Weekly charts have a tendency to calm and then focus the mind. Simply put - they filter out the daily market noise that more often than not, results in clutter, confusion and uncertainty. By referring to them on a regular basis, the investor can determine the longer term trends and can keep abreast of any SIGNIFICANT change that might necessitate a change of strategy on his or her part.
As a professional trader, I employ charts from 10 minute all the way to monthly and in some cases, yearly. I have found however, that over the years, the interval that I refer to more often than not when seeking to determine a major trend is the weekly. Following will be a series of weekly charts complied from various sectors. After reviewing them and the comments I have included, I believe that the reader will see why they are invaluable.
A note should be made here that all of the charts that I am going to include of the various sectors will have as their starting point, July 2000. In addition, I am employing only one technical indicator for the sake of simplicity. That indicator is referred to as "TSI", or the True Strength Indicator. I am also deliberating avoiding such common measurements as Fibonacci Retracements not because they are ineffective, but merely for the sake of keeping the charts as clean and unmarked as possible. The idea here is to allow the chart to "speak" to you and paint a picture in your mind as to the general trend or the development of trend simply by referring to one indicator. I will be referring to that indicator when I mention divergences or direction of movement and comparing that to the weekly chart.
A further clarification is also in order here: A buy signal is given when the TSI crosses from underneath the zero line and moves above it. A sell signal is given when the TSI crosses from above the zero line and moves below it.
The first chart we are going to review is the Dow Jones Industrial Average. You will notice that from March 2003 into February 2004, the Dow has had a nice ride up from the low near 7400 reaching a peak near 10,750, a gain of some 45%. Not bad at all! During this entire span, the TSI remained above zero indicating that the market was exhibiting fairly robust internal strength accompanying the up move. The first warning that something was wrong came in May of this year (2004) when the TSI broke below the zero line for the first time in well over a year. A temporary rally occurred shortly after this during the month of June bringing the TSI back above the zero line. That rally quickly failed however as the DOW put in a reaction high near 10,487 and then proceeded to fall below 10,000 for the second time in two months. As it did, the TSI broke down below the zero line once again this time surpassing its previous low. It has now developed a clear and defined down-sloping line which can be seen by referring to the indicator graph.
Notice also the precarious position of the Dow perched just above short term support at the last reaction lows of 9862 and 9763. Failure to hold these levels will confirm the weakness illustrated by the TSI and result in the Dow validating a clear topping pattern. All in all, the weekly chart on the Dow is not encouraging to would be bulls. The burden of proof now rests squarely on their shoulders.
Now let us turn our attention to some different sectors and see what kind of read we can obtain on the overall economy as reflected by the market. Remember, what we are attempting to do is to study the market and come up with our own INDEPENDENT analysis apart from the Wall Street raa-raa gang at CNBC and the rest of the shills for the brokerage industry. Investors should keep in mind that these have a conflict of interest and simply cannot be trusted to deliver unbiased advice.
The first sector I have chosen to examine is the Transports. The reason for this relates to Dow Theory. Simply put, any move up or any move down in the Dow Industrials must be confirmed by a corresponding move in the Transports according to this reliable and time-tested theory. What we find when looking at the Transports is a bit strange in all honesty. You will notice that the Transport chart is actually fairly bullish unlike the chart of the Dow Industrials which we just observed. Notice that a solid uptrend is still in place and that during the same time frame in July 2004 that the Dow itself was breaking below 10,000, the Transports were going on to make new highs! In short, the break down in the Dow Industrials has not been confirmed by the Transports if we adhere to Dow Theory. Yet, something is beginning to develop on the Transport chart which is quite ominous and bears watching - a classic case of divergence is occurring.
Notice that as the Transport sector made new highs in July, the TSI did not confirm those new highs. As a matter of fact, it demonstrated that the internal strength of the Transport rally was waning and that internally, this sector of the market is getting weak. Notice also that the Transports are sitting just above the blue uptrend line. A breach of this line will send the Transports down to a test of support near 2785 and then 2744. Should that occur as the Dow breaks its support line, we will have a Dow Theory confirmation of a top. That will be ignored at the investor's own peril. Additionally, the weakness in the TSI is indicating that the Transports are more likely to head down than they are to head up at this point.
