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DOW JONES AVERAGES and MSCI ACWI

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There are discussions right now if last few week’s sell-off was another failed breakdown. Was this another bear trap? Did Central Banks again manage to put a floor to equity markets? ECB’s dovish comments and BOJ’s negative interest rate moves both came this month, after sharp sell-off in equity markets.

Due to developing bearish chart patterns and the fact that major indices are below their long-term averages I’m weighing the possibility of a correction more than a strong bull market in the coming months. This time could be different and the technical outlook might prove to be a bear trap. I’m fine with that. That’s what markets are. Current chart set-up is something that I can’t ignore and I’ll try to explain here.

First let’s look at two major equity indices that we have been following. On a monthly scale “close” was at the border. The jury is still out in my opinion. Though, I would say last week of the month we have seen a good attempt to close at the higher levels for the month.

MSCI ALL COUNTRIES WORLD INDEX III

EURO STOXX 600 INDEX III

Richard W. Schabacker in his book TECHNICAL ANALYSIS AND STOCK MARKET PROFITS (Printed in US in1932) discusses Important Reversal Formations. Under this section there is a detailed study of Head and Shoulder reversal chart patterns. We are all familiar with the Head and Shoulder chart pattern. I want to draw attention to a specific type that we are seeing right now on equity index charts. Schabacker explains:

Schabacker ISchabacker II

Here is the chart he was analyzing at the time. Please note that the original chart doesn’t include the red trend line (neckline). I added this to show the similarities with the current chart patterns.

Schabacker III

Several decades later similar chart patterns are appearing on the widely followed and traded equity indices. Dow Jones Transportation Index broke down a similar downward sloping trend line. Head and shoulder price target is at 5,800 levels, still far from current 6,906 levels.

DOW JONES TRANSPORTATION INDEX

Now let’s look at some similarities between 2008 and 2016. In 2008, Dow Jones Industrial Average reversed its 4 year-long uptrend with a Head & Shoulder top. Neckline was downward slanting. After the breakdown there was a pullback that violated the neckline but couldn’t push above the long-term average or inside the trend channel. The head and shoulder top that formed in 2007-2008 showed significant market weakness due to its drooping shoulder.

DOW JONES INDUSTRIAL AVERAGE

Dow Jones Composite Average is now forming a similar Head and Shoulder top with downward sloping neckline. Both the long-term moving average and the lower boundary of the 6 year-long trend channel is violated. If this time is not different, current chart set-up suggests a correction is more likely in the following months than the continuation of the bull market.

DOW JONES COMPOSITE INDEX III

We can also look at MSCI ALL COUNTRIES WORLD INDEX and compare the top in 2007-2008 with the latest chart development. I think the current technical conditions can’t be ignored. I want to give these markets some more time to prove the bears wrong.

 

MSCI ALL COUNTRIES WORLD INDEX IV

MSCI ALL COUNTRIES WORLD INDEX

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2016 started with negative performance for global equities. And weak performance can continue in the coming months. Sharp sell-off in Chinese equities mainly driven by a devaluation of the Chinese yuan, resulted in a broad market weakness. Sharp price action is making the headlines as it is one of the few bad starts for the new year in several decades. However, since April 2015 charts have been showing market weakness. (Earlier updates on MSCI ALL COUNTRIES WORLD INDEX here)

Weakness can be seen from the MSCI ALL COUNTRIES WORLD INDEX failing to breakout to new high levels in April 2015. Global equities experienced the first sharp sell-off in August 2015. Last quarter of 2015 was a reaction to August sell-off. Now, it seems like the downward momentum is picking up steam. Index is below its long-term average once again. Breakdown below the September low at 374, can send the index towards 300-350 area. MSCI All Countries World Index captures large and mid cap representation across 23 Developed Markets and 23 Emerging Markets countries. (For more information on MSCI indices) With 2,491 constituents, the index covers approximately 85% of the global investable equity opportunity set.

