Happy November! I hope everyone had a safe Halloween. I hope by now everyone has come down off of their sugar high’s from the festivities. I know in our house, today’s was much more ‘sluggish’ than normal, with the boys having little energy for anything.
Although we are clearly still in an uptrend, I am continuing to see a lot of evidence that we might be forming a longer term top. Although none of our indicators are showing enough weakness to act defensively as of this moment, every day our analysis shows more and more weakness. But … what is interesting is that the process is taking a long time which is most likely indicating that the next correction that occurs will be stronger than the last few.
The reality is that we haven’t has a strong correction since April 2011 when the market dropped over 20% in 2 months. In 2012, we had two 12+% corrections, but both recovered relatively quickly, and 2013 has seen very little downside. Looking over history we generally have a strong correction (20% or larger) every 2 – 5 years, so we certainly could be due for one.
We do not use seasonal or calendar based indicators in our decision process, but rather look at the data and how the stocks are acting at that particularly time … but I do think we are overdue given the complacent views right now. In fact, all surveys of investor confidence are excessively bullish. We have a very frothy situation right now where most investors are extremely confident that the only place for the market to go is up. As I’ve mentioned in the past, usually when all parties feel the same way, a change is not far off.
A few items that are causing concern for me are …
1) The most important issue is that leading stocks are continuing their 3 week long pattern of breaking down. One by one we are seeing the 2013 leaders breaking down and losing value aggressively. It may be obvious, but leading stocks generally ‘lead’ the market, so if they are breaking down … it usually isn’t long before the indexes follow.
2) As I’ve mentioned previously, we are continuing to see defensive sectors take on a leadership position and outperform the smaller cap stocks. This week was no exception with the Dow Jones index eking out a 0.29% gain for the week while the Russell 2000 small cap declined 2.13%. if you stretch that out longer term a similar situation enfolds, over the past two weeks the Dow gained 1.4%, vs. the Russell losing 1.79%, and three weeks ago with the Dow gaining 2.5% while the Russell gaining only 0.96%.
So, over the past three weeks we’ve seen the Russell (smaller caps) rolling over from an uptrend to a decline while the Dow spent half the time in a strong uptrend to being flat this week … as if the Dow is following the leading smaller cap stocks off the cliff…
This is normal ‘topping’ behavior where the big guys start selling their riskier investments and move their money in the more defensive larger cap stocks that generally take less of a hit in a correction.
From a technical analysis perspective we are definitely seeing more selling pressure with volume much stronger on down days and key inflection points being broken particularly in the small cap realm. The other area of concern technically is that the majority of stocks are overextended … stretched far from their averages and like a rubber band when it stretches too far … the stocks need to snap back. Granted, when stocks get overextended a correction doesn’t have to occur to fix the problem, time can solve the problem if the stocks sit in a healthy manner not gaining price, but also not losing.
So far this is what we are seeing with the market as a whole is holding up well with little gain, but also little loss, creating a 3 week long “Doji”. Doji’s simply signify indecision in the market, where price does not go up or down. There are small battles going on between the bulls and bears, but no side has won as of yet.
With that said, each week we are seeing more and more volume, meaning the battles are getting more intense.
For now, we stay invested and continue to watch closely for further signs of a large scale breakdown. I would imagine next week will provide clarity as to the direction of the market through the end of the year. Until then, I hope you have a wonderful and safe weekend.
Resnn Investments, LLC