Still Underwater

Despite Tuesday’s rally, as I pointed out in my video recap, it amounted to an “inside day” on the major indices and sectors, not yielding many answers about the short-term direction of the market. Monday’s sharp sell-off has yet to be negated in many respects, which means the alternative thesis I discussed over the weekend is still a viable one.

Here is the relevant subsection from this past weekend’s Weekly Strategy Session.

3. The Alternative Thesis

The alternative thesis is that, regardless of sentiment which is highly subjective in nature when trying to gauge it, the market had already been showing cracks in the foundation. And last week’s V-shaped rally still did not adequately negate the issue of narrowing leadership. This thesis subscribes to the notion that market tops are a process, not a singular event. Therefore, sharp sell-offs, like we saw two weeks ago, followed by V-shaped rallies to new highs are all part and parcel of the wild price swings you see during topping processes.

Instead of getting caught up in semantics or dogmas, let us simply have a strategy headed into this week where we can tangibly measure the veracity of this alternative thesis, which breaks with the bullish prevailing uptrend and assumes a deeper correction is in the works.

Thus, we are going to watch the Dow Jones Transportation Average, Russell 2000 Index, and the homebuilder ETF, all three tried and true market leaders in recent quarters. Specifically, we are looking to see whether they confirm recent highs in the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite Index by making new highs in their own right.

On the following daily charts of the Russell, transports, and homebuilders, note that all three failed to make new highs last week, despite the major indices doing so. On its face, that is not necessarily bearish, per se. But if the alternative thesis is going to hold any water, then these areas of the market, again former leaders, would need to roll over hard imminently to make the topping thesis all the more pronounced and colorable. By contradistinction, if they make new highs and confirm last week’s moves by the major indices, the alternative thesis loses its luster.