Getting Technical

The Invisible Stock Market Correction

Most market watchers are looking for a healthy giveback of the postelection rally. They may not get it.

By Michael Kahn

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Pixabay
 
 
If there is one thing we should know about the stock market, it’s that there are no sacred cows. No market method works all the time, and many entrenched beliefs don’t work at all anymore. That is why we should not rule out a continuation of the market’s rally without a typical pullback or correction.
 
Futures on the Dow Jones Industrial Average plunged more than 750 points overnight on Nov. 8, as it became clear that Donald J. Trump was going to win the presidency. Pundits thought the market’s decline over the subsequent few weeks would be colossal. Yet when the market opened the next morning for regular trading, one of the sharpest rallies we’ve seen in a long time began.
 
As we might expect, a good number of analysts and traders — including yours truly — said that the postelection rally needed a decent short-term correction to work off overbought conditions and, as the media love to say, “take some profits.” Indeed, the Dow’s momentum indicators showed extended readings suggesting it was time for a pullback.
 
But the Dow, the small-stock Russell 2000, and a few other major indexes have held their ground (see Chart). The Nasdaq Composite continued to set higher highs and reached all-time highs this week.

Chart

 
Where is the correction? After all, we are taught in all investment seminars that markets do not go up in a straight line. Corrections are a necessary part of the process.

Yet we are also taught, or should be, that the market can maintain its posture longer than we think it can. The actual quote is: “The market can remain irrational longer than you can remain solvent.” Its attribution is a bit cloudy.

On Wednesday, the bears got an ideal opportunity to take the market down into that correction during the president-elect’s press conference, and indeed, biotech led the market sharply lower in the morning. But then the broad market rebounded.

This is not important for any policy or personal issues involved but because it was the excuse for that long-awaited correction to begin in a big way. It did not, at least that day, and that tells us there is strength in this market that continues to percolate beneath the surface.          

Charts of the market have only two components — price and time. Everything else is a derivative, including how fast prices are changing over time (trend and momentum) and how far apart nearby prices are from each other (volatility).

In a price correction, we typically see a decline after a rally. Conversely, in a time correction, we can see just a simple pause or even a chart pattern such as a triangle. Just before the market resumes its advance, price is usually very close to where it was when the correction began.

That is what seems to be happening with the Dow. The rally stalled out in mid-December, with a closing price of 19,911. That is about where it is now, despite numerous attempts to breach the 20,000 level along the way. (The Dow traded at 19,879 Wednesday afternoon.)

Technically, this has allowed momentum indicators to back down to more-neutral readings. It has also brought volatility down to levels below those seen last October, when the market was last trapped in such a tight range. For the Dow, this represents a multiyear low in volatility as measured by standard deviation-based Bollinger Bands analysis. The Standard & Poor’s 500 index is close to the multiyear volatility low it set last August.
 
A correction is supposed to work off the froth and excessive speculation of a strong rally.
Whether that happens in price or in time does not matter — so the correction-seeking pundits may have already gotten their wish.
 
Can the market still fall in price? Of course. But it will have to do so for other reasons than just being overdue for it.
            

Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.

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