MSCI ALL COUNTRIES WORLD INDEX

Europe’s STOXX 600 index has similar deteriorating outlook with the index now testing a 7 year-long trend line support. In April 2015 STOXX 600 reversed from 400 levels for the third time since 2000. Failure to clear 400 during its 3rd test suggests supply is overcoming the demand every time index tests 400 levels. If we see Euro Stoxx 600 breaking down its long-term trend line support, we will expect a larger scale correction towards 300 levels.

EURO STOXX 600 INDEX

Dow Jones Composite index that measures changes within the 65 companies that make up three Dow Jones averages: the 30 stocks that form the Dow Jones Industrial Average (DJIA), the 20 stocks that make up the Dow Jones Transportation Average (DJTA) and the 15 stocks of the Dow Jones Utility Average (DJUA), is also showing weakness with a classic bearish chart pattern; Head and Shoulder Top. Support level for the index is at 5,600 levels. Breakdown below 5,600 can send the Dow Jones Composite Index towards 4,700-5,000 area. (For more information on Head and Shoulder Top chart pattern)

DOW JONES COMPOSITE INDEX

 

DOW JONES COMPOSITE INDEX

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Dow Jones Averages are price weighted indices, while most of the broad market indices such as S&P 500 and Nasdaq 100 are market-cap weighted. In a price-weighted index higher prices will influence the direction of the average more than lower prices, regardless of the actual size of the company.

Dow Jones Composite Index measures changes within the 65 companies that make up three Dow Jones averages: the 30 stocks that form the Dow Jones Industrial Average (DJIA), the 20 stocks that make up the Dow Jones Transportation Average (DJTA) and the 15 stocks of the Dow Jones Utility Average (DJUA). The Dow Jones 65 Composite, like the three sub-indexes, is price-weighted.

Over the past two years Dow Jones Composite Index has formed a top formation usually regarded as Head & Shoulder. Head and shoulder chart pattern forms after a prolonged uptrend and signals a possible change in trend. Chart pattern is confirmed with the breakdown of the neckline. Similar chart patterns can be seen on some of the constituents of the top US indices. If not in the next few weeks, the first quarter of 2016 we can see some corrective price action on these charts. Confirmation of such price movement will be a decisive break below horizontal support levels (neckline).

DOW JONES COMP INDEX

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UPS

AAPL

DOW JONES TRANSPORT and UTILITIES

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I’m not a big fan of diagonal support/resistances. I like horizontal and clearly defined support/resistance levels on price charts. Especially horizontal support and resistance levels on the weekly and monthly scale charts. However, current price action and the outlook on the U.S. indices is worth mentioning. Most of the major Dow Jones indices are rebounding from trend channel supports.

Trend channel support is more reliable for the Dow Jones Utilities index as the lower boundary of the trend channel was tested several times over the past 5 years.

DOW JONES UTILITIES INDEX

 

Dow Jones Transportation index is trying to rebound from trend channel support.

DOW JONES TRANSPORTATION INDEX

 

Dow Jones Composite index which is a combination of Industrials, Transportation and Utilities is also finding support at the lower boundary of its trend channel.

DOW JONES COMPOSITE INDEX

DOW JONES COMPOSITE INDEX

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DOW JONES COMP INDEX

Dow Jones Composite Index measures changes within the 65 companies that make up three Dow Jones averages: the 30 stocks that form the Dow Jones Industrial Average (DJIA), the 20 stocks that make up the Dow Jones Transportation Average (DJTA) and the 15 stocks of the Dow Jones Utility Average (DJUA). The Dow Jones 65 Composite, like the three sub-indexes, is price-weighted.

While there are broader measures of stock market performance for U.S. equities, this is another index that I follow as it offers some clearly identifiable chart patterns. Since the beginning of 2015, Dow Jones Composite Index has been forming a symmetrical triangle, usually regarded as a continuation chart pattern in a strong uptrend. Earlier in 2012 and 2013, Dow Jones Composite index formed other types of continuation chart patterns (rectangle & ascending triangle) and each were followed by breakouts and resumption of the uptrend.

Breakout from the year-long sideways consolidation pattern (symmetrical triangle) can result in another period of strength in U.S. equities. Strong support for the index remains between 6,100 and 6,300. Breakout above 6,500-6,600 area will complete the consolidation.