Historically, May and June have been weaker months for stocks but that has not been the cast so far this year, with the post-election rally extending and taking US indices to new highs in June. An evening star pattern in the Dow, however, suggests that the rally may be nearing exhaustion and the potential for a summer correction growing in world markets.
The Dow has been trending higher since the start of 2017, continuing a rally that started on US election night in November 2016. Between March and Mid-May, the index consolidated but then staged another upleg over the last month.
Recently, the Dow completed a three day Evening Star candle pattern, consisting of a strong move up (green candle), a spike to a new high which was then reversed, and then a downturn. This bearish peaking pattern coincided with an overbought RSI, a negative RSI divergence and a failure to hold above 21,500, with the index peaking near 21,550. Combined these indicators suggest recent accumulation may be exhausted.
Since then, a downward correction has been unfolding with the index falling back toward 21,400 with next potential support near 21,300 a former resistance level, then 21,105 a 23% Fibonacci retracement of the advance that started in January.
Traders should also note that the Dow isn’t the only major index showing signs of peaking. Head and shoulders tops have been forming in the FTSE and the S&P/ASX. The Nikkei has been forming a bearish rising wedge. A rounded top has been forming in the S&P/TSX. Negative RSI divergences have been growing in the Dax, Nikkei, S&P 500 and other indices.
Historically May through October has been a weaker and more volatile time seasonally for stocks. The way stocks have been acting, however, it appears traders are still expecting smooth sailing for the US economy. It also appears that traders have been ignoring the Fed signalling that the end of the easy money, which has propelled stocks higher for the last several years, is approaching.
This week is the end of the month and the quarter, and trading action may indicate whether traders are more interested in adding to positions or taking profits heading into the early July holidays in the US and Canada and summer vacation season.
In terms of economic news, there are a number of Fed speakers who may give more colour on the central bank’s intentions. For data, US durable goods orders and Core PCE inflation may attract attention for their potential impact on monetary policy, whether they add to or detract from the case for a more hawkish Fed.
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