— “Profit Confidential” Column, by special guest columnist
Anthony Jasansky, P. Eng
Over the last two months, the stock market has been trading in a very narrow range, frustrating bulls and bears alike. Only the Dow Jones Industrial Average and the Dow Jones Transports made very marginal new 52-week highs last week. The Dow Jones Industrials remain the media’s favored indicator of stock market health. This, in spite of its inclusion of only 30 stocks and its bizarre formula based on price weighting of individual stocks.
From the following description (www.nyse.com), a solid argument can be made that the most representative price index of common stocks traded on the NYSE is the latest version of the NYSE Composite.
“In January 2003 the NYSE reintroduced the NYSE Composite Index under a new methodology that was fully transparent and rule-based. Under the new methodology, all closed-end funds, ETFs, limited partnerships and derivatives were excluded from the index. As of year-end 2004, the NYSE Composite consists of over 2,000 U.S. and non-U.S. stocks. It is a measure of the changes in aggregate market value of all NYSE-listed common stocks, adjusted to eliminate the effects of capitalization changes, new listings and de-listings. The index is weighted using free-float market capitalization and calculated on both price and total return basis.”
Excluding hundreds of new ETFs and Closed End Funds (CFs) listed on the NYSE is a very important feature of the index. A lot of them are invested in various fixed-interest-paying securities. Depending on the trend in interest rates, like the current historically minuscule rates, including these securities in trading data can substantially distort the breadth and volume trading data used by market analysts.
For example, on Friday December 1, 2009, as the Dow Jones Industrial Average made a marginal new high, 220 NYSE stocks also hit their 52-week highs. A quick look over the list of new highs has revealed that nearly 23% were various fixed income holding ETFs and CFs. The strength of income funds, driven by the Fed’s “zero interest policy,” make the NYSE breadth look much stronger than it actually is.
The chart of the NYSE Composite shows that the rebound in the market has stalled at the level corresponding to a 50% retracement of the 2007-2009 market meltdown. The same also applies to the S&P 500 and a few other indices. Interestingly, in spite of reported gains in the Chinese economy the Shanghai Composite has managed, so far, to retrace only 38.2% of its whopping 73% bear market slide.
Currently, there are no convincing indications by the technical and the sentiment indicators we keep as to the direction of eventual market breakout from the trading range of the last two months. My own subjective view is that the market rebound has been very over-extended and has elevated stocks to fundamental valuations much too rich for an economy still struggling, ignoring the ongoing vulnerability in the financial and housing sectors.
The stock price charts of Goldman Sachs and JP Morgan, the two leading stocks of the financial sector, show “ugly” topping formations. Even the stocks of the “world’s best banks,” such as Royal Bank, lost much of their upside momentum. The weak rebound in the housing index is another discouraging technical sign. Downside breaks in GS and JPM would likely turn the two-month market consolidation into a full-fledged correction of the March-October 2009 rebound.