A signal for the Dow from the Nasdaq

Looking at other markets can give you useful clues as to where your chosen market is heading, says John C Burford, So, what can the more volatile Nasdaq tell us about the Dow?

The US stock markets are flying. Sentiment is very bullish not just towards stocks but also the wider economy, with real estate a major focus of positive comment. Even British people are getting more optimistic.

But as all students of sentiment data know from experience, market tops occur when sentiment measures show high levels of bullishness. And when we see these signs, we should expect a major top of some kind up ahead.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

One of the great errors people make when discussing the stock market is that they believe a rising stock market indicates an improving economy, and is caused by an improvement in sentiment. They think that stocks forecast where the economy will be in the months ahead.

This is patently false.

Advertisement
Advertisement - Article continues below

If it were true, then why has the market consistently made its major tops in history when the most recent economic data is super-positive and sentiment is extremely bullish? You would expect under this model that after positive news, the market would always react positively.

But sometimes it does and sometimes it does not. It depends on context within the Elliott wave structure!

New economic data reflects the position after the fact and has absolutely no forecasting power.

If GDP for the latest quarter is reported, that data reflects business up to six months ago! Conditions and sentiment will have changed in the interim. So it is current sentiment that determines the price level of stocks, not old data.

And since the decision to buy or sell stocks can be acted on instantly with the click of a mouse, the stock market, being so widely followed by the public, is the best thermometer of public sentiment in real time.

There are always negative developments lurking in the background the rapid slowdown in China is an example today.

Advertisement
Advertisement - Article continues below

On Friday, I offered an analysis of the Dow and described two sets of tramlines that are currently working. And in one of them, we have seen a tramline break. Here is the current chart:

13-7-22-MWT-1

This break is the first sign that the stock market may be turning. It is not definitive, but could well be the first clue.

Also on Friday, the latest commitments of traders (COT) data shows another market swing to the bullish camp by the specs. Both the large and small specs took part in this and now the hedge funds (non-commercials) are now over seven-to-one in the bull camp.

Non-commercialCommercialTotalNon-reportable positions
longshortspreadslongshortlongshortlongshort
($5 X DJIA INDEX)Open interest: 117,118
Commitments
45,4116,34162054,20197,344100,232104,30516,88612,813
Changes from 07/09/13 (Change in open interest: 11,438)
1,729-1,635697,85313,3549,65111,7881,787-350
Percent of open in terest for each category of traders
38.85.40.546.383.185.689.114.410.9
Number of traders in each category (Total traders: 98)
3213636237238

This data point is a flashing warning light for the bulls. It is a very crowded trade indeed.

A clue from the Nasdaq

Yes, I believe there is and it lies in the Nasdaq. The Nasdaq is regarded as much higher-risk that the Dow. It contains the shares of more speculative and early-stage companies, frequently in the technology industry.

Generally, when sentiment is bullish, the Nasdaq will out-perform the Dow and vice versa. That has been true recently.

Advertisement
Advertisement - Article continues below

Because more bullish energy is invested in the Nasdaq, I expect it to lead the way down, followed by the Dow.

The majority opinion is that we are in a recovery and projections of GDP growth are positive. The possibility of deflation has been dismissed as preposterous by the vast majority of economists.

To test whether my theory of markets is correct, let's monitor GDP data after the markets have turned down and check if the numbers match the current projections. That should be interesting!

Google and Microsoft turn the market

Let's take a look at this decline:

13-7-22-MWT-2

There is a clear five-wave impulse wave down to Friday evening's low.

There we have a clear sign that the market may have turned, since five waves down implies a change in trend according to the Elliott wave model.

Advertisement
Advertisement - Article continues below

And this morning, the relief rally has carried right to the Fibonacci 38% retrace and is currently declining again.

Of course, if the market continues its rally into new high ground, this picture is cancelled. And so far, the Dow has not followed suit by offering a similar five-wave pattern down yet.

But as I write, we may be in the early stages of it here is the 15-minute chart:

13-7-22-MWT-3

We could currently be in wave 3, which would take it close to the 15,520 area.

I have a feeling this week will reveal many more clues, and could be pivotal in many markets.

Advertisement

Recommended

Visit/519524/how-my-2019-spreadbetting-tips-fared
Share tips

How my 2019 spreadbetting tips fared

Matthew Partridge reviews performance of his 2019 spreadbetting tips. This year’s winners include Bellway, JD Sports and Taylor Wimpey.
17 Dec 2019
Visit/519285/bettingon-politics-some-safe-labour-bets
Spread betting

Betting on politics: some safe Labour bets

Matthew Partridge outlines a few flutters on what should be safe Labour seats in the general election.
10 Dec 2019
Visit/518916/ds-smith-will-deliver
Spread betting

DS Smith will deliver: here's how to play the share price

Packaging group DS Smith is profiting from the online retail boom. Matthew Partridge explains how traders can play the share price.
3 Dec 2019
Visit/518908/betting-on-politics-28
Spread betting

Betting on politics: don't put your money on the SNP

Scottish voters are strongly opposed to another independence referendum, says Matthew Partridge. That opens up a few tasty punts against he SNP.
29 Nov 2019

Most Popular

Visit/520525/currency-corner-how-high-can-the-pound-go-against-the-euro-in-2020
Currencies

Currency Corner: how high can the pound go against the euro in 2020?

In the month in which we should finally leave the European Union, Dominic Frisby takes a look at the pound vs the euro and asks just how high sterling…
13 Jan 2020
Visit/520338/how-much-the-state-pension-will-rise-by-this-year
Personal finance

How much the state pension will rise by this year

While Boris Johnson promised to hold a full budget within 100 days of his election victory, many of the details of next year’s state pension increases…
10 Jan 2020
Visit/520575/20-predictions-for-the-2020s
Investments

Where will markets be in 2030? Here are 20 forecasts for the 2020s

A lot has changed in the last ten years – stockmarkets soared, technology transformed our lives and politics has changed beyond measure. Here, Dominic…
14 Jan 2020
Visit/520258/running-with-the-crowd-is-bad-for-your-finances-heres-how-to-resist-it
Investment strategy

Running with the crowd is bad for your finances – here’s how to resist it

To be a good contrarian investor, you have to avoid being swayed by the crowd. John Stepek explains how to go about it.
3 Jan 2020