pattern there's really nothing that can be done. Thus, we're waiting for an event that triggers either an upward breakout, such as a slew of much better-than-expected earnings from big companies, or a downward breakout, such as a series of poor earnings and a decrease in economic conditions. Time will tell just when this breakout happens, but until then, it's a waiting game. Which direction will it go? What will be the trigger for the breakout? Those two questions are at the forefront of my mind for the medium term.
Andrew
