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posted on 04 April 2016

The Clock Is Ticking

Written by

Weekly Technical Review 04 April 2016

During the last 18 months the S&P has experienced three declines of more than 10%. Each decline was followed by a strong rally, which was supported to varying degrees by central banks verbal support or additional monetary accommodation.

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The first rally lasted from October 14, 2014 until December 29, or 66 days. The rally from the August 24, 2015 low lasted 73 days and ended on November 4. The current rally began on February 11, and made a high on Friday April 1, 72 days after it started. Time wise each of these rallies is very similar. The primary difference is that after topping out on December 29, 2014 at 2093, the S&P held up until May 20 when it reached its all-time high of 2134, less than 2% higher than on December 29. After the S&P reached its high on November 4 at 2116, it held up until December 29 when it traded up to 2086, about 1.5% below its November 4 level. The prior patterns suggest that even if the S&P made a high on Friday April 1 at 2075, it is likely to hold up for a few more weeks.

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welsh.2016.apr.4.fig1.600x400

As I discussed last week, in order for the stock market to decline, there has to be a reason for investors to sell since the investment business is long only biased. The next hurdle facing the market is the Q1 earnings reports. Expectations have increased for better than expected revenues and earnings since the dollar has fallen during the quarter. Analysts are also counting on better forward guidance now that the dollar is down about 5%. Nike's earnings report showed that the dollar is still a mighty headwind since Nike's revenues would have been up 14% without currency adjustments, rather than the 8% gain Nike reported. If Nike's report provides some guidance, the majority of companies will disappoint and blame dollar strength for their shortcoming.

In the March 21 Weekly Technical Review, I thought oil was topping out and getting ready to decline. "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. As it turned out, oil made its high on March 18 at $42.49 a barrel on the May contract. Today it closed at $35.46, a decline of $7.03. I think the potential of oil making a new low below the low of $29.85 in January is higher than 50%. So far the stock market has been able to ignore the weakness in oil, but that will change if oil falls below $34 a barrel.

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welsh.2016.apr.4.fig3.600x400

I also thought in the March 21 Weekly Technical Review that the dollar had made a low. Euphemistically, that call was premature, rather than wrong, since I still think the dollar is very close to a trading low and the dollar has held above the stop at 93.80. The low on March 17 was 94.76 and the RSI was 29.6. Even though the dollar made a new closing low of 94.51 today, the RSI was 33.1, comfortably above the March 17 level, which represents a positive momentum 'divergence'. The dollar chart is based on the cash dollar index. A close above 95.11 will turn the short term trend positive. If the dollar begins to rally to 98.0 to 99.0 as I expect, investors will have another reason to sell, since so many strategists have cited dollar weakness as a big positive.

Momentum

The Intermediate Trend (IT) is a proprietary momentum indicator that measures the spread between the 5 day and 21 day averages of net advances minus declines, new highs less new lows, and the net of up and down volume. For the first time since the rally began on February 11, the IT has rolled over, reflecting a loss of upside momentum.

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welsh.2016.apr.4.fig5.600x400

The 21 day average of net advances minus declines has now recorded its second negative divergence, when the NYSE Composite posted a new high on April 1. This is another indication that market breadth is beginning to narrow, and is normally a precursor to a high in prices.

So far, the NYSE has stalled at resistance as expected, as noted by the lower red horizontal trend line (10,300), and the black rising trend line. Although the NYSE is unlikely to break this resistance, the next zone of resistance is the higher red horizontal trend line at 10,600. If the NYSE Composite is able to reach 10,600, the S&P will likely challenge its high of 2134.

Should the S&P make a new high, the NYSE Composite will not confirm it, nor will the Russell 2000. There is a wall of resistance on the Russell 2000 between 1140 and 1160, which is also where the down trend line from the all time high in June 2015 and early December high comes in. A new high by the S&P or DJIA that isn't confirmed by new highs in the NYSE and Russell 2000 would set up a classic market top.

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welsh.2016.apr.4.fig6.600x400

Short Term

Last week I thought there was a good possibility for the S&P to rally above 2056.60 based on seasonality and very short term sentiment. With a hand from Janet Yellen the S&P rallied to 2075 on Friday. It's possible that was the high, but I don't have a high level of conviction, which is why I have not taken a short position. To confirm at least a short term high, the S&P will have drop below the blue trend line and the low of 2043 on April 1, and 10085 on the NYSE Composite (S&P and NYSE charts on page 3).

Last week I suggested that if the S&P did manage to exceed 2056, it would be an opportunity to become more defensive by lowering exposure to the market. For aggressive investors, a new recovery high would provide an opportunity to establish a modest short position - 25% to 33%. I would recommend a stop of 2110 on a closing basis. A decline to 1950 - 1970 is likely to unfold in coming weeks, especially after mid April when first quarter earnings will be reported.

Tactical S&P Sector Rotation Portfolio Model Relative Strength Ranking

The Sector Relative Strength Ranking is based on weekly data and used in conjunction with the Major Trend Indicator. As long as the MTI indicates a bull market is in force, the Tactical Sector Rotation program is 100% invested, with 25% in the top four sectors. 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 Major Trend Indicator generated a bear market signal on January 6, when the S&P closed below 1993, and was confirmed on January 14. 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. As noted in the Weekly Technical Review on February 25, I allocated a 25% long position in the Utilities ETF (XLU) at $47.28, and a 25% long position in the Consumer Staples ETF (XLP) at $51.65. These positions were liquidated on March 15 for a gain of .92%. Past performance is no guarantee of future results.

The Tactical Sector Rotation program is 100% in cash as I await a pull back to below 1980.

welsh.2016.apr.4.table1

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