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posted on 18 April 2016

Short Term High At Hand

by Jim Welsh

Weekly Technical Review 18 April 2016

In the last WTV on 04 April, I concluded that the S&P was likely to hold up for a few more weeks based on how the S&P has traded over the last 18 months. The three declines of more than 10% that have occurred since September 2014 have been followed by a strong rally.

resistance.top.arrow

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 an initial 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 for another 142 days until May 20. Despite the extra 142 days, the S&P was less than 2% higher than on December 29, when it made its all-time high of 2134 on May 20. After the S&P reached its high on November 4 at 2116, it held up until December 29, an additional 55 days. In this instance the S&P made a lower higher at 2086, about 1.5% below its November 4 level. These prior rallies suggest a window that stretches from May 26, 55 days after the April 1 high, to August 21, if the S&P holds up a similar 142 days.

Note: Click on any graphic for a larger image.

welsh.2016.apr.18.fig.1.600x400

Two factors support the market holding up for awhile: sentiment and market breadth. Despite the non-stop rally since February 11, bullish sentiment has remained muted. Based on the Investors Intelligence weekly survey, the net percent of bulls has faded after jumping in late March, even though the S&P is 1.5% higher. One factor that has likely tempered investor's bullishness is the outlook for earnings. Although expectations have come down a lot, the reality is that earnings are still falling. Historically, falling earnings has not been especially bullish for the stock market, unless valuations have been crushed by a bear market as in 2003 and 2009. Beating depressed expectations can support the market, but can lower earnings really support much higher valuations? I don't think so.

The second factor is market breadth, which has been more healthy during this rally than the rallies after the lows in October 2014 and September 2015. Last week, the advance / decline line exceeded its high from last April. I think the A/D line is the most important technical indicator, but it too is not infallible.

welsh.2016.apr.18.fig.2.600x600

During the 2000 - 2003 bear market, the A/D line bottomed in October 2000, and then began a gradual but persistent uptrend. Despite the uptrend in market breadth, the S&P dropped from 1364 in October 2000, to a low of 776 in October 2002.

welsh.2016.apr.18.fig.3.600x400

Granted, a big part of this divergence between the A/D line and the S&P was due to the 80% collapse in technology stocks which represented 34% of the S&P in March 2000. Currently, there is no single sector that is so over weighted in the S&P, so an unwinding like the technology stocks experienced between 2000 and 2003, or financial stocks between 2007 and 2009, is not going to happen. The ability of the A/D line to exceed its high last April is a positive.

Since the February low, the S&P has posted higher highs and higher lows, so the trend is up. At a minimum, the S&P will need to make a lower low and then a lower high, before the uptrend can be considered at risk. The last trading low was on April 7 at 2033.

However, there are reasons why a short term high is likely soon. The DJIA closed above 18,000 today for the first time since last July, the S&P is less than 6 points from 2100, and the Nasdaq Composite is less than 1% from 5,000. These are all nice round numbers which often provide investors a reason to take profits. The chart of the S&P can be counted as a complete 5 wave advance from the February 11 low, as indicated on the chart below. In addition, the S&P made a new high today at 2094, but the RSI is lower than on April 1 when the S&P closed 203 (67.0 vs. 71.4).

welsh.2016.apr.18.fig.4.600x400

Although the A/D line has made a new high, the upside momentum of market breadth, as measured by the 12 day average of net advances minus declines, has been posting lower peaks for several weeks.

welsh.2016.apr.18.fig.5.600x400

As I have often discussed, in order for the stock market to decline, there has to be reasons 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 estimates have been slashed, and the dollar has fallen during the quarter. Now that the dollar is down about 5%, analysts are also counting on better forward guidance. The bulk of earnings will be released in the next 3 weeks, so we will soon know whether the dollar is a help or still a hindrance as I expect.

Over the past month, as hopes for a freeze in oil production continued to build, I maintained that a freeze was unlikely.

"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."

There was no agreement, but oil prices did not plunge as much as expected. Yesterday, Kuwaiti oil workers went on strike, which lowered Kuwait's oil production from 3 million barrels a day to 1.1 million barrels. This outage is in addition to the loss of about 800,000 barrels a day due to pipeline problems in Iraq and Nigeria. These pipeline issues will be fixed and the strike in Kuwait will end. In the short run, the supply and demand imbalance that has roiled the oil market will be temporarily improved.

welsh.2016.apr.18.fig.6.600px

Longer term, the imbalance will reassert itself and lower oil prices will follow. At a minimum a decline under $36 a barrel is coming, with a test of $32 possible in coming months. Producers and commercial speculators are still quite short, while the dumb money large speculators are long, which suggests that the path of least resistance is lower.

The dollar index has held above the stop at 93.80, although it did dip intra-day to 93.62 on April 12, before closing at 93.94.

welsh.2016.apr.18.fig.7.600px

Today the dollar index closed at 94.46. Negative sentiment has increased disproportionately in the past few weeks relative to the amount of price decline, which is why the dollar is likely close to a good trading low. If the dollar does rally, it would provide investors another reason to take profits and do some selling in the stock market. Ironically, the decline in the dollar will embolden some Fed members to consider raising rates since dollar strength was cited as a reason not to raise rates at the March meeting. Given the weakness in Retail Sales in March and in Industrial Production, I can't imagine that the Fed will increase rates at their April 26-27 meeting.

The rally in the stock market since the February 11 low has been fueled by central bank manipulation (Yellen, Draghi, Kuroda, PBOC) and short covering in the oil market spurred by 'talk' of a production freeze by Russia and Saudia Arabia at 35 year highs, first aired coincidently on February 11. GDP growth was likely below 1% in the first quarter and earnings, even outside the oil patch, probably fell. All that said, the market has been able to surmount the band of resistance between 2040 and 2060 that I thought would cause at least a pullback to 1970 -1950. To confirm that a top of some significance has been formed, the S&P will have to close below 2033, which was the low on April 7.

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.

welsh.2016.apr.18.fig.8.600x400

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 MTI confirmed a new bull market on March 30, when the S&P closed at 2065. Another indication that the market will be more vulnerable to a deeper correction will occur when the MTI begins to flatten out as it did during November last year. The next few weeks have the potential to define the balance of 2016.

The Tactical Sector Rotation program is 100% in cash as I await a pull back to below 2033 and lower.

welsh.tactical.rotation.table.2016.apr.18

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