By Kris Sayce, editor, Casey Daily Dispatch
What a day for stocks.
There wasn’t much green yesterday…
But there was plenty of red.
It’s COVID… the Delta variant… or rather, what impact it could have on company earnings… and the impact that would have on stock prices.
The S&P 500 fell 1.6%. The Nasdaq fell 1.1%.
And the Dow Jones Industrial Average fell 2.1%.
So what’s the deal? Is this a pullback you should buy? Or a pullback that’s about to go even further?
We’d like to know. And we figured you’d like to know, too.
So we turn to the charts… to see if they can tell us anything about where the market is heading next…
If this is your first time reading the Dispatch, welcome. If you’ve been here before, welcome back.
At the Dispatch we have two goals:
To introduce you to the most important investing themes of the day, and
To show you how to profit from them.
We do this by showcasing ideas from our in-house investing experts: Dave Forest and Nick Giambruno. And from the founder of our business, Doug Casey.
Right now, the most important theme of the day is whether you should take advantage of yesterday’s stock selloff and buy. Let’s take a look…
This Is an Important Trendline
Whenever we look at charts, we always turn to our colleague, Imre Gams. As we’ve mentioned in previous issues of the Dispatch, at Casey Research, we aren’t traders.
But we do use the skills and expertise of traders to help us identify the market’s direction… and how we can help you take advantage of that.
In this case, we asked Imre to give us his take on the most iconic of the market indices, the Dow Jones Industrial Average (DJI).
Here’s what he told us:
It appears the DJI is struggling to build momentum.
On May 10, the Dow put in a short-term top. The ensuing correction lasted until June 18.
Since then, price action in DJI can best be described as slowly grinding higher. That’s in contrast to the Nasdaq, which had bounded to a new record high almost every day since June 18.
Of course, that all changed yesterday, with the Dow falling more than 700 points and the Nasdaq down 1.1%.
Looking at the chart, Imre explained why the Dow has struggled to build momentum since the high in June:
For the purposes of a quick analysis of the Dow, we’ll take a simple approach. We’ll use a single trendline and the 100-day moving average.
It’s easier to explain, especially to non-traders. And it gives us pretty much all the information we need to know anyway.
Here’s the chart.
You can see on the chart that Imre has drawn a trendline by connecting the low from March 2020 with another significant low from October 2020 (that’s the point in the middle of the chart where the index value touches the trendline).
According to Imre, this is an important trendline as it contained the entire rally in the Dow up until June of this year.
You can see that. The Dow index value repeatedly stays above the trendline. That was until the trendline broke in June.
That was significant. As Imre explains:
Traders’ eyes were on the Dow to see if a serious correction of 15% or more would occur after that breakdown. That hasn’t happened yet.
But this is where the 100-day moving average comes into play. Notice how it worked as a support level after it broke through the trendline, with the Dow bouncing nicely off it. It acted as a support after yesterday’s selloff too.
Also look at how over the past few days, the Dow has met the underside of that trendline. It means that trendline has changed from supporting the Dow’s advance to resisting the Dow’s advance. While the Dow has still crept higher since that June selloff, it hasn’t – so far – broken back above it.
While your editor isn’t a technical analysis expert, we appreciate how these chart patterns form. And we appreciate how it’s possible to use them as a guide for future price action.
This Won’t Continue Forever
So we asked Imre about what we can learn from this current setup, and what is likely to happen next:
The support provided by the 100-day moving average is very helpful. It gives us a clear indication of where the current floor for prices in the index should be.
The current situation where the Dow seems trapped between a moving average and a trendline won’t continue forever. Something must give.
But for the Dow to build up bullish momentum, it must break through that trendline and remain above it.
However, the 100-day moving average is very important. If the Dow breaks below this moving average, then we’ll see a deeper technical correction take place.
Imre explained to us that he expects the trend to resolve itself within the next few days. That the market will break one way or the other.
Folks often criticize technical analysis for being wishy-washy or for sitting on the fence. But that misses the point. It’s not necessarily about picking each price tick.
It’s about identifying key levels that can support a trend when the price breaks one way or the other. It means the market is in a transition phase – like now.
As we’ve shown before, that can either result in momentum for a new trend, where the price continues to move in that direction. Or it can result in a quick reversal, with the price rebounding back through a support or resistance line.
In this case, we still need to watch the market closely. Before diving in, the market suggests it’s better to wait a while longer before we know for sure whether now is a time to buy.
As always, we’ll watch this market action closely and provide more details as the direction becomes clear. Stay tuned.
Editor, Casey Daily Dispatch