When it comes to technical analysis, I follow a century-old—and very effective—market direction tool called Dow theory. And right now, that indicator is flashing a red warning sign.
The idea behind Dow theory is very simple. It says that for stock market prices to continue rising, both the Dow Jones Transportation Index and the Dow Jones Industrial Average need to be advancing at the same time.
As it stands, this isn’t the case. Please look at the chart below and pay close attention to the blue circled area. The Dow Jones Industrial Average is represented by the red line and the Dow Jones Transportation Average is represented by the black line.
‘Dow Jones Transportation Average Index vs. Dow Jones Industrial Average Index,
Jan.-Apr. 2015,’ Chart courtesy StockCharts.com
Until mid-March 2015, both of these averages were moving in the same direction. Now, the Dow Jones Transportation Average is collapsing, but the Dow Jones Industrial hasn’t followed. This is the wrong combination to have. In fact, the disparity between these two averages is the biggest we have seen in the last two years!
The Dow Jones Transportation Average is down more than five percent year-to-date, while the Dow Jones Industrial is slightly up.
According to the Dow theory, stock prices are set up for a decline.
Collapsing Copper Suggesting Market Sell-Off Ahead, Too
Sadly, Dow theory isn’t the only indicator suggesting a market sell-off is nearing. When I compare copper prices to the stock market’s performance, they suggest we may be headed towards a bigger crash than we saw back in 2009.
Please see the chart below comparing copper prices (brown line) and the stock market as represented by the S&P 500 (green line).
‘Copper Spot Prices vs. S&P 500 Index, 2000-2015,’
Chart courtesy of StockCharts.com
Copper prices have been trending downward since the beginning of 2011, while equity prices have marched higher—a massive disparity. This is not a good combination to have. The last time copper prices crashed was in early 2008 and a few months later, stock prices crashed.
Where Stocks Prices Are Headed Next
I have seen several stock market crashes in my investing career. They usually happen when nobody expects them.
Right now, there’s too much optimism towards the key stock indices. The valuations are insane (in my opinion), as it’s almost every other day that we hear about some company doing an initial public offering (IPO), raising a significant amount of money on a simple idea and no earnings as if it’s the 1999 tech bubble all over again.
I see the upside for stocks as very limited, if any. My forecast for the stock market remains negative. There’s a perfect storm brewing for stock prices; it’s just a matter of time before the market falls apart.