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A Correction Creeps Closer

Though 2018 could be another strong year, evidence is mounting that a pullback may finally be in the cards.


It was a great 2017 for stocks, with record high after record high and an enviable string of gains in every month of the year for the first time ever. While there is still some gas left in the tank, technical analysis reveals some issues that should give one pause.

Early last month, I wrote here that the rally had kicked into a dangerous overdrive. It was based on the Standard & Poor’s 500 index trading above the channel that had guided it higher since the start of the bull run in early 2009. Technology was in a pause, but banks had broken out to the upside. Market breadth in general was still strong, so I concluded that there was no need to sell just yet—but also urged readers to keep an eye on things because conditions were getting threatening.

While we cannot make sweeping conclusions based on the final week of the year due to light trading and portfolio-restructuring shenanigans, we can still glean a few bits of evidence from the action.

For starters, the week ended on a very sour note, with the Dow Jones Industrial Average scoring a 118-point decline. It was not a very big move percentage-wise, but the relatively heavy volume told us that traders didn’t want to hold too many stocks over the long weekend. Tuesday’s rebound was likely relief at the end of an uneventful time off. Morning volume was modest and not roaring back to start a new year.

In the bigger picture, the daily chart shows momentum warnings on several formats. Most chart watchers will recognize the bearish divergence between common indicators such as the relative strength index and price action (see Chart 1). While the Dow eked out its 71st record high of the year—itself a record—momentum indicators set lower highs.

This tells us the market was coasting, not powering into the record books. A lack of sellers during the slow week was the reason the Dow gained—not because there was a surge of bullish activity.

The next warning comes from Bollinger Bands, which form an envelope around market action. When price action hugs the upper border, it is bullish, not bearish, unlike many other envelopes and channels. When price starts to peel away from the upper band, it’s another sign that the bulls are tired.

As John Bollinger himself warns, when the market makes a high above the bands—which we saw in early December—and then makes a higher high within the bands, it tells us the market has lost steam.

From a nontechnical point of view, tax reform is done and new challenges take its place. These include ever-escalating rhetoric from North Korea, unrest in Iran, and another looming government shutdown. Given the big win in 2017 for stocks, and the fact that managers likely got fat bonuses for riding it out, it seems the wind is gone from the market’s sails for a bit.

What’s more, in midterm election years, January is not the strong month it we usually believe it to be, according to Jeff Hirsch, editor of the Stock Traders Almanac and chief market strategist at Probabilities Fund Management. When you put the technicals, the geopolitical environment, and seasonal tendencies together, it gives the new year a shaky platform on which to build.

Again, this is far from a call for the end to this bull market, but it does look as if the market has changed. Last month, technicals offered a warning by identifying a very overstretched advance. This month, indicators and other conditions add a little more bite to back up that bark.

Getting Technical Mailbag: Send your questions on technical analysis to us at online.editors@barrons.com. We’ll cover as many as we can, but please remember that we cannot give investment advice.

Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.

Comments?E-mail us at online.editors@barrons.com

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