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posted on 07 June 2016

Macro Tides Technical Review 06 June 2016

Written by

Stock Market

In the May 23 Weekly Technical Review (No report on May 30 due to the Memorial holiday), I thought the S&P could bounce up to 2085, after closing at 2048 on May 23. The primary reason a rally to 2085 or so was expected was due to sentiment.

bull.bear.balance

The top panel in the chart below shows the 10-day average of the Call/Put ratio. As noted on May 23, the 10-day average of the Call/Put ratio had dropped under 1.0, indicating that investors have been buying more puts than calls during the prior two weeks. The blue arrows illustrate the other instances when the Call/Put ratio fell below 1.0, and as I pointed out, in each instance the S&P subsequently rallied. The S&P has rallied, reaching 2113 today before closing at 2109. Since May 23, the Call/Put ratio has jumped from 0.93 to 1.08 as of Friday, and will climb higher today based on the CBOE data for today.

Click in any chart for larger image.

welsh.tech.2016.jun.06.fig.1.600px

Although the Option Premium ratio didn't drop to a level that has marked solid trading lows on May 23, it was down enough to support the notion of a short term rally. As of Friday though, it is back down to a level that has occurred near prior market highs.

welsh.tech.2016.jun.06.fig.2.600px

Between May 24 and May 31, the percent of bulls in the weekly Investors Intelligence (II) survey popped from 35.4% to 45.4%. The increase of more than 10% in one week is unusual and illustrates a sharp shift in sentiment from cautious to more optimism. The net Bulls in the recent II survey rose to 21.7, not far below the 23.7% reached just as the S&P was posting a high on April 20.

welsh.tech.2016.jun.06.fig.3.600px

The 21 day average of net advances minus declines provides a good indication of how over bought or over sold the market. In the other instances when the Call/Put ratio was under 1.0, the 21 day average of net advances minus declines was below -400. At the lows last August and in January it exceeded -700. On May 23, it was just above zero, and not even close to being over sold.

If the S&P did run up to 2085 or so, I thought the 21 day average of net advances minus declines would quickly become over bought, and likely limit any additional price gains.

So far, the S&P is less than 1% above 2085, and the 21 day average of net advances minus declines has indeed become overbought. As of today's close the average is up to 490, but as you can see, it is below the two prior highs of 715 on March 7 and 548 on April 27.

Unless this average is able to exceed to the April 27 high, it will continue the pattern of lower highs and represent a warning that the upside momentum is continuing to lose steam, which is usually a precursor to a price high.

welsh.tech.2016.jun.06.fig.4.600px

Another indication of how overbought the market has become is the percent of stocks above their 200 day average, which has reached 71%. This is positive until the S&P begins to post higher prices, accompanied by a percentage of stocks above their 200 day average of less than 70%. This is what developed as the S&P was making its high in April of last year, as only 62% of stocks were above their 200 day average compared to March through July of 2014, when the percent held above 70%. Even the October 2014 swoon was foreshadowed when the 200 day percent peaked at 68% on September 2.

With more than 70% percent of stocks above their 200 day average, the market is overbought, which is a short term problem. A bigger potential problem is the divergence between the S&P and the NYSE and Russell 2000. The S&P is about 1% below its intraday all-time high, but the NYSE closed today -6.6% below its all-time high from May 21 last year, with the Russell 2000 -10.1% shy of its high. As long as the percent of stocks above their 200 day average remains healthy, these price divergences are a back burner concern.

welsh.tech.2016.jun.06.fig.5.600px

As I discussed in the April 25 Weekly Technical Review, the low in February may represent wave 4 from the March 2009 low. If correct it suggests that wave 5 began at the February 11 low and could potentially lift the S&P to 2360 in coming months. My goal has been to identify the top of wave 1 and the low of wave 2, so I can reestablish long positions in the Tactical Sector Rotation program.

welsh.tech.2016.jun.06.fig.6.600px

At the February 11 low, the market was extremely oversold and sentiment was in the dumps. The market has now become overbought and sentiment far more optimistic. I originally thought wave 1 of wave 5 from the February low ended at the April 20 high of 2111. I expected a decline below 2040, with a decent potential that the S&P could fall to 1970, before wave 2 of wave 5 would be completed. The S&P did drop to 2026 on May 19 and today exceeded the high of 2111. So the obvious question is whether the low of 2026 was the end of wave 2? I don't think so. Instead, I think wave 1 from the February low is ending soon, which should set up a decline below 2026 before wave 2 finishes. If I'm wrong, it should be obvious, since the market would be entering wave 3 and should explode higher on much stronger volume. If the S&P fails to breakout, any selloff would likely draw comparisons to how the S&P has declined every time it has tried to make a new high since February 2015. Should the S&P manage to better 2134 without following through, the divergences between the S&P and the NYSE and Russell could convince technicians that the market is doomed, again. For any decent decline to take hold there must be a reason to sell that scares investors just enough to turn sentiment fairly negative. My expectation is that at the end of wave 2, the 10-day Call/Put ratio will be below 1.0, the 21 day net advances minus declines will be under -400, and the Option Premium ratio will spike above 1.30 at a minimum. Until the S&P provides a convincing upside breakout, I will remain patient until more evidence of the end of wave 2 materializes.

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.tech.2016.jun.06.fig.7.600px

The MTI crossed above its moving average on February 25, generating a bear market rally buy signal. The MTI confirmed a new bull market on March 30. 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.

For the first quarter, the Tactical U.S. Sector Rotation program was up 6.1%. I also recommended via email on December 31 a 10% position in the gold ETF (GLD) and a 10% position in the gold stocks ETF (GDX). These positions were closed during February with a gain of 1.0% for GLD and 1.8% for GDX. The total return for the first quarter was 8.9%, which does not include management fees. Past performance is no guarantee of future results. The total return for the S&P 500 in the first quarter was 1.4%.

The Tactical Sector Rotation program is 100% in cash as I await a pull back to below 2026 and potentially as low as 1970 -1950.

welsh.tech.2016.jun.06.tactical.table

Jim Welsh

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