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Misguided Market Peaks

|Includes:CHL, PetroChina Company Limited (PTR), YZC

In a MarketWatch article titled "7 Ways to Spot a Market Top" (found here), it is suggested that there are key ways to tell whether or not we are at a top in U.S. stock markets. First, we're going to selectively choose (cherry pick) the points that we can refute or demonstrate weaknesses. Second, we're going show how, even at a stock market peak, abandoning new investment opportunities can potentially be a mistake.

Starting with the first of the "7 Ways to Spot a Market Top" is the claim that:

While the U.S. stock market is trading at record highs, three blue-chip Chinese companies - Petro China (NYSE:PTR), China Mobile (NYSE:CHL) and Yanzhou Coal are trading near 52-week lows, points out Brad Lamensdorf, chief investment officer of the Lamensdorf Market Timing Report. All three stocks peaked in January [2013]and have been skidding ever since. Given the key role China plays in the global economy, 'this looks like a bad sign for US stocks,' Lamensdorf said.

While it cuts us deep to suggest that a 52-low implies proof that a top in the market is at hand (don't forget our vested interest on this topic), there are clear weaknesses in this argument. First and foremost, look at the chart for the respective stocks.

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For PetroChina (PTR) the stock peaked in April 2011. Since then, the stock has been unable to exceed the prior peak. A technical analyst would have immediately recognized this and would not make the basis of their analysis the 2013 peak because it is lower than the 2011 top.

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In the case of China Mobile (CHL), the stock peaked in August 2012.

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In the instance of Yanzhou Coal (NYSE:YZC), the stock peaked in May of 2011. If what Mr. Lamensdorf says is true, U.S. stocks should have shown more signs of weakness before the most recent declines. Based on the information that we've provided, the first of 7 ways to spot a market top is very weak at best.

The second of 7 ways to spot a market top reflects on the performance of the Spanish stock market indexes. Unfortunately, there is no PROOF that, based on the movement of the three indexes, that we've seen the top in the U.S. stock market. Instead, it only reflects on what has happened in Spain. In addition, the time span that is used is narrow at best. What is a better alternative to indicate a possible top in the market? First and foremost, Dow Theory could have been a better guide for consideration of when and if we were at a market top in advance of the actual peaks. As an example, the Spanish IBEX 35 Index, is shown below from 2006 to the present.

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From the peak of the IBEX 35 Index in 2007, the decline was down to the March 2009 low near 6,936.90. The increase of the IBEX 35 Index could have been expected to increase at least half of the prior decline before giving clear indications of a change in direction in the market. According to Dow Theory the best case scenario would be for the market to retrace 50% of the previous decline.

Our own example of a real-time application of Dow Theory projections in advance of a market top is our April 3, 2009 posting titled "Bear Market Rally Targets" (found here), when the Dow was at 8,017.59. At that time, we said that the Dow Jones Industrials Average had an upside target of 10,360.02 based on the Dow Theory 50% principle. Dow Theory clearly outlines how to interpret market direction based on the stock market movement after the retracement of the 50% principle. Therefore, it would have been clear that the decline was in the cards and not helped by the European Financial crisis.

In our considered opinion, calling the top is easy after the fact, however the tools were in place to allow for understanding the potential upside limits beforehand. Additionally, there is no proof that the Spanish markets have topped out, based on such a short time frame (June 2012 to June 2013). In fact, according to the precepts of Dow Theory, the marginal top of January 2013 could not be considered to be "in" until the IBEX 35 declines below the 2012 low.

The third of 7 ways to spot a market top is based on the FTSE Europe relative strength index. The indicator only shows the last year of movement. The problem with this is that we don't have a "relative" view on which to test the accuracy of this indication. Although not the exact index and without the exact measure of time for which the indicator is at (a considerable weakness to leave out such information because we cannot independently test what should be widely available), we've outlined the Vanguard FTSE Europe ETF (NYSEARCA:VGK) with a relative strength indicator on a 28-period trailing interval.

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As can be seen above, the RSI has not necessarily give a clear indication of where the top in the market is when reviewed over a period from 2006 to the present. As an example, in 2012, the two RSI peaks resulted in higher market levels afterwards. Likewise, the RSI low of 2010 resulted in an even lower level for the Vanguard ETF in 2012. Worse still, the early 2008 low in the RSI was much lower than the early 2009 RSI low. However, the 2009 low in price was a staggering -58% lower than the early 2008 price for the Vanguard ETF.

Again, without the source of the RSI provided and the exact index that was used over a substantial period of time to verify the quality of the indicator, it would be difficult to suggest that the information provided was enough to prove that we could use the information to identify a market top, or bottom.

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Stocks: PTR, CHL, YZC