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After the QE3 'Sugar Cube,' SPX Declines


Also, sectors decouple: Witness the Dow Jones Transportation Average and the Dow Jones Industrial Average.

Last week, the tight trading range option was violated as the SPX declined to 1430.53, which was just slightly above my 1400 – 1422 support zone. The QE3 market surge came on top of an already strong rally that began on June 4. The nearly four-month old rally of about 16% has left 90% of portfolio managers (or PMs) underperforming the SPX. As year-end approaches, this underinvested crowd is now staring at not only performance risk, but bonus risk, and ultimately job risk. Indeed, just pull up a chart of the SPX and think about all of the underinvested participants that are not keeping up with the "Dow Jones" as they approach year-end performance report cards.

Manifestly, it seems like everybody is unhappy. To use the quote, I referenced a few weeks ago from Merrill Lynch's legendary strategist Bob Ferrell:

Money managers are unhappy because 70% of them are lagging the S&P 500 and see the end of another quarter approaching. Economists are unhappy because they do not know what to believe: This month's forecast of a strong economy, or last month's forecast of a weak economy. Technicians are unhappy because the market refuses to correct, and gets more and more extended. Foreigners are unhappy because due to their underinvested status in the US, they have missed the biggest double play (a big currency move plus a big stock market move) in decades. The public is unhappy because they just plain missed out on the party after being scared into cash after the crash. It almost seems ungrateful for so many to be unhappy about a market that has done so well... Unhappy people would prefer the market to correct to allow them to buy and feel happy, which is just the reason for a further rise. Frustrating the majority is the market's primary goal.

Adding to the angst has been the Dow Jones Transportation Average (INDEXDJX:DJT), which has decoupled from the Dow Jones Industrial Average (INDEXDJX:.DJI). Verily, since the June 4 low the industrials are up roughly 11% while the transports are flat. This decoupling has become even more noticeable recently, causing many pundits to suggest there is a big decline coming for the Industrials. Last week Mark Hulbert, in his MarketWatch column, elaborated:

The transports, as virtually everyone who is even slightly paying attention already knows, are seriously lagging the Dow industrials. It is widely assumed that this bodes ill for the stock market. But I am not so sure. A careful market analysis of the last three decades suggests that the Dow Jones Transportation Average is not the leading indicator that so many think it is.

Now many argue that the transports are a leading indicator because if companies are doing well the transports will benefit from higher volumes to carry those goods to market. Others will opine that our economy is more service-based, and not as manufacturing-driven as it used to be, so the transports don't count. As an avid believer in Dow Theory, I am always watching the transports. Yet, the recent weakness, at least to me, is not yet concerning.
No positions in stocks mentioned.
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