Portfolio Watch – Week of October 7

Weekly Market Update by the Economic Trends Research Group

Stocks

In the last update, we shared this chart with you that illustrated how the Dow Jones Industrial Average may be forming a “head and shoulders” top.  This top can often lead to a decline with the level of decline equaling the distance from the top of the “head to the trend line.

We pointed out that should the ‘neckline’ be broken to the downside, a decline to roughly the 13,800 area could be possible.  We stated, “Should the Dow break below 14,850 we would expect that a decline to around the 13,800 area could follow which is the approximate prior major low which could serve as support and a “mirror image” of the distance from the top of the ‘head’ in the ‘head and shoulders’ formation to the neck line.”

Over the last week, this pattern has continued to move toward completion and looks more likely this week than last week.

The market remains oversold and a brief rally before prices potentially break downward through the neckline remains a possibility.

Seasonally speaking, the month of October has seen several significant market corrections, so a decline beginning in October would be in line with seasonal expectations for the market.

A daily chart of the Dow makes this head and shoulders top pattern even more evident as seen from this chart.

While an initial decline for the Dow to just below the 14,000 range would not be surprising, ultimately, before this economic winter season ends we are looking for a far more significant decline.

Gold has remained in a tight trading range over the past week and our trend following indicators have gold officially “not trending.”  However, as we’ve stated numerous times, we ultimately expect the price of gold and the level of the Dow to reach par prior to the end of the present economic winter season.

US Government bonds remain in an uptrend over the last month, in spite of a brief pullback as investors watch and wonder about the ultimate outcome of the current political game of chicken taking place in Washington.

Meanwhile, the US Dollar reached a 23 month low against a basket of foreign currencies last week.  As far as currencies are concerned it’s a race to the bottom from a devaluation standpoint.  From a fundamental perspective, this world wide devaluation will ultimately be good for gold and other precious metals in our opinion.

Silver, a precious metal with an industrial application is rallying over the past week.  While our trend following indicators have silver in an official ‘no trend’ area, there may be two signs that silver could be ready to rally.

The weekly chart here is of an ETF that attempts to track the price of silver.

Notice on the chart that there was a recent ‘gap down’ in price.  If you look at the price bars in the latest decline, you notice a price gap about two thirds of the way down.  More times than not, in our experience, these price gaps end up being closed.  Should that occur here, price will have to rally.

Secondly, when reviewing the MACD indicator at the bottom of the silver price chart, one can observe a possible bullish divergence.  While silver prices fell to lower levels, the MACD histogram traced a higher low.  That is often an indication of a price reversal.  In this case, that indicator flashed a ‘buy’ signal in silver which ended up being accurate.  Given the price gap that exists in conjunction with this bullish divergence, we would tend to expect a rally in silver to close this gap.

Meanwhile, the VIX, or the volatility index, is edging higher as seen here.

Often, prior to a big stock market move, VIX moves preceding the big market move.  While the VIX is still in a relatively “safe” range historically speaking, we are watching it for a breakout move higher which would increase the likelihood of a stock market correction commencing sooner rather than later.

Unfortunately, there is no indicator to tell us what the policy response of the Federal Reserve might be should a market correction begin; however, we know one thing for sure.  The Fed has fewer tools to use should a market correction occur than they did after the last market correction.

“The simple believe anything, but the prudent give thought to their steps.”

Proverbs 14:15 NIV