posted on 21 March 2016
Written by Jim Welsh
Weekly Technical View 21 March 2016
As noted last week, the stock market has been juiced by a steady stream of central bank interventions (manipulations?) and modestly better economic news in the U.S. Last Wednesday, the Federal Reserve put the cherry on top of the rally when it announced that it would only increase rates twice in 2016, rather than the 4 times it had indicated previously.
(Click on any chart below for larger image.)
Overlooked amid the celebration of higher stock prices is one simple fact. Central banks are doing more because everything they have done to date has failed to generate the desired economic result, namely a self sustaining recovery. When companies begin to report first quarter results, investors are going to be reminded that revenue growth remains tepid and earnings growth elusive relative to the valuation of the stock market. The March 4 Global Business Outlook survey by the Fuqua School of Business found that CFO's think there is a 31% chance of a recession by the end of 2016, up from just 16% in June 2015. I'm not in the recession camp, but I do think the U.S. economy is going to slow in the second quarter and the global economy is not going to rebound much, despite the ministrations of central banks. If correct, the stock market will have to stand on its own two feet, a balancing act that could prove challenging without further support from central banks.
The end of quarter pressure on money managers to be fully invested is likely to help the stock market hold up a bit longer. That said there are more signs that the rally from the low on February 11 is nearly over. In the March 7 Weekly Technical Review I noted that sentiment had remained quite cautious, despite the rally and the solid employment report, which was released on March 4. Since the FOMC announcement last Wednesday, bullishness has jumped as measured by the Call/Put ratio. The 10-day average popped from 1.107 on March 15 to 1.231 on March 18, which was almost as high as the 1.237 level reached on November 4 one day after the S&P topped. The daily Call/Put ratio of 1.487 and 1.383 on Thursday and Friday, in response to the Fed news, were the highest since June 10, 2015.
The net percent of bulls minus bears in the Investors Intelligence weekly survey rose to 14.1% as of March 15 from 4.0% on March 8. Since the survey was taken the day before the Fed announcement, it seems very likely that the percent of bulls climbed further and may be near the high in early November of 18.8%.
The Option Premium Ratio has almost reached the level that coincided with the early November high and the high in July 2015.
The pronounced level of fear that enveloped investors in early February has been replaced by optimism, which is a warning sign of at least an impending short term high. What's missing are more signs of failing momentum. The 21 day average of net advances minus declines registered a divergence on Friday March 11 as the NYSE was posting a new high, and again on March 18. However, the 21 day average of net advances minus declines is well above the overbought level (red horizontal line), which indicates that market breadth is still fairly healthy.
Another hint that the strong momentum displayed by the market is waning is the shrinking number of new highs. As the S&P made new high on Friday and today, the number of new 52 week highs shrunk from 177 on Thursday to 143 on Friday and just 56 today.
The Dollar and Oil
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." The decline in the dollar index picked up steam after the FOMC announcement, since foreign currency traders had expected the Fed to increase rates more than twice in 2016. From its high of 97.06 before the Fed announcement, the dollar fell -2.56% by Friday morning, before recovering. After the dollar pushed above 100.00 in March 2015, I thought a multi-month correction was likely, since the overwhelming sentiment toward the dollar was bullish. The recent decline in the dollar and the Fed's announcement has resulted in a big shift in psychology. Now very few foreign currency traders are bullish the dollar and the dollar is oversold. I think the dollar is near a good trading low, if it hasn't already bottomed. The RSI on the dollar index fell to 29.0 on March 17 after the dollar index closed at 94.80, compared to 27.3 on March 10 when the dollar index closed at 96.06. (Chart on next page) This positive divergence is supportive of a rally in the dollar index in coming weeks up to 98.0 to 99.0. Just as the decline in the dollar was supportive of a rally in risk assets, a stronger dollar is likely to pressure oil and equities, especially if it occurs against a back drop of subpar earnings reports with companies citing the stronger dollar as the culprit. If the dollar index closes below 93.80 I'm wrong.
The rally in oil since its low in February provided financial markets a big boost. As discussed last week, the 38.6% retracement in the cash price for oil from the high in June 2015 and the low in February was $39.60. On Thursday, the cash price for oil closed at $40.19, which is close enough. More importantly, the pattern from the low looks complete as a 5 wave rally. Even if oil has bottomed, it looks vulnerable to a decline of $6 to $8 a barrel in coming weeks and a rout if OPEC fails to agree on any meaningful freeze or reduction in output. I will be surprised if Saudia Arabia agrees to a freeze and allows Iran to continue to boost its production at the April 17 meeting.
The NYSE Composite touched its upside resistance late last week as did the Russell 2000. I think the upside potential from current levels is less than 1%.
Short Term Pattern
I thought the S&P could reach 2041, before this move up was over. The high today was 2054. The 78.6% retracement of the decline from the high of 2134 last May to the low of 1810 in February is 2065, which is .5% from today's high. The S&P is now into the Major Resistance area between 2040 and 2080. Although the market may hold up until the end of the first quarter, I don't think the S&P will be able to surpass this formidable resistance if I'm right about a slowing in the economy during the second quarter.