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posted on 07 March 2016

Optimism Rising In Face Of Limited Upside

by Jim Welsh

Weekly Technical View 07 March 2016


Last week I cited two reasons why I thought the rally would continue, even though it had retraced half of the decline in the S&P from November 3 to February 20, and had relieved the deeply oversold condition that had developed after posting the largest decline to start a new year ever.


As of February 18, the net percent of bulls minus bears in the Investors Intelligence weekly survey fell to its lowest level since October 2011 at -14.5%. Despite the two week rally, the percent of net bulls minus bears, only rose from -14.5% to -1.0% as of February 25. In last week's survey it nudged up to +2.1. I suspect that the percent of bulls will jump when this week's numbers are released on March 10 in the wake of the employment report. When investors are provided a bullish or bearish reason they can understand that explains why the market has been rising or falling, sentiment shifts more abruptly. The positive jobs report will certainly serve that purpose since it alleviated investor's concerns that the U.S. economy was on the doorstep of a recession. With that worry out of the way, investors feel it is now safe to get back into the market. My guess is that the percent of net bulls minus bears will pop to +10.0% or more in this week's report.


The rise in optimism over the last week is illustrated by the increase in the call/put ratio (CPR), since investors have been buying more calls in anticipation of higher prices. As of Friday, the CPR was back to the level it reached in late January and at the end of December, just prior to selling off.


Another reflection in the shift in sentiment can be seen in the Option Premium Ratio (OPR). The OPR spiked higher as the S&P made a low on January 20 and February 20, as the market bottomed. It has now dropped to the level it was in late November (blue horizontal line). If the S&P does rally one more time, it may drop to its early November level, just as the S&P was topping (red horizontal line).

ImageThe NYSE Composite is comprised of 1,700 stocks, so it is a better representation of how the majority of stocks are performing. As you can see, it is approaching the down trend line that connects the highs from last June, November, and December. This suggests the upside is fairly limited in the short term.

The sharp rally off the September 29, 2015 low ended after the rising blue trend line was broken on November 4. That break ushered in a quick 4% correction, before the S&P rallied and posted a lower peak on December 2.

ImageOne of the first signs that a short term high has been put in now will be confirmed when the S&P breaks below the rising blue trend line from the low that has contained each pullback since February 20. As of today's close, the trend line was at 1982. The pattern in the S&P would look better if the S&P rallied above the high of 2009.13 from Friday March 4. The initial rally from the low of 1810 on February 20 carried the S&P to 1931, a gain of 121 points. An equal rally from the low at 1891 on February 24 would target 2012.


With Friday's high of 2009, the S&P has already pushed into the range of resistance I mentioned last week between 1999 and 2040, which is denoted by the two red horizontal lines. (Chart below) If the S&P violates the sharply rising blue trend line, a quick drop to the black horizontal line near 1940 - 1960 is likely. If investor's psychology has shifted due to the market's rally and employment report, the buy the dip mentality will bring in buying as the S&P approaches the black trend line.


The 21 day average of net advances minus declines reached a very overbought level as of Friday March 4.

This display of dynamic momentum is not likely to reverse on a dime. A ball thrown into the air at 30 m.p.h. will lose upside momentum much faster and reach a peak much more quickly than a ball thrown at 60 m.p.h. Since the current rally far exceeded the high achieved during the October rally last year, the odds are higher that any subsequent rally will challenge and likely exceed the initial high on this rally. This suggests that if the S&P does drop to 1940 - 1960, the next rally could reach 2040 and the underside of the major resistance area as indicated on the chart later below.


The second reason why I thought the S&P would rally further last week was based on time. From its high on November 3 to the low on February 11, the S&P declined for 100 calendar days. From its low on February 11 to the high on February 25, the S&P had only rallied for 14 calendar days, which seemed disproportionately small relative to the amount of time the S&P spent declining. As I noted last week, if the market rallied 38.2% of the 100 days the market had declined, it would project a rally to March 20, and April 1, if the rally consumed 50% of the time it spent falling. March 18 is a quadruple witching expiration for options and futures, so a continued rally that tops near the expiration would optimize the squeeze on shorts.

Major Trend Indicator

The Major Trend Indicator (MTI) generated a bear market signal on January 6, when the S&P closed below 1993. The bear market signal was confirmed when the MTI dropped below the red horizontal line on January 14. When a bear market signal is generated, the Tactical Sector Rotation program is either 100% in cash or 100% short the S&P 500. The Tactical Sector Rotation program went 100% short when the S&P closed at 1990.26 on January 6. The short position was reduced to 50% on February 8 when the S&P closed at 1853, further lowered to 25% early on February 24 as the S&P traded under 1895, and closed on February 25 when the S&P was 1942. The S&P's average 'cover' price on the short trade was 1885.75. The short trade earned 5.2%. Past performance is no guarantee of future results.

The MTI crossed above its moving average on February 25, generating a bear market rally buy signal. This signal will remain in place as long as the MTI is above its moving average and the S&P does not violate important chart support. From its low on February 20, the S&P rallied from 1810 to a high of 2009 on March 4, a gain of 199 points. A 50.0% retracement of the rally would bring the S&P down to 1910. If the S&P closes below 1910, a test of the low on February 24 at 1891 would likely follow. I don't think it would be a good sign if the S&P is not able to hold above 1910, since the rebound in equities, oil, and emerging markets are merely bear market rallies that are impressive enough to convince many investors the worst is behind us.

As I wrote in the January 26 issue of Macro Tides,

"If the Dollar index does decline modestly in coming weeks, it should be positive for risk assets in general. When the Dollar index fell by -7.1% between midMarch and mid-May, the emerging market ETF (EEM) rallied 15% and oil jumped 20%."

Since January 26, the Emerging Market ETF EEM is up 12.0%, and oil has rallied 15.2% as of March 7.