Mind The Charts: Stocks Are In The Riskiest Position In Seven Years

MAJOR STOCK INDEXES ENTER CORRECTION TERRITORY… After suffering the worst start to a new year in history, the U.S. stock market has entered correction territory which is defined by a drop of 10% from its old high. The charts pretty much speak for themselves. All three major stock indexes fell to three month lows in heavy trading. The next downside target is the two lows formed in August and late September.

What the indexes do from there will determine whether the current downturn is just a correction or something more serious. Unfortunately, some portions of the market have already broken those support levels.

SMALL AND MIDCAPS BREAK SUPPORT… Relative weakness in small and midsize stocks gave early warnings in December that the yearend rally was mainly a large cap affair and too narrow to continue. That situation has gotten a lot worse since then. Charts 4 and 5 show the Russell 2000 Small Cap and the S&P 400 Mid Cap indexes falling below their 2015 lows. That puts them at the lowest level since October 2014.

That’s another important test for them and the rest of the market.

TRANSPORTS ENTER BEAR MARKET TERRITORY… Chart 6 shows the Dow Jones Transportation Average falling to the lowest level in two years. It has lost -25% from its late 2014 high which puts it into bear market territory. What’s surprising is that the transports haven’t gotten any help from plunging energy prices. That may carry bad news for Dow Theorists who link the direction of the transports with the Dow Industrials.

It may carry good news for the Dow Utilities, however, which are showing more resilience. Chart 7 shows the Dow Utilities holding up a lot better than everything else.

It was the only market sector to register a gain during the week. Its relative strength line (top of chart) is rising as well. Since utilities are considered bond proxies, their relative strength large reflects the recent rotation out of stocks and into bonds.

BOND/STOCK RATIO FAVORS BONDS… As usually happens when stocks fall, bond prices are rising. That’s especially true of longer-dated Treasury bonds. The green line in Chart 8 is a ratio of the 7-10 Year Treasury Bond ishares divided by the S&P 500 SPDRs. The ratio spiked last August when stocks tumbled.

The ratio has spiked again to the highest level in three months. Bond prices are also benefitting from the deflationary impact from falling commodity prices. Two other assets attracting safe haven buying are gold and the Japanese yen. Some measures of foreign stocks (both developed and emerging) have already fallen to 52-week lows. That doesn’t bode well for U.S. stocks which are now in the riskiest position since the bull market started seven years ago.