Warning Signs

Market Warning Signs

There are plenty of warning signs in the market right now. They exist out in the fundamental world - Fitch cutting the UK is a good example, but there have been a lot of ratings cuts with no effect, right? Here we don't have to argue about fundamentals, we look just at the charting side.

There has been a clear correlation between USD/JPY for some time. As the Yen falls, money is fleeing Japan to the US equity markets because there is nowhere to go and earn any kind of reasonable return in Japan. You can argue about the extent of the effect, but it seems pretty clear from the correlation that the Japanese money has had a positive impact on US equity markets. Notice that the peak of USD/JPY was within a day or two of the top in the S&P 500:

USD/JPY 2013

That chart reminds me of another chart, an old favorite, with which we all are familiar:

Well, history doesn't repeat exactly, and currencies are difference beasts than equities. However, blow-off tops have a nasty habit of acting the same way regardless of what is being charted.

Below is the daily chart of the SPY. It fell out of its channel last week. Some people see a head-and-shoulders topping pattern forming. That may indeed happen, which implies some sideways movement from this point. If one is coming, though, it hasn't formed yet.

SPY after April 19 2013

Again, we can argue about what it means. It probably isn't good.

The weekly SPY chart makes the point a little clearer:

SPY Weekly as of April 20 2013

The weekly chart on the SPY is showing a clear-cut reversal. This is another warning sign. Yes, the market could turn right around and head higher, but markets tend to be a bit like Battleships: once set in motion, they have a certain momentum to them. The momentum this past week, for the first time in a while, was to the downside. This downward bias includes the other major equities averages.

IWM Daily Chart on April 20 2013

The IWM has a reputation for leading the broader market. It is in the worst shape of all. Here, one arguably sees a head and shoulders topping pattern, with increased volume as a downtrend channel forms. This is clearer on the IWM weekly chart, which shows the downtrend is farther along than it might appear on the daily chart.

IWM Weekly chart as of April 20 2013

If equities are in trouble, where could the money fleeing a sinking market be going? Good question. The answer appears to be, among other places, bonds.

TLT Daily chart as of April 20 2013

There is another place for risk-averse money besides bonds. Many remember the "Nifty Fifty" from long ago, big, dividend-paying stocks that supposedly could not go down. Of course, down they went with the broader market, just a little later. Dividend stocks have a reputation for outperforming during Bear Markets, so they are one of the first places to which hot money flees when it becomes scared:

Dividend Stocks tend to Outperform during Down Markets

Unfortunately, tracking the relative popularity of high-dividend stocks in a Bullish environment is tough, because everything is going up. The thing we will be looking for more and more is the out-performance of those stocks should the market stumble. Watch also for market touts on channels like CNBC to start hyping them.

The bottom line is that there are warning signs. Whether you believe them or want to face them, they are there. The market still could hit new all-time highs, as the cover of Barron's for April 22, 2013 predicts. Many traders with very good justification, however, take such covers as the supreme contrarian indicator. Draw your own conclusions.

Barron's Cover for April 22, 2013