7 Signs the Stock Market is Ready to Run Smack Into a Wall

Posted on August 20 2017

The stock market’s relentless rally to records may soon be facing a key test.

A number of indicators point to a steady, halting deterioration of some of the factors that have helped Wall Street equities score a steady stream of all-time highs.

Peek beneath the hood of the action, and market technicians point to some unsightly problems within the market’s machinery.

Here are a few:

1. Russell 2000 falls into downtrend

The small-cap oriented Russell 2000 index (RUT) on Thursday fell below its widely-watched 200-day moving average for the first time since June 29, 2016, or about 14 months. The 200-day moving average is viewed by many chart watchers as a dividing line between longer-term uptrends and downtrends. Moreover, small-caps are viewed as gauge of economic health, with a divergence suggesting that investors aren’t sufficiently bullish about the near-term outlook for equities or the economy. The index briefly turned negative for the year on Friday.

2. Correlation breakdowns

Jonathan Krinsky, chief market technician at MKM Partners, points out a recent breakdown in the relationship between the S&P 500 index (SPX) and Germany’s DAX. Krinsky, in a research note on Aug. 13, said when the indexes exhibit a negative correlation, meaning they move in the opposite direction at the same time, that tends to signal a pullback in the S&P 500.

Here’s how he explains it:

1. There have only been five other occurrences of this in the last twenty years: June ’98, Feb. ’00, October ’05, and August ’14, and April ‘15 2. Four of the five occurrences preceded medium to large market pullbacks (’98, ’00, ’14, ‘15), with ’00 preceding the end of the tech. bubble and ’15 preceding the August flash crash.

3. Wall Street’s volatility gauge, the VIX

A popular gauge of Wall Street volatility, the CBOE Volatility Index (VIX) has come off historic lows and slowly, but steadily moved above its 200-day moving average, which it breached on Aug. 10, and continues to hold above that long-term trend line. That is a bullish sign for the gauge but a negative for stocks because the so-called fear indicator tends to trade inversely with stocks.

The gauge, also known as the VIX, measures options bets on the S&P 500 index. And because stocks fall faster than they rise, it’s often seen as a measure of expectations for near-term market drops. The VIX has only been around this level, 15, on two other occasions this year, back in May and in April, only to slip lower. It remains below its historic average of 20.

4. Gold rally

Gold futures (GCZ7) jumped above $1,300 an ounce, for the first time since the U.S. presidential election back in November. Gold has traded above both its short-term and long-term moving averages.

There have been a number of factors for that move, including a weaker dollar and diminished expectations that the Federal Reserve will raise interest rates again in 2017. But overall, haven demand amid worries about stock valuations and a number of risk events have been a big driver for gold and may signal that investors are hedging their bets for an equity slide.

5. Dow transports break down

The Dow Jones Transportation Average (DJT) which includes airline, railroad, and package-delivery companies, has been diverging from the Dow Jones Industrial Average. This is viewed as a sign of overall weakness in the market because so-called Dow theorists posit that the companies that move goods and services should be climbing in lockstep with the broader market. When they don’t, it is viewed as a bearish signal and one that may eventually see the broader market fall.

6. Bad breadth

A greater number of stocks are hitting 52-week lows than 52-week highs on the New York Stock Exchange—something the market hasn’t seen since July 2015, according to Jason Goepfert, president of Sundial Capital Research.

MarketWatch’s Sue Chang explains that this is a bad omen for markets because it shows gains are based on a narrow selection of individual stocks. A healthy uptrend involves a greater swath of companies moving higher. That said, the pullback in individual stocks may make some sense given the trepidations around lofty valuations.

7. Trump agenda

Trump’s policy agenda is at risk.© Provided by Dow Jones & Company, Inc. Trump’s policy agenda is at risk.

Perhaps the biggest signal that the market may face an extended period of weakness is President Donald Trump. Not solely because of his recent rhetoric that Wall Street business leaders have found unpalatable, but because his campaign promises, including tax cuts and a boost to spending on roads, bridges and tunnels, look to be in jeopardy. Such pledges had been credited as a driving force behind market gains, a long with relatively better corporate earnings reports and a stable economy.

Doubts about the president’s ability to follow through because of his inability to work with leaders inside of Washington and in the business community makes that pro-growth idea less likely, at least in the near term.

Mark DeCambre – Marketwatch – August 19, 2017

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