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Dow Theory, one of the oldest stock market forecasting methods, has shown a new buy signal: the Dow Jones Transportation Average joined the Dow Jones Industrial Average to close above January highs, according to Bank of America Merrill Lynch.
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CNBC.com |
However, the bank's [BAC
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] analysts said on Monday that a momentum indicator known as breadth thrust, which focuses on the proportion of advancing to declining stocks, shows a pull-back of 15 to 20 percent this fall when combined with the Dow Theory buy signal.
Last week the broad-based S&P 500 index closed above 1000 for the first time in nine months and is now up around 50 percent since March lows, while the Dow Industrials recently saw their best five-month run since 1938. The run-up has left many investors trying to second guess if and when a correction is due.
"The Dow Jones Industrial Average closed above its January high in late July, and the Dow Jones Transportation Average closed above its January high on Friday," Merrill said in a research note. "According to the Dow Theory, this signals a new primary uptrend and is a bullish indicator for the market."
Dow Theory aims to identify the primary trends in stock markets, lasting from one year to several years. It stipulates that the industrials index must "confirm" a high or a low in the Dow Jones Transportation Average for a trend to last.
Breadth thrust indicates when the market moves from an oversold condition when a gauge of the proportion of advancing stocks moves above a certain level. Merrill's analysis shows that significant corrections have followed strong rallies when a breadth thrust has occurred at the market bottom.
"This analysis, along with the Dow Theory new buy signal, points to a more modest 15 to 20 percent pullback," said Merrill.
Merrill is watching a number of indicators to gauge whether the market is entering an immediate correction. These include investor sentiment gauges, the peaking of buying and rise in selling, loss of leadership in technology, the percentage of stocks above their 200-day moving average, and a peak in China's equity market.
They say stock charts indicate S&P 500 support levels, or levels at which the index should not easily fall below, at 930 to 900 and resistance levels, presenting a barrier to for the index on the way up, at 1055 to 1065.
Data is a real-time snapshot *Data is delayed at least 15 minutes