The Rear View Mirror

The Rear View Mirror

August 21, 2017 Off By Chuck

 You can’t do the same things others do and expect to outperform. – Howard Marks

When trying to get a reading on the overall stock market health most everyone uses the SP500 index as their proxy. The problem with doing that is twofold; 1) it includes only 500 stocks. While it is a much better proxy than the Dow Jones Industrials (30 stocks), it is a far cry from including all stocks in our markets which is currently in the neighborhood of 4500. 2) the SP500 index is cap weighted which makes the smaller companies less important. Ideally any index used should include as many in the universe of listed stocks as possible and be equal weighted.

The Value Line Geometric Composite Index (XVG), originally created in in 1961, includes more than 1700 stocks which are equally weighted using a geometric average. Because it is based on a geometric average the daily change is closest to the median stock price change. Suffice to say that while still not perfect it does a much better job of representing the US stock market than almost any other proxy.

With my long term model still very bullish and my short term model flashing red warning signs it’s a good time to check in on the market (using a daily and weekly chart of XVG) and see what it is telling us, if anything. There is nothing more bearish than a failed breakout and is exactly what occurred and we see on the daily chart below. Note how the failed breakout occurred while RSI momentum was creating negative divergence. Since then price breached the 200-day moving average to the downside and closed Friday just below horizontal support (breakdown). The saying is from false breaks come big moves so that failed breakout was a potentially ominous signal and one that got my attention. As you know, horizontal support lines are drawn with fat crayons as they are not one specific price, rather they represent a range or zone. So, Friday’s close may be nothing more than being within that zone and not an actual breakdown. That is why confirmation is always needed when a breakouts or breakdowns occur. Suffice it so say, next week’s price action will be very critical. A confirmed breakdown, points lower with the first two targets are marked with the green horizontal bars, T1 and T2.

Taking a look at a longer weekly look, XVG broke its 2016 bottom uptrend line two weeks back while forming negative RSI momentum divergence. Looking left, notice what happened the last time this occurred from the 2012 bottom uptrend line, price fell 27%.

Since the 2011 failed top, investors have become conditioned to just buy the flipping dip (BTFD) as pullback buyers have been rewarded each time it has occurred. If we get follow through to the downside in the coming week(s), if recent history is our guide, it will likely just be a minor blip on the road higher. But because all bull markets eventually come to an end, investors should never become complacent as every dip may be the start of something much bigger. Either way, the answer will only be known in the rear view mirror.