Five Key Signs of Market Downturns

Monday, October 6, 2014

By Sheila & Rich Jamison          

Market volatility continues. Recent JFG Insights on preparing for where we go from here have drawn interest and questions. Most questions center on how to tell when markets are actually turning and not just suffering a drop on that day.

If only it were this easy

Markets generally don’t simply go up for a period of time and then, one day, turn around and go down for the next cycle. That would be easy to handle; sell everything on the first down day, wait out the down period, and buy it all back (cheaper too) on the first up day.

But it isn’t that easy

No, markets are volatile. Days can alternate between good and bad. That renders the approach in the last paragraph essentially useless to us. Day traders may play this way, but it’s not of value to investors. For our purposes, day trading is too close to sitting in at the blackjack table.

Market timing?

The media frequently discusses “market timing” with gusto. What is omitted from those discussions is any definition. This leads to confusion. How can there be studies saying it’s good and studies saying it’s bad? Generally, because these studies use different definitions for market timing.

At the long end of the spectrum, anyone who sells anything during their lifetime can be accused of market timing. At the other end, we get back to the day traders before we hear that term applied. Somewhere in between 20 minutes and a 20 years there is what we feel is a beneficial way to move in and out of the market.

Looking for the longer trends

Trend is another word that varies depending upon who uses it. There is no absolute definition of when a trend begins and when it ends. The points you pick determine what you call a trend.

The DJIA’s 80-year trend

To get back to the long end of market timing, let’s use the Dow Jones Industrial Average (DJIA) as an indicator of the overall market. The DJIA was 40 in 1932. It closed above 17,000 last week. So, over that period, the DJIA has been in an uptrend. Does that mean it was good to be in the market all that time?

Obviously not. Between being in the 14,000s in 2007 and 17,000 now, it was 6,594 in March, 2009. The trend from 2007’s 14,000 down to 2009’s 6,594 was a downtrend … and a good time not to be in the market. The trick is differentiating between a drop in the value that is short-lived and one that says something bigger could be coming.

How Do We Judge?

We use several indicators* that show a potential change in the overall market direction. No one by itself provides enough information. But combine all five and we get a pretty good sense of where the market is headed.

This is not infallible. Everything around the markets is always subject to change … even if it worked a zillion times before. That’s the derivation of the common warning “past performance doesn’t guarantee future results.”

The Five Indicators

  • Positive Trend Indicators Below 50%

  • Lower Tops in the Bullish Percents

  • Relative Strength of Defensive Classes Besting Those of Offensive Ones

  • Major Indices Trend Charts Turning Negative Violating Important Support Areas

  • Narrowing of Leadership from Individual Sectors

Before Your Eyes Glaze Over

Unless you’re managing your accounts yourself, you don’t need to know how to measure these indicators. In fact, you don’t even need to be aware of them … as long as whomever you depend on is. I will explain more about them here for one reason … to help you feel more comfortable because you know more about what is going on.

What These Indicators Tell Us

The basics are this – all of these indicators tell us something about what is going on in the markets. (Need I say it again? Never predict. Look at and listen to the markets. They will let you know what IS going on.)

Indicators Explained 101

In an oversimplified way, this will explain what each of the five key indicators tells us:

  • More than half of the trends of individual securities in the universe monitored have changed from positive to negative. In different words, more than half of the securities measured are now in negative trends.

  • These charts show us when buy signals for securities in the universe monitored are becoming fewer.

  • Remember RS as an arm-wrestling contest between any two competitors. This indicator tells us when defensive asset classes are beating the offensive ones.

  • Trends of the major indices turning negative is self explanatory. The DJIA’s downturn from 2007 to 2009’s low is a good example. These show us when an index’s value has dropped far enough below the ‘norm’ to consider the drop to be outside volatility and potentially the beginning of a more significant downturn.

  • This measures what we call favored sectors. Sectors are often faster at signaling market turns. When the number of favored sectors falls, there could be additional ones to follow.

Pretty Simple, Wasn’t It?

I mean, of course, the concepts underlying the five key indicators. Though the calculations may not be easy, the idea of what each is doing is. Each shows a different measure of what is happening in the market now. The more of them that line up in one direction, the higher the probability of them pointing us to the right path.

Bottom Line

We never even try predicting. We work with a number of indicators that show and tell us when things are actually changing – changing by enough magnitude to say, “It’s time to get ready for what might be around the very next corner you turn.”

* The universes we follow include securities on the New York Stock Exchange, in the S&P 500 index, in the NASDAQ composite index, all optionable stocks, 40 sectors and subsectors. the DJ Bond Index, US 5-, 10- and 30-year Yield indices, The World Index, currency indices and sundry others that depend on the indicator.

Charts from the following sources were used:
Barchart.com, Dorseywright.com, Finance.yahoo.com and Fnvesting.com.
Data for period through close of business on October 3, 2014.

The Wall Street Journal; The Wall Street Journal Online; Bloomberg News; BBC News; The Associated Press; Crain’s New York Business; MFS research; NYSE; NASDAQ; Dorsey-Wright Associates; NYMEX.com; CNBC’s Power Lunch & Squawk Box programs; Investing.com; Markit.com; the New York Times; Standardandpoors.com; Djindexes.com; 247wallstreet.com; MarketWatch.com; Morningstar.com; Thomsonreuters.com; the Financial Times.com; Briefing.com; BusinessWeek.com; Dol.gov; Fxstreet.com; Streetinsider.com; Ycharts.com

The data above were taken from sources deemed reliable. However no guarantee can be made as to their completeness and accuracy.
Interpretations of the data, views and/or opinions expressed are those of the Jamison Financial Group based on market and economic conditions as of October 3, 2014 and are subject to change. They do not necessarily reflect the opinions of any other individual, group or organization.
Nothing in the above is meant to be, nor should it be construed as, investment advice or recommendations to buy or sell any security. Individual securities whenever mentioned are for illustrative purposes only and may not be relied upon as investment advice.
All indices are unmanaged and are not illustrative of any particular investment. A direct investment cannot be made in any index.
The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.
The NASDAQ Composite is a market-weighted index of all the over-the-counter common stocks traded on the NASDAQ system.
The S&P 500® is a market-capitalization-weighted index of common stocks.
Tax and/or legal information contained herein is general in nature and for informational purposes only. It should not be relied upon as advice. Consult your tax professional or attorney regarding your unique situation.
Past performance is no guarantee of future results.

© 2014 Jamison Financial Group. Please feel free to distribute copies to individuals you feel may benefit from the information presented. Commercial use is prohibited.