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These charts show why investors should be worried

Lawrence Lewitinn
Lawrence Lewitinn

The market’s recent bounce back from a brutal selloff may have some investors complacent. But one technician sees more trouble ahead for the markets.

“Indices are trying to carve out a bottom,” said Mark Newton, chief technical strategist at Greywolf Execution Partners. “The lows are near. However, the damage that's been done makes it look like there's a lot more volatility in store in the months ahead and we could have more downside into the fall.”

Newton bases it outlook on several charts, including those of the NYSE Composite (^NYA) Index, the Shanghai Composite (000001.SS) Index, and the Dow Jones Transportation Average (^DJT).

Source: Mark Newton, Greywolf Execution Partners

Unlike the S&P 500 (^GSPC), which is comprised of the largest publicly-traded U.S. companies, the NYSE Composite Index is made up of all the stocks trading at the New York Stock Exchange. “Why this is interesting is because this is very much a much more broad-based index than just looking at the S&P,” said Newton.

Both indices saw a bull market starting in 2009 and both faced major selloffs in January. But the NYSE Composite has broken below its August 2015 lows and remains there. That concerns Newton, who sees the 9,550 price as a key level. The index closed at 9,426.91 on Friday after a 2% rally.

“It's important that we regain that 9,500 level,” he said. “Failure to really get up back above these highs is going to suggest we likely have a little bit further to go into sometime this fall and get down at least down ... near 2011 highs which lies slightly down right above 8,000.”

Source: Mark Newton, Greywolf Execution Partners

Newton doesn’t see much of a direct, long-term relationship between U.S. and China’s markets. But the collapse in indices such as the Shanghai Composite beginning last summer led to uncertainty in global markets, including that of the United States.

An important technical support level for the Shanghai Composite is 2,800, according to Newton. That’s about 4% lower than Friday’s close.

“This level has already been tested once,” he said. “If it can hold that, potentially we can try to rally off this. But a break of that level could be far more negative for China.”

Should that happen, Newton predicts U.S. stocks will follow suit.

Source: Mark Newton, Greywolf Execution Partners

Another index showing concerning signals is the Dow Jones Transportation Average. Dow Theory, one of the oldest ones in technical analysis, holds that transportation and utility stocks should confirm rallies in industrial shares.

As Newton points out, the Dow Transports have underperformed the major market indices for well over a year. Similar to the NYSE Composite Index, the Transports broke a long-term trend line and also broke below its August 2015 lows.

“This caused some real acceleration on the downside,” Newton said. “It is an intermediate term negative with the Dow Jones Transports down now more than 20%. Structurally, having broken a six-year uptrend, it does suggest further weakness between now and the months of September and October which historically is when a lot of these markets tend to bottom out.”

Source: Mark Newton, Greywolf Execution Partners

Yet he sees a few signs of some near-term stabilization in the Transports, such as “hammer” formations in the index’s candlestick chart in the past week.

“A hammer pattern is when you have an extreme move to the downside but it rallies and recoups all that to close unchanged or slightly positive,” explained Newton.

“That’s really interesting given the fact that markets have become so oversold,” he said. “Pessimism has been on the rise. We've seen extreme bearish sentiment. And now the Dow Jones Transports, along with a lot of other indices, have suggested signs that things are starting to hold.”

For Newton, that means the market could stage an oversold bounce in the weeks ahead but the only way the rally would have legs would be if it the index broke back above its August 2015 lows of 7,458.99. The Transports closed at 6,778.54 on Friday.

“The longer-term view is a little bit more negative based on what happened,” he said. “We have seen some extreme trend damage that should lead to further weakness going forward over the next 6 to 8 months.”