July 13th, 2023

Another “Sucker’s” Rally?

The Consumer Price Index came in at 3 year-over-year, which was less than expected. Core inflation also came in under the forecast. Interest rates dropped sharply and stocks rallied at the idea that the Fed will once again talk about cooling rate hikes. The S&P 500 is hitting fresh 52-week highs (let that sink in for a moment), and the Russell 2000 keeps gaining 1% per day. Everything is great, right? What could go wrong?

Before we get into the New Dow Theory, we need to understand what the old theory is and why many are calling for a change. Then we can look at what the current theory is telling us about where the market is going.

Dow Theory is a fundamental principle of technical analysis that provides guidelines for understanding and analyzing stock market trends. It was developed by Charles H. Dow, one of the founders of the Wall Street Journal and the Dow Jones Industrial Average (DJIA), in the late 19th century.

The Dow Theory is based on the analysis of two key indices: the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA). According to Dow, the movements of these two averages can provide insights into the overall health and direction of the stock market.

In simple terms, the Dow producers were the ones producing goods, and Dow transports were the ones carrying those goods to the people.

You can see from the chart above that the Dow Transports (the bottom chart) tried to break out a few times, away from the Dow Industrials, in 2023.

While Dow Theory would claim this as a Bear Market False Breakout, we have to keep in mind that the Dow 30 that make up the Dow Industrials are no longer the major makers of goods.

Sure, some of them are, but I’d argue that the index is vastly different from the intent back in Charles Dow’s day. While JP Morgan has an important place in today’s economy, I’d argue that they don’t make anything – at least not like the Dow components did in the early 1900s.

The New Dow Theory compares the S&P 500 against the Nasdaq and once again looks for a confluence of the two indices to tell us the direction of the market.

You can see from the chart above that the Nasdaq broke out earlier than the S&P 500, but toward the end of June, both indices broke out to fresh highs, and the bull move was confirmed.

Both indices are looking at their previous swing highs and if both can break higher from here, we will once again have another bull move confirmed according to the new Dow Theory.

So, what could stop the parade? Well, we don’t talk about it too much but with earnings coming up around the corner we have to acknowledge that the S&P 500 is trading above its average earnings estimates, meaning that the market is overpriced at these levels, especially with low-to-moderate growth planned for GDP.

That means to keep up with current trading prices, stocks will need to beat earnings differently, and that usually means cost reduction. We will see how many companies talk about cost reduction or earnings estimate reductions during this earnings season.

While we are fundamentally way overpriced, you can’t fight what the tape is giving you and right now, the bulls could show they are still in control for a little longer.

Today’s trade idea is on Agilent Technologies (A). While I’m not a big bearish trader, I’m looking at a market that continues to rip higher while this stock struggles to gain ground. Weekly, this stock has been making a series of lower highs and lower lows.

Dropping down to the daily timeframe we can see that this stock has gapped down and is in a consolidation zone. 

You could certainly trade this as an iron condor between the $115 and $125 areas, but I’m looking for a drop lower. If you’re patient and want to stalk this trade, I’d see if it will trade up a little higher, up to $122.50 before placing a bearish trade.

If you’re looking at the last candle and saying, ‘That looks like a doji’ (trend reversal candle) and thinking this could start going lower, I’m looking at the 18 AUG 125/130 call spread for a net credit of around 1.20. That involves selling the 18 AUG 125 call while simultaneously buying the 18 AUG 130 call.

With most spreads, I’d set a profit target of around 50% – 80% and I’d look to exit the trade at either 100% of the credit received or close the trade if the current price crosses above the short strike.

If you have any questions, comments, or anything we can help with, reach us at any time.
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Jeff Wood

Editor, Filthy Rich Dirt Poor
Coach, Options Testing Lab

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