Now let's take a look at the next sector - the Real Estate sector. In all honesty, this one looks like it could go either way at this point. Personally, I believe that this chart is revealing exactly what one would expect it to reveal. The reason is that there exists two very different and yet strongly held points of view as to where interest rates are headed in this nation and it is interest rates that hold the key to the ultimate direction that prices in this sector will trend.
One school of thought is the stagflation school which asserts that the Fed will be forced by the market to hike rate drastically to counter the inflationary forces unleashed by its reckless monetary policy of the last few years. This would obviously devastate the real estate sector as rising mortgage rates would sound the death knell of this industry as the easy money party comes to an end.
The other school of thought is that the huge amounts of indebtedness at all levels in the nation will produce a deflationary spiral in which the Fed will actually be forced to cut interest rates even further in an attempt to prevent the money supply from contracting and sending the economy into a deep depression. Some who hold this view actually believe that we could see the Fed actually reversing itself and taking back its recent rate hikes and dropping interest rates. This would engender a temporary resurgence in refinancing activity once again and would spur one more building boom in the real estate sector as would be home buyers rush to take advantage of rates that they know they will never see again. Such a boom would be short lived but it would allow the real estate sector one more lease on life and thus serve to benefit it. This of course would be reflected in higher prices for home builders and outfits associated with real estate.
This uncertainty is clearly portrayed on the chart. Notice the sharp drop in the sector in April 2004 which occurred when the Fed first began jawboning the market with talk of higher interest rates to ward of inflationary pressures due to the wonderful economic news they were delivering us. Investors were spooked and sold the dickens out of the sector en masse. The TSI plunged and dropped below the zero line for the first time in a year. However, subsequent economic news reflected an economy losing momentum. Throw high crude oil prices into the mix along side of disappointing job numbers and suddenly, many were no longer convinced the Fed was going to hike. This of course would serve to benefit the real estate sector and thus many investors plowed right back in again driving the market up sharply in the process and kicking the TSI back above the zero line once again. By examining that line, you can see that is has now leveled off and is basically flat-lining as investors wait to see which way to take the market.
Next we come to look at what I consider to be perhaps the most important sector of the Dow - the Financial Sector. My reason for thinking this way is due to the profound shift that has taken place in the makeup of the American economy. There is no question that the manufacturing base of this nation is slowly being moved offshore to the Asian-Pacific basin, most notably China. All one has to do to confirm this is to simply visit the local Wal-Mart and read the "Made in" tags. Barring any unforeseen radical adjustment in both wages and regulations in the U.S., this shift overseas is permanent in my opinion. Throw a build up in service sector jobs being outsourced abroad as well, and it is easy to see that the U.S. is making a definite transition toward becoming a nation of consumers rather than producers. However, there is one sector that seems to have been relatively unaffected by this paradigm shift and that is the financial sector.
Bluntly stated, it is my opinion that America's new role seems to be better designated as the money changers in the temple of the world economy. We supply the necessary financing to the rest of the world to modernize their economies so that they can all-the-better compete with us. We have become the kings of paper with the benefit having largely gone to the large New York based investment banks such as J. P. Morgan and Goldman Sachs, et al. In my opinion therefore, the performance of this sector has perhaps become more important as a leading indicator in confirming Dow direction than the venerable Transports. Formerly, "made in America" goods would require transportation to move them from factory to distribution points. The health of the Transport sector was at that time very indicative as to the overall health of the American economy. Today, it seems that the transport sector is more busily engaged in moving imported goods from Asia and elsewhere around the world out of American ports to distribution points where American consumers can eagerly devour them. So while the transport sector may indeed show signs of health, it is not necessarily correlated to the health of the American economy anymore. This, if true, and I repeat that this is merely my opinion, would render Dow Theory as it has been historically applied, a lot less relevant than it has been in the past. As a matter of fact, it might actually be a good idea to use the Financial Sector in place of the Transport Sector as a method for applying Dow Theory. It would better reflect the changes of the modern world. We will simply have to see.
