There was a top extension in the NYSE composite index yesterday; which was also the last day of the current turn cluster. This combination always means that we recommend a trade and so it is here – sell US equity indices short.
US stock markets have been rallying lately and were pushing up into some resistance from old compressions, as we reported. This started on Friday last week/Monday this week and these compressions held markets down for several trading sessions. Yesterday’s strength pushed markets deeper into resistance (or even through it, as in this case) and now we have this extension. Those traders who sold short earlier will have found the last part of this rally a bit uncomfortable, but we now advise staying short, re-shorting or adding to short positions.
The US index that has most closely defined the price movement over the last six months has been the Dow transport index, here shown at a weekly scale:
This is now at the top of its range and so is likely to falter yet again. This index has been a great comfort to us in our recommendations and this will be the fourth or fifth time that we have advised taking short positions in a variety of equity markets when it is at the top of its range or long positions when it is at the bottom. Eventually, this index will break into a trend and it is highly compressed, as shown here. It is artificially maintained in its range (as are most markets in developed economies) by the tension between dire economic fundamentals (except in Germany) and the aggressive pumping of money to try and invigorate these stumbling indebted economies. Most indices don’t show this as clearly as this does, which is why we keep referring to it. When the end of the range comes, we will probably be caught on the wrong side of the break, but we are aware of the danger and will advise if we see a reason to abandon this approach.
There is some extra help for our bear view from other indices that have also extended recently:
The high degree of correlation that has persisted for over a year ensures that a drop in US stocks will have other consequences. One of the least obvious is that energy prices will probably now fall. We recently pointed out that several Nymex contracts were compressed. These have broken down and some follow-through weakness is now likely. The bullish counter-argument from Brent crude has now gone away so we are full-on bears.