Trader’s Narrative

Who could have imagined that with crude oil at +$110, the transports would be one of the highest relative strength sectors out there?

Well, if the stock market was strictly logical we would have figured it all out centuries ago. This is exactly what makes trading so fascinating.

Bullish Percent
The recent swing low was in early January, when the bullish percent for the sector reached a measly 5%. Five percent!

Do you know the last time they were that low? Try July 2002.

But since you’ve read my post about timing the market with bullish percent charts, you know all about that and of course, took obscene advantage of it. Of course.

But there’s more going on here. Take a look at this chart:

The top chart shows the relative strength of the transports (to the S&P 500). Notice the higher lows and the higher highs. Then check out the completed head and shoulder formation with a nice quick retest of the neckline.

Believe it or not, it has already made it to the October 2007 highs. In contrast the Dow Jones Industrial average is still well below that area on its chart.

Dow Theory
According to Dow Theory, major signals are given when the two major sectors (sometimes along with the third: utilities) confirm each other.

While the recent action is not bullish per se, at least according to strict Dow Theory, it sets up what is called a “non-confirmation” - in this case, for a decline. That is, because the Dow Transports didn’t confirm the lows that the Dow Jones Industrial Average reached but instead headed up.

What would be truly bearish, according to Dow Theory, is if both the Dow Jones and the Transports print prices lower than their January levels.

So right now what we have is simply the potential for a buy signal, if the Dow Jones continues to rally and rises above its February highs.

The Investor’s Intelligence Long Term Composite Indicator is a proprietary indicator generated from the scores awarded to over forty indicators. These indicators have been selected across a wide range of disciplines covering index trends, breadth, sentiment, money-flow and financial/economic factors. The scores awarded to each indicator are weighted to create an indicator that generates signals at market extremes…

The last time this aggregated indicator reached similar extremes were in August 2007, summer of 2002, and October 1999. So although the II sentiment measure is stubbornly stuck in bullish mode, their Composite indicator is most definitely flashing a buy signal.

My guess is that it is because of the rapidity of the decline as well as the low bullish percent indices for so many sectors.

Financial stocks have been the favorite punching bag of the shorts. And no expletive does the price action justice, especially if you’ve been long any of them as I have.

The problem is that no level of oversold seems to bring in enough strong hands to give it a reprieve. It seems that ever little bounce is just another chance for the shorts to pile on.

Things have gotten so bad that only 15.22% of the stocks in the sector have buy formations according to point and figure charting (as of yesterday’s close). To find things in similar disarray, we’d have to go back to early 2000 (14%) and late 1998 (11%).

Obviously, both of those were great buy points.

What gives more impetus to the argument now is that the banks and brokers are not the only stocks that are extremely oversold according to (bullish percent charts). Pretty much everything is - with the exception of energy. In fact, the last time the bullish percent indices for this many sectors were collectively this low was in mid August 2007.

For more information, follow this link to see how I use bullish percent charts to time the market.

This week the financial giants Goldman Sachs (GS), Bear Stearns (BSC) and Morgan Stanley (MS) will be releasing their quarterly earnings reports.

I’ve been patient and hopeful with this sector since it has been showing the classic signs of oversold extremes.

But each time it is given a chance to bounce back, it only musters a meager step or two forward… and then falls back.

You can see this in the bullish percent index of the sector:

In July it reached an extreme oversold level of 25% but couldn’t gain any traction. Then again this November the index fell to 20%. But after a feeble “dead-cat” bounce it has rolled over again. This behavior is a marked contrast to the previous years when the bullish percent index remained at very high levels and only sporadically dipped lower.

Looking at the price chart itself (the Philadelphia Banking Index) we see the same thing. A classic downtrend pattern of lower lows (green) and lower highs (red):

No question that things are downright ugly. Within the sector, only 17% of the component stocks are now sitting above their 200 day moving average. This is extreme. But it has been the case for most of the time since the swoon in July. Only 4% closed above their short term, 10 day moving average and a paltry 13% above their 50 day moving average.

But when oversold levels don’t lead to lasting rallies, you know something is wrong. The banks and financial stocks are acting very tired here and I would either wait to see a dramatic washout (the kind that has you gasping) or a miraculous sign of strength before giving them the benefit of the doubt again.

The last time I visited the transport sector, it was in mid August when the whole market was making its intermediate low. Like many sectors, the transportation sector had an extremely low bullish percent index. It reached a low of 15% which was as low as it had been for more than 2 years:

And once again, the bullish percent chart for this sector is in deep oversold territory. It is already bouncing back but there is still an opportunity to pick up great bargains in rails, trucking and shipping stocks.

Although the sector was deeply oversold the index didn’t really respond last time (August 2007). I think this time price will be more accommodating to a rally since it has fallen to major support and also, we’ve already seen bargain buying create a spike bottom.