The Dow Jones industrials gained more than 90 points Monday, rebounding from last week’s 400-point slide.
Once again, investors have come to the rescue, buying on dips and setting their sights on more record highs. All’s well, right?
Not according to market analysts who follow technical indicators. To them, the summer rally that began in mid-June and ended July 17 was an illusion, and more trouble lies ahead.
Technical market analysis– the process of forecasting future price action in markets or individual securities based on past actions–has received little attention in recent years, as falling interest rates, robust corporate profit growth and a steady flow of billions of fresh dollars into equity mutual funds told investors just about everything they needed to know to buy stocks.
What’s more, academics devoted to the theory of efficient markets have presented compelling evidence that whether any stock goes up or down on a given day is essentially a coin flip, so there is no predictive power in studying past trends in stock prices.
But last week’s sudden erosion of the summer rally sent investors looking for causes, and veteran technical market analysts were ready with a troubling picture.
In jargon typical of the technician’s craft, the discouraging word they use is “divergence.” The major stock market indexes–the Dow indus-trials, the Standard & Poor’s 500-stock index and the Nasdaq composite index–have diverged from more arcane, though important, market indicators.
“The technical guys who were around in the 1970s and 1980s are noting things that are sending up warning signs,” said Gregory Nie, technical market analyst at Chicago-based Everen Securities. “It’s been the cause for a lot of action in the market” recently.
Richard McCabe, chief market analyst at Merrill Lynch in New York and one of the most-followed market technicians, pointed to the weak pattern of advancing stocks versus decliners.
“One of the most glaring indicators is the fact that each day, the advance/decline number has never been able to get above the highs it made in April,” he said. “At that time, the Dow industrials, the S&P 500 and the advance/decline number were in gear on the upside.”
Also troubling McCabe is a breakdown in stocks making new 52-week highs. “When the Dow and S&P made new highs in July, the number of stocks making new highs was far less than in the summer and fall of last year.”
Louise Yamada, a senior technical analyst at Salomon Smith Barney, watches indicators of “buying power” versus “selling pressure.” “It tells us the summer rally has been more an alleviation of selling pressure than buying power,” she said.
She points to the below-average trading volume of the New York Stock Exchange through the June-July rally. “If you don’t have volume, you can’t go up,” she said.
Yamada also notes the long-term weakness in small-company stocks. The ratio of the Russell 2000 index of small-company stocks to the S&P 500, a large-company index, has been in a declining trend for four years, she said.
Nie points to the slide in the Dow Jones transportation average as another technical divergence eroding market sentiment.
Disturbing stock price chart patterns are evident in individual issues as well as the popular market indexes. For example, Minnesota Mining and Manufacturing, a component of the Dow industrials and the S&P 500, failed in three attempts this spring to break above its 52-week closing high of $100.37 set Oct 22. The stock closed at $78.37 Monday.
Aircraft giant Boeing, farm equipment manufacturer Deere and oil-service contractor Halliburton are other stocks with weak technical chart patterns, each having collapsed through the floors of closing lows established over the last 12 months, Yamada said. “When you break down a support level, someone’s perception of the company has changed,” she said.
What’s changed for many companies is the hope that the worst of the Asian crisis is over.
In one of many jarring indicators, McCabe found that, as of last Thursday, 57.5 percent of all New York Stock Exchange stocks and 85 percent of all Nasdaq stocks have fallen 20 percent or more from highs reached between Jan 1, 1997, and May 31, 1998.
Big-name stocks with demographic appeal to the Baby Boom generation–stocks in the pharmaceutical and financial-service sectors, for example–as well as a few big-name computer-technology stocks continue to keep the major indexes aloft, Yamada noted.
These are the stocks that must slide before the technical picture improves and a new rally can be sustained, many technicians say.
“Before the process is complete, at some point the big stocks must catch up on the downside,” McCabe said. “There must be more disappointments among stocks that can’t disappoint.”
