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June 21, 2021

Stock Market Outlook: weak technical indicators suggest caution

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Relatively weak technical indicators have been signaling diminished bullish power and growing weakness. Some now are suggesting a medium-term downtrend for the stock market.

Stock prices turned down last week after news that the Federal Reserve revised upward its estimate of inflation to 3.4% this year, compared to its previous 2.4% estimate. In addition to "higher and more persistent" inflation, the Fed now expects rising interest rates starting next year.

Investor sentiment indicators have warned of bullish complacency and unsustainable overbought Greed for many months. A substantial majority of bulls implies potential vulnerability to a downside stock market price reversal or sideways correction/consolidation.

Economically sensitive commodities, such as Copper and Lumber, topped out six weeks ago and have turned weak. A growing number of investment strategists suspect that we may be near the peaks of government monetary and fiscal stimulus, favorable economic and corporate earnings comparisons, and investor sentiment. If these peaks are indeed behind us, then more normal, two-way, up-and-down stock price action, with more typical 5%-10% downside corrections, very well might lie ahead.

Probable Potential Reward appears less than Probable Potential Risk for the stock market. Stock prices have run far ahead of quantifiable reality. Stocks are overbought and overvalued relative to traditional measures: sales, earnings, dividend yields, and book value. Stocks are priced for an extremely optimistic future, ignoring all potential bumps in the inherently unpredictable road ahead. History shows that overly high stock prices are followed by low returns, and overpaying for stocks is not profitable.

The SPDR S&P 500 ETF Trust (SPY) fell 2.22% last week for its largest decline in 4 months. Most technical indicators confirmed the weakness. Leading technical indicators, RSI, MACD, and On-Balance Volume have been and remain significantly weaker than price. Relatively weak technical indicators suggest diminished bullish power. The 50-day SMA (simple moving average, now at 416.00) had been providing support on price dips, but it was violated on Friday, signaling a medium-term downtrend. The many traders who rely on the 50-day SMA will be expecting further price declines.

The QQQ Nasdaq 100 ETF (QQQ), which is heavily weighted by Technology stocks, rose to a higher high on Thursday. QQQ significantly outperformed the S&P 500 ETF last week, possibly suggesting a change in investors' preferences. Leading technical indicators, RSI, MACD, and On-Balance Volume did not make higher highs, so they continue to lag price, thereby demonstrating bearish divergence against price. Relatively weak technical indicators suggest diminished bullish power and the potential for price weakness.

The Russell 2000 ETF (IWM), which is composed of relatively small-capitalization stocks, continued to underperform the SPY last week, as it has since 3/18/2021. IWM price broke down below its 50-SMA on Friday, signaling a medium-term downtrend. On-Balance Volume, a leading indicator of price, fell to its lowest level since March. RSI and MACD short-term momentum oscillators turned down, confirming the price downtrend.

Both the Dow Industrial and Transportation Averages peaked on 5/7/2021, and both broke down below 50-day SMAs and their May lows last week, signaling significant weakness relative to SPY and medium-term downside corrections. Leading technical indicators are bearish.

The Percentage of S&P 500 stocks above their own trailing 50- and 200-day SMAs peaked in April, and so these breadth-momentum indicators have been diverging bearishly relative to the price of the S&P 500. The majority of the S&P 500 stocks are now below their own trailing 50-day SMAs, which is a sign of developing broad market weakness.

The Cumulative Daily Advance-Decline Line fell to a 3-week low last week. That drop was the largest decline since early May. Still, the A-D Line remains stronger than most of the other technical indicators. Holding consistently above its 50-SMA since early November, the A-D Line has been an accurate indicator of the stock market uptrend. At this point in time, the A-D Line is not yet confirming a substantial downside correction for the stock market.

Net New Highs fell below its 50- and 200-day moving averages, signaling a move toward a bearish trend. Net New Highs peaked on 5/10/2021 and failed to confirm new highs for the S&P 500 this month.

Dr. Copper, a top economic forecaster, fell sharply last week to its lowest price level in 2 months. Copper broke down below its 50-SMA. The technical indicators have been and remain weaker than price, which is an unfavorable sign because they tend to lead price. Copper appears to have topped out, and so the economy very well may be topping out as well.

Lumber price broke down below its 50-day SMA (simple moving average, now at 1271.34) on 6/7/2021 and continued to decline 9 out of 10 days since. Lumber is confirming a bearish trend change for the medium term. RSI, MACD, and On-Balance Volume are leading indicators of price, and they remain weaker than price, which is evidence of bearish divergence. Lumber Bulls have been looking forward to continuing robust demand for new houses, spurred by abundant money printing, low interest rates, pent-up demand, and expectations of further rapid inflation of house prices. The chart of Lumber appears to be telling us that the peak of this optimism has passed.

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Robert W. Colby, CMT,
is a consultant to institutional and private investors and traders, providing regular analytical reports, custom research services, and trading systems tailored to clients' objectives. Clients include the most successful traders and investors in the world. Robert is the author of The Encyclopedia of Technical Market Indicators, Second Edition, McGraw-Hill, 2003, which has become the standard reference for indicator and trading systems design. Previously, at several large Wall Street firms, Robert worked as a proprietary trader, technical analyst, and fundamental analyst. He also was adjunct professor at New York University and New York Institute of Finance, where he developed new courses on technical analysis and market timing.

Robert W. Colby is a Chartered Market Technician (CMT), an accreditation granted to members by the CMT Association (https://cmtassociation.org/) after demonstrating professional competence and ethics over a period of many years. Robert has been a member since 1980, and he strongly supports the CMT Association's high standards. He also supports the The Technical Analysis Educational Foundation (https://www.taeducation.org/about/), which works to have technical analysis included in the curriculum of major business schools. The CMT Association is the national organization of investment analysts, stock market analysis professionals, and certified market technicians in the United States.

 
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MetaStock® PC Software for Technical Analysis
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