by Jeffrey Saut, Chief Investment Strategist, Raymond James
September 22, 2014
“In Greek mythology Sisyphus was a king of Ephyra who was punished for chronic deceitfulness by being compelled to roll an immense boulder up a hill, only to watch it roll back down, and to repeat this action forever.”
I have been reminded of the Greek mythology character Sisyphus since mid-July as investors tried to “roll an immense boulder up a hill, only to watch it roll back down.” In this case the “boulder” in question has been the D-J Industrial Average (INDU/ 17279.74), which since late July has tried seven times to better its all-time high of 17138.20 made on July 16th of this year. Each of those attempts failed, only to see the “boulder” roll back down the hill. Last Wednesday, however, Sisyphus succeeded as the Industrials vaulted above their mid-July closing high along with a new all-time closing high from the D-J Transportation Average (TRAN/8633.83). The dynamic duo notched new all-time closing highs the next day as well (see chart 1). Simultaneous new highs between the Industrials and the Trannies are a pretty rare event. Typically what happens is one of the indexes makes a new reaction high and then shortly thereafter the other index follows. In 2013 it was the Transports that made new highs in January, but it wasn’t until March the Industrials confirmed that high with a new high of their own. In the current case we got back-to-back Dow Theory “buy signals” last Wednesday and Thursday. Since I have been on the road, I have not had time to review my notes of the past 50 years, but off the top of my head I can’t remember the last time that happened. I did, however, have time to run an overbought/oversold analysis on the 30 components of the Industrials and found that only Caterpillar (CAT/$102.51/Market Perform), Chevron (CVX/$124.80/Strong Buy) and Exxon (XOM/$97.12/ Outperform) are currently short-term oversold.
Nevertheless, according to Dow Theory, the primary trend of the equity markets remains “up,” as Dow Theory has opined since the summer of 2009. Does that mean we will never have the 10% - 12% pullback the historical odds call for this year? Obviously I don’t know because I thought we had commenced such a pullback last July. But, when the S&P 500 (SPX/2010.40) refused to break below 1900, and then traveled above its overhead resistance zone of 1940 – 1950, I had to give up on that view. Still, there is some “hair” surrounding the stock market’s current situation. As one of the portfolio managers in San Francisco asked me last week, “I was happy to see the Dow Theory Buy signal on Wednesday but am puzzled by an analyst (whose name will go unmentioned as his material is for purchase) who discussed the McClellan Oscillator’s action on Tuesday – the day before the Dow Theory buy signal. Because you pay attention to the McClellan Oscillator, here is a small piece of this analyst’s research for your reflection:
‘Here is one of the remarkable divergences that existed today [Tuesday, September 16] at the market close. The Dow was at or within 0.2% of a two-year high on a closing basis at the same time the ratio adjusted McClellan Oscillator was closing at an oversold level of -35 or lower. Would you care to venture a guess as to how many times that has happened over the past 85-90 years? The answer is there have been only 8 prior days over the past 90 years where such a great divergence has occurred. Not all of them have marked market tops of any importance but several of them have marked definite danger zones for the market. Similar coincidences occurred on June 3 and June 8, 1948. The latter date was within 0.2% of the high that was registered five trading days later on June 15. That high lasted for almost the next year and a half. It happened again on June 6, 1950 which was within one week of the June 12 high which marked the highest point for the next four months. It happened again on March 9 and March 10, 1976. The closing prices on those dates were not exceeded by more than 2.1% over the next 5½ years. The most recent appearance prior to the current one on September 16 occurred on July 15, 2014. That was one day before the all-time high close on the Dow which has held through today’s action. We believe the fact that such a rare coincidence occurred again this Tuesday, September 16, could well be a warning sign that a market top of some importance has formed.’
“My question is [the PM speaking]: If this is a similar pattern, will this week’s occurrence be followed by a Dow market top on Wednesday/Thursday; and is this anything, or does the Dow Theory ‘trump’ concern about the action in the McClellan Oscillator on Tuesday?”
My response was that I think Dow Theory “trumps” everything because it tells us the primary direction of the equity markets, although whoever wrote about the adjusted McClellan Oscillator is very astute and has notes going back a lot farther than my notes. That said, I am not quite sure what an “adjusted” McClellan Oscillator is. I will say, however, that the NYSE McClellan Oscillator I have used for years is not oversold, but more neutrally configured (see chart 2). I would also add that whoever the analyst is, his analysis foots with a number of the negative divergences I have written about over the past few months. Then too, we are now at session 31 in the “buying stampede” and the typical stampede tends to last only 17 – 25 sessions. A few have extended for 25 – 30, but it is rare to have one go for more than 30 sessions.
Yet while the Industrials were doing their thing, I was in the San Francisco Bay area. Last Sunday I had dinner with some portfolio managers (PMs). On Monday I saw accounts and finished the day at Franklin Templeton’s world headquarters seeing PMs and then presenting in their tiered classroom. Tuesday saw more of the same until that evening when I spoke to a group of high net-worth investors at the Toll House Hotel in downtown Los Gatos, which was the highlight of the week, at least for me. The affair was a sit-down dinner with a wine tasting. Now anyone who knows me knows that I know a lot about wine, but the winemaker at this event I had never encountered. Surprisingly, the wine was as good as the best I have ever tasted and was called Patland (www.patlandvineyards.com). It was probably the excellent wine because the verbal exchange between the investors and me was invigorating. The next day it was more of the same, as was Thursday. Friday was spent in Carmel speaking at a conference. Throughout all of my meetings was the ubiquitous question about when the Fed would begin raising interest rates. I think the consensus now pegs a rate ratchet at about nine months from now. Accordingly, I have included a chart in this report chronicling the S&P’s 10 macro sectors’ historical performance nine months prior to a rate rise. I do find it interesting that the Financials are at the top of said list because the KBW Bank Index (BKX/$73.69) is making new reaction highs. One of the ways we have been investing in financials is via my friend David Ellison, who manages the Hennessy Small Cap Financial Fund (HSFNX/$23.65) and the Large Cap Financial Fund (HLFNX/$21.05). As a sidebar, I own HLFNX.
The call for this week: Last week we got back-to-back Dow Theory “buy signals” (Wednesday and Thursday), which is a pretty rare event and tells us the primary trend of the equity market remains “up.” According to Dow Theory, the primary trend of the market has been “up” since the summer of 2009, which is why I continue to believe we are in a secular bull market that has years left to run. Still, the move to new all-time highs has been selective and accompanied by many divergences like the one the unnamed analyst discusses. I think the current situation is best summed up by another friend, namely Don Hagen, who is also the PM at Day Hagen Asset Management, when he writes, “We remain mildly overweight equities, favoring US equities over international. However, within the international arena, our models favor Emerging Markets over Europe and Japan.” This morning the SPX preopening futures are down ~9 points on Chinese economic worries and as Syrian Kurds cross into Turkey.
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