In my Twitter feed I am starting to notice more and more stock market analysts making some bearish calls on the future direction of the stock market.
The majority of the time, these analysts, particularly those predicting a market top, tend to be wrong. But, they keep making such predictions because when they do get it right, they can thump their chests.
Sure, there may be some concerns on the horizon, but keep in mind, the stock market is a discounting mechanism…it prices in what it feels will be future corporate earnings. Naturally, those earnings are heavily dependent upon the performance of the economy.
While many of these analysts like to use complex models to predict the market, and these are typically wrong, I like to focus on simple Dow Theory.
Dow Theory tracks the direction of the Dow Jones Industrial Average and the Dow Jones Transportation Average. The theory holds that both of these indexes should be trending in the same direction.
When they are both making new highs, the market is healthy. When they are both making new lows, the market is unhealthy. Analysyts who follow Dow Theory are then also wary of any divergences between the two averages.
For instance, if the Dow Industrials are making new highs, but the Dow Transports are not following suit, then the overall market may be ready to turn lower.
This was the case in 2015. The Dow Transports had peaked in late 2014, and started heading lower. The Dow Industrials managed to make marginal new highs in May 2015, but then struggled for the rest of the year, finally finding a signficant bottom in early 2016, after about a 15% decline in the Dow Industrials.
Current Market Status
So, where do things currently stand?
While the upside momentum in the stock market has slowed over the last few months, the trend remains to the upside. While the Dow Transports had a rough week this past week, all of the major market averages made new all time highs in the last couple of weeks.
This is the Dow Industrials performance over the last year. While momentum has slowed, the index made a new high this past week.
The Dow Transports had been lagging in recent months, but made a new all time high last week before the recent sell-off.
While the current bull trend remains in place, the weakest and typically the most volatile period of the year is just ahead. August and September are two of the weakest performing months, while major market bottoms are typically found in October.
The volatility in the market is currently at historic lows. If volatility increases, it will likely be a result of a news item that drives the market lower from here. Given the ongoing political situation in Washington, a modest market correction would not be surprising.
I search for stocks that have significant upside momentum along with a big increase in trading volume. I then look for a fresh breakout opportunity to enter a position.
This week, I like MEIP (MEI Pharma). It has broken out of a major trading range and has made some nice upside progress since. The stock is attracting more attention as well, as evidenced by the much higher trading volume in recent weeks.
The recent high for this stock is $3.26, so you would want to buy on a breakout above that level.
That concludes this week’s market commentary.