With this in mind, please refer to the chart of the Dow Financials below. You will notice that the financial sector has much to be grateful to the Fed for over the course of the last year. Easy monetary policy with the lowest rates in some 45 years has proven to be a windfall profit scheme for those in the money lending business. That can be easily evidence by observing the strength in this sector over the same time frame. The solid uptrend is confirmed by the TSI which has remained above the zero line for that entire period. Neither is there the slightest bit of divergence during this time frame. Yet, much like the Real Estate sector, the first mention of inflation along with corresponding talk of interest rate hikes earlier this year, served to knock the Financial sector for a loop. The TSI dropped below zero while the uptrend line was broken. A brief reaction rally occurred in May which lasted to June before the index rolled over to the downside. Notice that the TSI is now below zero and headed downward. From where I sit the Financials are at an important crossroads. Unless they can recapture the high of the last reaction rally, they are in danger of violating the critical support area. If that occurs, it will signal that the financial sector is in trouble and could easily portend a breakdown in the Dow Industrials. Again, we will have to wait and see. An interesting note here should be made. Should the Financials manage to somehow rally back to their highs of March, the TSI will not have garnered enough strength to avoid setting up a divergence. That will indicate that this rally, should it occur, might be one last hurrah before we commence moving down in earnest.
The next sector I want to examine is the Airline Sector. There is no way to describe this sector except by using the word, "ugly". Can anyone say "unfunded pension liabilities" or "expensive aviation fuel"? It seems like hardly a day passes in which we are not treated to some bad news coming out of this sector. Talk of bankruptcies is now fairly commonplace.
You can readily detect the weakness in this sector with just a quick glance. The downtrend is obviously glaring. Whereas the broad market rally that took place over the last year saw several sectors demonstrating some real strength, the Airlines could barely generate enough giddy up to make it out of the basement. Since December 2003, the TSI has been below the zero line and has now resumed its downtrend again. Additionally, the Airlines have managed to carve out a dangerous looking Head and Shoulders formation the breach of which signals a move down to the region near 74-75. This just happens to coincide very closely with major chart support going back to October 2002. Should that give way, the ramifications to the Airline sector will be devastating. I would think that should such occur some airlines will indeed head into bankruptcy and/or might simply disappear altogether as potential buyout candidates.
The next sector I would like to examine is the Auto sector. It is not much better than the Airlines in all honesty. You can observe that it is in a definite down-trend and unlike the Transports, Real Estate and Financial sectors, could not even muster the necessary strength to surpass its previous reaction peak of May 2002. Sellers simply could not wait long enough to unload these shares as the broad market rally carried them upward. Truth is, the market is more than likely looking at the unfunded pension liabilities of some of these firms and sluggish car sales and is worried. After all, now that Automobile dealers have had their zero percent financing and cash back rebates, what else is left? Could it be that they will actually pay consumers to buy their new cars? If interest rates are indeed headed up, then auto sales will probably decline especially if the refi market dries up and consumers can no longer tap their home equity to buy new big ticket items such as automobiles. Notice also that the TSI has turned over in this sector as well and has begun to head downward.
The next sector I want to visit is the Retailers. This is a critical sector to examine when attempting to ascertain the overall health of the economy as it yields valuable clues as to the state of mind of consumers. Are they spending or not? Since the American consumer has become the driver responsible for the not only the U.S. economy but for the global economy as well, it behooves us to listen to what the market is telling us about this key sector. What we find here is disconcerting to say the least.
Notice that the Retailers have broken down technically after posting a classic divergence. The recent high of early March 2004 was not confirmed by the TSI. As a matter of fact, it was revealing subtle but definite signs of internal weakness as the Retailers went on to make new highs. It is interesting to note that the high in this sector occurred just as many consumers were receiving tax refund checks from our most gracious lords and kings at the IRS. It seems that the market was already discounting the fact that once that stimulus had run its course, the feds were out of gimmicks. The refi market had already been tapped out leaving the tax refunds as the last arrow in the financial elites' quiver. The TSI has broken down below zero and is in a definite downtrend at this point as it confirms the breakdown of the Retailers price chart. It will be interesting to see if the Retail sector eventually goes on to retrace the entirety of its up-move that began last year. With consumers loaded to the gills in debt and having already tapped their home equity to continue the mad spending spree of the last few years, it is quite conceivable. Add to that some anecdotal reports that savings, although abysmally low, are up slightly, and we could be seeing the beginning of the consumer retrenchment which thus far has been absent ever since the stock market bubble broke in 2000 and the country was plunged into recession. If so, this is not good news for the U.S. economy nor for that matter, the global one as well.
The final two sectors we will examine will be the Energy and Precious Metals sectors.
