A Big Warning Sign for Stocks

 

While many of the market’s hottest stocks just keep going and major market indexes this week scored record highs—again—the bears have planted a big red flag.

On Thursday the Dow Jones Industrial Average closed at an all-time high just shy of 21,800. The day before, the Standard & Poor’s 500 index hit its record close near 2,480, and the Nasdaq Composite index reached its closing peak of 6,422.75.

Bang-up sales and earnings from FAANG stars Facebook and Netflix propelled those stocks to new all-time highs. Alphabet, parent company of Google, and Amazon had sharply lower second-quarter results, wiping out the brief ascent of Jeff Bezos, who owns 17% of Amazon’s outstanding shares, past Bill Gates on the Forbes list of the world’s wealthiest people, with a net worth of over $90 billion. Nice work if you can get it.

I’ve written recently that the FAANG stocks are ripe for profit taking or correction. These are great, disruptive businesses, but investors have piled into these shares and they now trade at hefty, if not nosebleed, valuations. Even trees don’t grow to the sky.

Yet the market may have a bigger problem than the FAANGs.

That would be the Dow Jones Transportation Average, or the Dow Transports. The Transports comprise companies as diverse as airlines, railroads, and package delivery services. One of the latter, UPS, issued a disappointing outlook Thursday. Its shares tumbled 4% and the Transports closed down 3.1% on the day to a two-month low.

But the Transports have been suffering for a while. Since hitting their own all-time high of 9742.76 on July 14th, they’ve lost 6% of their value. That’s not much—it counts as a mild correction.

But Dow Theory holds that any all-time highs in the Dow must be confirmed by new highs in the Transports, or the bull market won’t last. When the DJIA goes one way and the Transports another, that’s called a “divergence.”

To use another technical term, the Transports’ sell-off is a major “nonconfirmation” of the Dow’s all-time highs. To close that divergence, either the Transports must rally to new highs or the Dow will move down with the Transports.

This market has come a long, long way. Even with an alleged “spike” in volatility, the VIX index is still only slightly below 11, historically very, very low. The slumping Transports and “sell on the news” FAANGs suggest investors and stocks need to at least pause and take a deep breath.

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Last week, this commentary said, “For U.S. investors, currency changes have wiped out much of European markets’ excess gain.” An astute reader pointed out this was not the case, so I have corrected the piece and regret the error.

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