Are We Seeing The Green Shoots In the Market?

Most U.S. major indices made all-time highs in August/September 2021. Smaller cap, Russell 2000, was the first to reach its all-time high on March 15, 2021, followed by Dow Jones Transportation Average on May 10, 2021. Dow Jones Industrial Average reached this milestone on August 16 and NASDAQ Composite on September 7. S&P 500, NYSE Composite, and Wilshire 5000 Total Market Index made their respective all-time highs on September 2.

Since then, they have been drifting lower, i.e., correcting or consolidating. This price action is not unusual as late summer / early fall is when the stock market stumbles. Small-caps and Transports usually lead in such moves for a variety of fundamental, technical, and market sentimental reasons.

Another seasonal trait of markets is that October/November is the time when they rebound, again for several fundamental, technical, and market sentimental reasons. So, naturally, this is the time to investigate if any such move is developing.

The term “Green Shoots” is typically used to describe signs of economic recovery or positive data during an economic downturn. Still, we will expropriate it to describe a resumption of the uptrend following a correction or pullback.

Industrials Make, Transports Take

Fig. 1: Dow Jones Industrial Average and Dow Jones Transportation Average

First created in 1884 by Charles Dow, the co-founder of Dow Jones & Company, the Dow Jones Transportation Average is the oldest U.S. stock index. Along with the Dow Jones Industrial Average, which started in 1896, it forms the backbone of the Dow Theory, one of the earliest trading strategies. The theory is based upon Charles Dow’s editorials in the Wall Street Journal and was refined by W.P. Hamilton, the fourth editor of the Journal, in his seminal book The Stock Market Barometer published in 1922.

Charles Dow believed that the stock market’s chaotic movements could be studied profitably using these two indices as indicators. Dow Theory – S.A. Nelson first used the term Dow’s Theory in his 1903 book, The ABC of Stock Speculation –¬† states that the market calls (bullish or bearish) should only be made when the two indices confirm each other, i.e., start moving in the same direction. (A 1998 study by Stephen Brown, Alok Kumar, and William Goetzmann found that, on a risk-adjusted basis, a Dow Theory portfolio would be one-third less risky or volatile than a buy-and-hold portfolio.)

Transports are, typically, the leading economic indicator of the economy and, by extension, the stock market (see Fig. 1). They deal with the shipping and trading activities of the economy and provide the early warning of supply-chain diagnostics. There was a reason this index peaked in May 2021 before the broader market’s peak in August/September. The reports of the supply-chain bottlenecks revealed the reasons later.

Green Shoots – Transports Turning Around

Fig. 2: Dow Jones Transportation Average

Dow Jones Transportation Average is again moving ahead of the Dow Jones Industrials Average (see Fig. 2). Since early July, it has been trading within a Horizontal Channel, bounded by the upper limit of 14,990 and the lower limit of 13,950. It formed a Double Bottom on October 1 and completed the pattern when it rose above 14,588. The 61.8% Fibonacci extension target of the pattern is 14,963 and the 100% extension is near 15,195.

On October 7, the index broke above a downtrend line from the May 2021 high. Since May, it has continued with a sequence of lower-lows and lower-highs, but a move above 14,989 will break that sequence. If that happens then, the index would be officially in an uptrend again.

Green Shoots – Broader Indices Breaking Above Downtrend Lines

Fig. 3: Major U.S. Indices

Other major U.S. indices РS&P 500, NASDAQ Composite, and Wilshire 5000 Total Market Index  Рhave also risen above their respective downtrend lines from all-time highs in September (see Fig. 3). Their downtrend lines have a slope of 45 degrees, which is typical.

The slope of the downtrend line for the NYSE Composite was much steeper. The index broke above its downtrend line on September 23. It dipped below the line again on September 30 before rising above it on October 5 for the second time. The downtrend line for Dow Jones Industrial Average is flatter, and the index hasn’t yet broken above it.

Green Shoots – Technicals Pointing Toward Reversal

The daily charts of major indices are forming patterns that suggest that a reversal is possible. Dow Jones Industrial Average made a low of 33,741 on July 16, 2021. On September 20, it tested the low and then immediately bounced up. A subsequent decline in early October also tested the low. A rise above 35,061 will break its sequence of lower-highs and lower-lows.

NASDAQ Composite made a low of 14,178 on July 19 and tested it on October 4 before bouncing off. S&P 500, NYSE Composite, and Wilshire 5000 Total Market Index also neared their July lows in early October before bouncing off. RSI oscillator is flashing Bullish Divergence for S&P 500 and Wilshire 5000 Total Market Index.

The indices still have to rise above their last high to start a new sequence of higher-highs and higher-lows, one of the requirements of the uptrend. That level is 4,464 for S&P 500 and 15,085 for NASDAQ Composite. The increasing momentum of the past few days suggests that indices are more than likely to break above.,

Green Shoots – MACD Crossover Buy Signal

Stock Trader’s Alamance has developed a tactical season switching strategy based on their research that the stock market performs better during October-April. The strategy adds a timing tactic using a MACD oscillator to generate entry and exit signals. On October 8, their system generated a buy signal for Dow Jones Industrial Average, S&P 500, NASDAQ Composite, and Russell 2000.

Bottom Line

Enough green shoots are appearing that indicate that it is highly likely that the correction that started in August/September may be coming to an end. By historical comparison, this correction is relatively shallow – S&P 500 declined only 5.9% from the high – but the past eighteen months track-record says that it may suffice again. Nevertheless, for the uptrend to resume, the market has to start making higher-highs and higher-lows, which hasn’t happened yet.

 

 

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