Though there has been some improvement in the past 20 years, most fundamental analysts still do not analyze their data using technical analysis. I have found that using trend lines and divergence analysis on fundamental data can often be very useful in confirming your views on the market or on a sector.
In the early 1980s, there was one data series that I regularly watched. It was the number of Help Wanted ads that were in the newspaper. When the number of ads was rising, it was a positive sign for the economy. Conversely, a declining number of ads was a sign that the economy was contracting.
For example, the number of ads turned lower in early 1981 and did not start to rise again until October of 1982. They had formed a clear pattern of lower highs and lower lows (a downtrend), and when it was broken, it indicated that the recession was over. It was consistent with the bullish action in the stock market as it bottomed in August 1982. The recession was officially over in November 1982.
The Help Wanted ads also peaked well before the 1991 recession, but in 2005 the Conference Board replaced it with the Help Wanted OnLine®. The chart shows that the uptrend in these ads, line a, was broken in the summer of 2007 several months before the major stock markets made their highs. By early 2008, it was falling sharply, and it was later determined that the recession began in December of 2007.
The downtrend in ads, line b, was broken in the fall of 2009, and a year later, it was determined that the recession officially ended in June. The ads are positive as they continue to show a pattern of higher highs and higher lows. This is a positive sign for the future growth of the economy.
Another favorite data series from the Conference Board is their Leading Economic Index (LEI), which is made up of ten variables including the unemployment rate, jobless claims, building permits, stocks prices, etc. It has a fairly good record of predicting recessions over the past 50 years.
The chart from the Conference Board shows the LEI in blue and the CEI or Coincident Economic Index in red. The LEI was rising by November 2001, which was determined to be the end of the dot-com recession. By 2003, it was in a clear uptrend, line a.
In the middle of 2004, the LEI moved above the CEI (point 1), which I saw as a sign of strength. The LEI peaked in 2006 and then formed lower highs in 2007, line b, as the S&P 500 and Dow Industrials were peaking. It was then diverging from the CEI.
The LEI plunged in late 2007 and early 2008 as the uptrend, line a, was broken. In the spring of 2009, both the LEI and CEI had started to improve. By later in the year, both were in clear uptrends. Both lines are still rising though the LEI is well below the highs from 2006.
The attitude and the seasonal trend of the consumer is also very important to both the economy, as well as the investor. The chart shows that after the 2003 low, the Consumer Confidence turned higher, and by 2005 lows, there was a clear uptrend, line a.
Consumer Confidence flattened out in the latter part of 2006 and in 2007, line b. Then in the fall of 2007, it started to drop sharply and violated its uptrend, line a. The ensuing plunge in confidence was quite dramatic as it did not bottom out until early 2009.
There were signs in early 2010 that the level of confidence was changing as the last peak before the final low, line c, was overcome. Higher highs were made again in 2011, and the data shows a clear uptrend, line d. In May, it rose sharply to 76, breaking out above the resistance at line e.
This long-term chart shows the Consumer Sentiment from the University of Michigan, along with the Conference Board's Consumer Confidence. I have chosen to draw trend lines only on the Consumer Confidence data (in green), though you can see that the Consumer Sentiment confirmed the changes in trend.
The uptrend from the 1983 lows, line a, was broken in early 1990 as the recession officially began in July and ended in March of 1991. The Dow Industrials peaked in July and dropped 22.8% in the next five months.
The series of higher lows in the Consumer Confidence in 1992 and 1994 was the start of a powerful uptrend, line b, that was not broken until early 2001. Of course, the Nasdaq Composite peaked in March of 2000, and by the time the Consumer Confidence bottomed in early 2003, it had lost over 75%.
The rally from the 2003 lows was much smaller by comparison, and the support at line c was broken in the fall of 2007. Both are now clearly positive but a reading below 60 would be a reason for concern.
There are quite a few data series that can give you a good reading on the home construction sector, and one of my favorites is the NAHB/Wells Fargo Housing Market Index, which is plotted below with the single family housing starts.
The HMI is a monthly survey of NAHB members, which asks them to rate their prospects for single family homes at the present and for the next six months. The HMI peaked in late 1999 and then formed lower highs in 2006, even though the housing starts were continuing to make new highs. This was a significant divergence as it helped create an overly large inventory that has made it more difficult for the housing market to recover.
The HMI turned down in early 2006, and then in late 2006, it broke the long-term support (line c) that connected the 1991 and 2003 lows. A few of months later, the additional support, line b, was also broken This confirmed the very negative outlook of the home builders.
The HMI formed higher lows in 2009 and early 2012 (line e). The bottom was confirmed in May as the resistance at line d was overcome. This was noted in a Week Ahead column at the time.
The first hint of a bottom in the home construction stocks occurred on October 18, 2011, when volume surged in the home construction stocks.
Since October 2011 lows, the DJ Home Construction Index (DJUSHB) is up over 124% versus just over a 30% gain in the Spyder Trust (SPY). The Index was up 164% on May 15 but has dropped 40% in less than a month.
On the right, you will see the long-term monthly chart of the DJUSHB and the H&S top that it formed in 2004-2007. The neckline (line a) at 548 was broken at the end of June 2007, and the eventual low in late 2008 was 130.
The Home Construction Index made a low in late October of 2011 at 164.93 and rose for the next two months, closing above its 20-month EMA by the end of the year. At the end of May 2012, the 2010 swing high was overcome on a closing basis. This completed the bottom formation and coincided nicely with bullish signal from the HMI the following month.
The current rally has taken it just above the major 38.2% Fibonacci retracement resistance from the 2005 high. The 50% level is at 624.38. There is initial support at 442 with the rising 20-month EMA now at 410.
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The weekly chart of the DJ Home Construction Index overcame its 18-month downtrend, line a, in early December of 2011. The relative performance moved through its downtrend (line b) a few weeks earlier as indicated by line 1.
The uptrend that connects the 2011 and early 2012 lows, line c, has been tested several times over the past two months. The weekly RS line confirmed the January 2013 highs but then broke its uptrend, line d, in April. This is often an early warning sign.
The RS line made much lower highs, line e, in May, which was a sign that home construction stocks were no longer leading the S&P 500 higher. The RS line is now back below its WMA and a drop below the April low would be consistent with further weakness in the Index.
In terms of price, the DJUSHB has support now in the 440-446 area. If it is broken, then the major 38.2% Fibonacci retracement support is at 405 with the 50% support at 359. A drop to the 38.2% support would mean a further 20% decline from current levels.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.