The stock market lost ground last week with the S&P 500 Index (INDEXSP:.INX), NASDAQ Composite (INDEXNASDAQ:.IXIC) and Russell 2000 Index (INDEXRUSSELL:RUT) all turning negative for the first time since November 8. The loss followed three weeks of consecutive gains and broad based rally. The losses also occurred despite a host of favorable economic reports.
The failure to celebrate the positive economic news is likely due to the fact that stocks entered the week overbought with investor optimism more widespread. This suggests that short-term liquidity is becoming exhausted and the stock market rally may be getting tired.
The Dow Transports, however, moved opposite the trend finishing the period with a modest gain. The performance of the Dow Jones Transportation Average (INDEXDJX:DJT), which has gained 11% since the election, is considered significant given their record as a leading indicator of the economy. Dow Transports leadership bodes well for the broader market’s prospects.
Reports of stronger-than-expected gains in manufacturing and the lowest unemployment rate since 2007 nearly guarantees the Fed will raise interest rates in December. The good news is that a rate hike is likely built into current prices.
Entering the new week stocks are poised for a higher opening on Monday. The S&P futures first reaction to the Italian referendum was to move lower in overnight trading. But given what followed the Brexit and Trump victory the markets likely were not to be fooled again by the movement toward nationalism and popularize. This does not take away from the stress that could be applied on the banking sector in Italy and the increased pressure on the Eurozone as a result of the collapse of the Italian government.
The early part of December could find U.S. stocks continuing to struggle with an overbought condition, mounting investor optimism and potentially premature enthusiasm over the prospects for a year-end rally.
On balance of the technical indicators favor further upside for stocks. The broad market stalled last week but the reaction since November 8 suggests that most areas of the market are in harmony with the popular averages. The Dow Transports, in addition to playing a role in economic forecasting, have a long history in technical analysis as it pertains to Dow Theory signals. The Dow Theory signal model suggests the primary trend is bullish when both the Dow Jones Industrials (INDEXDJX:.DJI) and Dow Transports (9049) are in gear. In recent years, the industrials and transports have been at odds with the industrials hitting record highs while the transportation average has failed to surpass the 2014 peak (9310). The transports have made up significant ground in 2016 and are within striking distance of reaching new high ground, which would trigger a Dow Theory buy signal. This would confirm the message from other measures of the strength of the broad market breadth that indicate that most areas are in harmony with the primary trend.
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