posted on 13 June 2016
Written by Jim Welsh
MacroTides Weekly Technical Review 13 June 2016
In last week's review, I noted:
I posted the 06 June Weekly Technical Review on Linked-In and entitled it "A Short Term High Is Nigh". The S&P posted its high on June 8 at 2120 and today closed below the high on May 10 of 2084, and the lows on June 1 and June 3 at 2085. Closing below 2085 should seal a short term top in the S&P, as the 30 minute chart of the S&P illustrates.
Click on any chart for larger image.
The breakdown below 2085 is likely to lead to a test of the more important support at 2040. After the FOMC minutes of the April 27 meeting were released on May 18, the S&P peeled off 35 points in 4 hours of trading, as it fell from 2060 to 2025 between 11am PST on May 18 and 830 PST on May 19. By the end of trading on May 19, the S&P had recovered to close at 2040.04, avoiding a close below 2040 by the slimmest of margins. The 2040 support area bent, but it did not break. As I said in the May 23 WTR,
We're likely to find out soon.
If the S&P does breech its support at 2040 on a closing basis, how low might it go? At a minimum, I expect the S&P to drop below the low on May 19 at 2026. However, there are some news events that could result in a deeper decline.
The Federal Reserve will announce on Wednesday that they are not raising rates. This is almost universally expected, so the real attention will be parsing each word of the FOMC post meeting statement for clues about the July meeting. The Brexit vote is one of the reasons the Fed will hold off at the June meeting, with the other reason being the weak May employment report. Since the Fed won't know the outcome of the Brexit vote, or whether the May employment report was a fluke or not, I suspect there won't be a clear signal about the July meeting. That won't stop the talking heads from squeezing any and every nuance from the FOMC statement.
Great Britain votes on June 23 whether to remain in the European Union or not. Polls show that the "Brexit" vote is fairly close, with those wanting to leave the EU outnumbering those who want to stay by a small margin. Should the vote to leave win, it has the potential of promoting an unwinding of the EU since polls show a majority in France, Finland, and Italy favor leaving the EU. As the vote draws closer and the polls show the leave vote winning, I think there is a reasonable chance that those who want Britain to remain in the EU will feel motivated to vote and make the difference. If this proves correct, there is likely to be a relief rally, as those who bet on Britain leaving are forced to cover short positions that would have benefited from Britain voting to leave the EU.
After the minutes of the April 27 FOMC meeting were released on May 18, the S&P tried to break down, but then recovered in part on the notion that a Fed rate hike in June or July displayed the Fed's confidence in the economy and was thus bullish for the stock market. From the low of 2026 on May 19, the S&P rallied to 2105 on June 2, just before the employment report was released on June 3. Although the S&P rallied to 2120 after the jobs report ruled out a June hike, the market seemed to respond more to the prospect of a stronger economy that would boost earnings, than the same old story of the Fed not acting due to a sluggish economy. This suggests the market might fade after trying to rally once the FOMC statement is released, as investors focus on the prospect of earnings not improving as much as hoped in the second half of 2016.
The main point is there is plenty of news coming that will undoubtedly cause an increase in volatility during the next two weeks that could result in a deeper sell off in the S&P than just falling below 2026. The rally from the February low of 1810 to the June 8 high of 2120 was 310 S&P points. A 38.2% give back of the rally would bring the S&P down to 2002, while a 50% retracement would bring the S&P down to 1965. My guess is the S&P will likely bottom between 1980 and 2005.
On January 13, the S&P rallied to 1950 before falling sharply to the January 20 low of 1812. It then rebounded to 1947, before falling to the low on February 11 at 1810. As the S&P came off the February low, it spiked up to 1946, fell to 1891, before breaching the resistance at 1950. This suggests the 1950 level is important support, should the S&P fall that low.
For the first time since mid March, the Volatility Index (VIX) closed above 16.5 on Friday, before jumping today. Since its close on Thursday, the VIX has soared from 14.64 to 20.97 today, an increase of 43.2%, as the S&P fell just 1.7%. The surge in the VIX seems disproportionate to the size of the decline in the S&P and suggests traders could be anticipating a big decline in the next two weeks that may not be quite as large as they are anticipating.
If the Brexit vote fails, the VIX could drop sharply as the S&P rallies, especially if it drops to 2040 before the vote on June 23. If the VIX holds above 16.50 on any rally in the S&P, it would increase the odds of another leg lower before a good low is established.
As discussed in prior Reviews, I think wave 4 from the March 2009 low ended at the February 11 low. Wave 5 has the potential to lift the S&P to 2360 - 2400 by early next year. Wave 5 will sub-divide into 5 waves itself. Last week I thought that the first part (wave 1) of wave 5 from the February low would end soon, which would set up a decline below 2026 before the second part (wave 2) of wave 5 finishes. The S&P rallied from February 11 until June 8, so the move up lasted four months. From a time perspective, wave 2 is likely to last at least 6 weeks and potentially 10 weeks. This provides a time window for the end of wave 2 of late July through late August.
The information provided by a number of technical indicators will be more important than the amount of time. 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.
If the S&P drops into the price window of 1985 - 2005 and these technical indicators are at the aforementioned levels, the odds of a good trading low will increase. As of Friday, the 10-day Call/Put ratio was 1.08, after a lot of puts were bought on Friday. The moving average of the Option Premium ratio was .74 on Friday, so it isn't even close to 1.30.
As of tonday's (Monday) close, the 21 day net advances minus declines was +74, down from +588 on June 8.
Short term, the S&P is somewhat over sold, so a bounce to 2095 - 2105 is likely. The most likely catalyst for a bounce is the FOMC meeting scheduled for Tuesday, with the release of the FOMC statement at 2:15pm E.S.T. on Wednesday. The 'Pre-FOMC Announcement Drift' analysis published by the New York Federal Reserve in July, 2013 found that the average daily returns during Federal Open Market Committee meetings for the S&P 500 are outstanding - 5 times greater than returns during all other trading days.
If anything, this effect has become more amplified since 2013 associated with the Fed's QE programs.
The above chart is from the Fed's analysis and shows the average cumulative minutely return on the S&P500 index on three day windows.
The sample period is from September 1994 through March 2011. The dashed vertical red line is set at 2:15 p.m. EST, the time when FOMC announcements were typically released in this sample period.
If I'm wrong about a decline below 2026, it should be obvious, since the market would be entering wave 3 of wave 5. Wave 3 is the strongest part of any advance so the S&P 500 should explode above the old high of 2134 on much stronger volume.
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. 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 0.92%.
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.
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