Let's turn our attention to the Energy sector first. Here we can see a powerful bullish trend that commenced in January 2003 and has simply continued to surge ahead defying the expectations of many of the chattering heads now so abundant in financial TV land. The stunning up-move has resulted in an increase of nearly 60% in the last 18 months. - Imagine getting those kind of returns every couple of years for the next 10-15 years! There are some warning signs however that the prudent investor should be cognizant of. The first is that the steep preliminary uptrend shown as the dotted blue line has been violated. It is not a significant breach but it is wise to note it. What makes me a bit more concerned is that the breach has been accompanied by a divergence signal in the TSI. The TSI is still above the zero line but it reveals a market that is beginning to lose internal strength.
My take on this is that apparently many investors are of the mind set that the run up in crude prices is getting close to topping up for the time being and are beginning to slide some money off the table even as the price of crude continues to defy gravity. This will bear watching closely since any further disruptions in an already tight supply situation could send crude oil skyrocketing northward. In that event, many of the same skeptics that are currently selling will likely turn around and either charge right back into this sector or at the very least, be forced to cover many of their shorts. A surge in price could actually negate the divergence on the chart if it was strong enough. Keep in mind, that simply because a divergence occurs, that is no reason to assume that a sell off or trend reversal is going to occur. It simply gives a heads up that internal strength is waning and that some fresh impetus is going to be needed to drive the market further upward. In the case of crude, should something happen to a major refinery, a pipeline or a tanker, crude will be at $50/bbl in a heartbeat and the Energy sector will push to new highs. Just be vigilant is the message from this chart.
The last chart is the one that we gold bugs are most interested in seeing. It is the Dow Jones Precious Metals Sector. I specifically did not choose to use the HUI or the XAU for the sake of consistency. Every other sector I have examined I have relied up the Dow Jones sectors and for the purpose of comparison, I felt it important to stay with the same. Additionally, the similarity between the charts of the HUI and XAU and this one from the Dow are remarkable. I am of the opinion therefore that this is a suitable proxy with which to work..
At first glance there is not particularly anything exciting about the Precious Metals sector. The sector peaked at the same time the price of gold itself peaked near $430 earlier this year. Since that time it has struggled to regain its composure as all the friends of gold can too well relate. Some of the junior miners have been hit so hard that it has been said they were having garage sales with drill equipment, used chisels and hard hats. It seems that some investors were of the apparent mind set that gold was no longer ever going to be worth anything again and were ceasing operations completely. The last statement is an obvious attempt at sarcasm but in all honesty, the way some of these mining shares had been beaten up on, I sometimes wonder if there are some people who really do think this way.
Regardless, there is something that bears watching in the Precious Metals sector and I believe it should give the disconsolate gold and silver bugs something to encourage them. Notice that a coil is forming on the chart. Simply put, a coil, sometimes referred to as a triangle, is a trading pattern which reveals a range constricting within two boundaries that is becoming progressively tighter. Trendlines drawn both above and below the pattern intersect at a point or apex toward which the market price is moving. The concept is similar to that of a coiled spring which is being compressed by the application of force. Eventually, the stored energy is released as the coil unwinds. So too, a market forming a coil, can be likened to a spring under compression which is storing energy and only awaits an event to allow it to be unleashed.
The difficulty is in predicting which way the coil will unwind. Will it erupt to the upside or collapse violently to the downside - the pattern itself usually does not tell us - we simply have to wait and see. Momentum traders will then go with the direction of the breakout and jump on board. In this case however, we see something which seems most promising to me. Notice that the TSI has been sloping upward and moving towards the zero line. It is actually in an ascending pattern. This implies that while the market is constricting it seems to be developing strength and moving away from weakness. Based solely on this indicator, my guess is that once the coil unwinds, it will be a bullish break to the upside. Again, time will tell.
In conclusion, we can sum up our findings as follows:
The broad market is definitely showing signs of having topped out. However, that has yet to be confirmed by the Transport sector. Real Estate is in a holding pattern attempting to discern which way interest rates are likely to go. The Financial sector seems to have broken down and the Airlines are a mess. The Auto sector is in serious trouble. Retailers have broken down and appear to have topped out. Energy is still looking strong however some warning signs are occurring which should be heeded. Precious Metals have still to make clear which way they are headed but the bias appears to be to the upside at this point.
Dan Norcini
August 17, 2004Dan is a professional off-the-floor commodity trader residing in Texas and can be reached at dnorcini@earthlink.net with comments.