News reports about market breakout are misleading
Friday my youngest son had a day off from school so I stayed home to do some things with him. I can honestly say that I didn’t even think about the stock market until late that evening. That changed after an offhand comment from my wife. My beautiful bride pays no attention to the stock market. So when she told me she saw a news broadcast earlier in the day reporting a breakout day in the stock market, that caught my attention.
“What exactly did they say?” I asked.
“They said the Dow set a new record high, as high as it was several years ago when the markets were going crazy.”
That really piqued my interest, so I quickly turned to a news channel so I could find out what caused this dramatic market surge. As I listened to the reports of the day’s market activity, the broadcaster made it sound like the day’s events were truly significant. Unfortunately, the tone of the reporting was misleading at best. It was true that the Dow and the S&P 500 reached new multi-year highs on March 17. Unfortunately, that fact alone is virtually meaningless.
Below is a 10-year chart of the Dow and the S&P 500 to show what I mean. The black line is the daily price movement of the Dow and the gold line is the S&P 500. Notice that while the Dow reached its highest point since 2001, it really did not make a dramatic breakout. Here’s another way to look at it: Since the prior peak in 2001, the Dow has now advanced 0.14%. If I am an investor who bought the Dow in 2001 the fact that five years later I am now back to even on my investment does not make me feel warm and fuzzy. And if instead, I bought the Dow at its all-time high in January of 2000, I’m still down about -3.5%.
Don’t get me wrong, I’m always happy when the market is advancing. But after reaching that peak on Friday, major averages have since dropped right back into the narrow trading channel that has constrained their movements for more than two years. Since the beginning of 2004, the Dow has advanced 7.5%. Since Nov. 3, 2005, the Dow has advanced 7.5%. In other words, we keep covering the same ground.
Take another look at the chart and see the month-to-month and year-to-year volatility of these indices for the first eight years of this chart. Those wild swings can be frightening, but they also make it possible to make money. Remember the old investing adage of “buy low and sell high?” For more than two years the difference between the lows and the highs has only been a few percentage points so it has been difficult to heed that advice.
Last week I outlined some reasons why I think the major market averages are soon going to break through the top of this range and stage a more significant rally. I still think that is the most likely scenario. But I’m not going to get excited until the indices break through the top of the channel and advance for several market sessions. I will also be more excited about a rally in the Nasdaq than in the Dow and the S&P 500. Often blue chip stocks rally when people are worried about market conditions. They seek the security of big name stocks. Most major market advances occur when the Nasdaq is the leader.
We continue to see industry sectors rotate leadership roles as the economy and markets try to resolve this sideways consolidation and decide whether or not the major averages will advance or retreat. In recent sessions we saw weakness in real estate. IShares Cohen & Steers Realty Major Index Fund (ICF) is still up 3.6% over the past month and these funds are still in an uptrend even though they saw a couple sharp down days. The telecommunications and transportation sectors are also still trending up. Over the past month, the best performing ETF has been Merrill Lynch’s Internet Infrastructholdr’s (IIH) which is up 7.5%. The top international funds have been Sweden (EWD) and Japan (EWJ), up 6.7% and 5.5% respectively for that period. Some of the weakest sectors over the past month have been energy and gold–sectors that led the markets just a few weeks ago.
For several weeks I’ve written about the tight sideways channel. I keep hoping for a breakout either up or down. I can’t stress enough how unprecedented it is to have this long a period with such a narrow trading range. As long as the markets remain in this state, it is going to be very difficult for anyone to make money.
Have a great weekend.