Saturday, January 21, 2012

Market Reaching Short-term Overbought Levels

Despite a handful of economic reports that didn’t quite measure up to expectations, stocks gained for the third consecutive session. The catalyst for the rise was a drop in jobless claims and better-than-expected earnings from Bank of America (NYSE:BAC). And the euro rose by 0.8% against the U.S. dollar, which also had a positive impact on stocks.

At the close, the Dow Jones Industrial Average was up 46 points to 12,625, the S&P 500 rose 6 points to 1,315, and the Nasdaq gained 19 points at 2,788. The Big Board traded 805 million shares and the Nasdaq crossed 497 million. Advancers beat decliners by 2-to-1 on the NYSE and by 1.4-to-1 on the Nasdaq.

DJT Chart
Click to EnlargeTrade of the Day Chart Key

There is much to study in today’s chart of the Dow Jones Transportation Index, which broke to a new high yesterday. It is considered to be the measuring tape for expected economic growth, and so a dramatic move by this index is noteworthy. The transports have been in a bull channel since November, and we confirmed a triple-top breakout in our Jan. 4 Daily Market Outlook.

This is a powerful chart with not only a visible bull channel but a new confirming high from its Relative Strength Index (RSI) and a pending golden cross (bullish crossover of 50-day moving average through the 200-day moving average) possibly just a day away. But a spike like yesterday’s 84-point (1.6%) advance is often followed by profit-taking.

Note that the index has advanced to almost the exact midpoint of the October 2010 to July 2011 consolidation — a thick zone of potential sellers. And also note that its RSI, though confirming the uptrend, is at its highest level since October 2010.

Short-term conclusion: The market, though still very strong, is reaching overbought levels. And with January options expiring today anything can happen. Rather than chasing stocks at this level it would be more prudent to buy on pullbacks. And if you’re looking for help making quick profits, you may want to check out my colleague Joe Burns.

Longer term conclusion: The Dow Jones Transportation Index may be telling us that a breakout will eventually occur — remember, it is this index that is most efficient in predicting future economic growth. And, it is an accepted fact that presidents will use their power to boost the economy in the election year concluding their first term in office. This record of the performance of the S&P 500 confirms the power of the presidency in economic matters.

  • 1936, Roosevelt vs. Landon: +33.9%
  • 1956, Eisenhower vs. Stevenson: +6.5%
  • 1964, Johnson (surrogate for Kennedy) vs. Goldwater: +16.5%
  • 1972, Nixon vs. McGovern: +19%
  • 1984, Reagan vs. Mondale: +6.3%
  • 1996, Clinton vs. Dole: +23.1%
  • 2004, Bush vs. Kerry: +10.9%

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