Those looking for simplicity and easy answers should stay far away from the stock market. Although stocks represent ownership in an operating business, we cannot look at linear relationships to explain price swings. Instead, markets are complex and driven by evolving forces. Therefore, investors should assimilate a broad array of data in order to make decisions. That is the impetus behind my desire to look for confirmation of significant moves across various markets.
Different markets are driven by different factors. Brazil's Bovespa measures an emerging resource-driven economy that will be affected by total world growth and commodity prices. European markets are more developed and less prone to wild swings. Closer to home, the NASDAQ offers a measure of technology stocks; the Dow Jones Industrial Average (Dow) is designed to reflect the manufacturing base of the country; and the Russell 3000 gives an indication of how small companies are performing.
Given that indices are designed for different reasons and driven by competing interests, I am hesitant to rely upon one number as a measure of the market. Instead, I look for confirmation. If the Bovespa leaps higher along with the NASDAQ it shows that the global economy is recovering as companies buy natural resources to increase production of technology goods. If the FTSE and Dow also confirm the moves, it shows that larger, industrialized companies are also seeing an increase in commerce.
Together, these synchronized moves show that global conditions are improving to the benefit of all. However, if the moves are not confirmed by one another, it indicates that the rally is a random event that does not have great weight. A move up in the Bovespa with no parallel rally in an industrialized market raises the question of who is the end user of the commodities being sold.
Applying this framework to the current environment leaves us with more questions than answers. Following last week's massive gains, we now must consider whether the sell-off is complete and prices are prepared to run higher. Select markets say yes, but the broad array of indices is less conclusive as the current rally does not exhibit broad strength. Instead, four markets have reached new annual highs over the past two days, but all the other markets I track remain an average of 3.5% below recent peaks. Until these markets can push higher, we should remain skeptical of the current rally and expect prices to fall back into the established trading range, forcing investors to continue dealing with the same conditions over and over.
Over coming weeks, investors should watch for a few key developments. My focus will be on the Dow Theory. The Industrials recently closed above 8,800 to better their recent high, but the Transports refuse to confirm. A move by the Transports above the recent peak of 3,404 will indicate the current trading range is breaking higher. Going deeper, we should watch many international markets to see if the recent peaks from June can be bettered as well. If prices move above recent highs, it indicates the bear market is over and this rally has legs. A failed confirmation would mean the rise in the markets was only a bounce in a downward trend that has more room to go lower.