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posted on 21 June 2016

It's Brexit Week For The Market

Written by

MacroTides Weekly Technical Review 20 June 2016


Last week I noted that Great Britain votes on June 23 whether to remain in the European Union or not, and the polls show that the "Brexit" vote is fairly close. Last week the polls showed that those wanting to leave the EU outnumbered those who want to stay by a small margin. Markets have seesawed based on the latest poll numbers.


At the beginning of any referendum, those who want a change are far more motivated than those who find nothing wrong with the status quo. When the status quo is on the threshold of being upset, human nature takes over. Most people do not like change, especially when they don't have a clear vision of what the future looks like. This is certainly the case with the Brexit vote, since no one knows what the repercussions will be, if Britain votes to leave the EU. I have thought those who want Britain to remain in the EU would feel motivated to vote and make the difference. If I'm correct about this aspect of human nature, more of the undecided voters will choose to maintain the status quo and defeat Brexit.

On Sunday a new poll showed that those wanting to remain in the E.U. now outnumber those in favor of Brexit. As expected, the S&P opened up strongly as those who bet on Britain leaving were forced to cover short positions. Even if Brexit is voted down, it will not change the angst of those who wanted to leave, nor will it affect the majority of those in Franc and Finland who are also in favor of leaving the E.U. The vote may be over on June 24, but after years of subpar growth, sentiment in favor of the E.U. is waning. I think support for the E.U. will weaken further, as solid economic growth remains elusive, in part due to negative interest rates which are failing to spur lending and spending.

Federal Reserve

As expected the Federal Reserve announced last Wednesday, that they were not raising rates, and as I expected, there wasn't a clear signal about the July meeting either. Since the low in the S&P on May 19, the market has responded more to the prospect of a stronger economy and rising earnings, than the same old story of the Fed not acting due to a sluggish economy. My guess was that the market might fade after trying to rally, once the FOMC statement was released, as investors focused on the prospect of earnings not improving as much as hoped in the second half of 2016. In the minutes after the statement was announced, the S&P bounced from 2079 to 2085, and then lost 35 points in less than 3 hours of trading.

Click on any chart for larger image.

After bottoming on Thursday morning at 2050, the S&P spiked to 2101 this morning on the new Brexit poll results before closing at 2083. Last week I noted that the S&P was somewhat over sold, so a bounce to 2095 - 2105 is likely, which was fulfilled at this mornings high. The odds favor that this morning's high (Monday 20 June) is the high for the rebound since the May 19 low, and will be followed by a decline below 2050 before the end of June.

Janet Yellen testifies before Congress on Tuesday and Wednesday, and she will undoubtedly reiterate her post FOMC press conference comments. She indicated her unwillingness to raise rates unless the data improves and Brexit fails to pass. I suspect the market will try to rally if she appears dovish, but the upside is limited. If she raises the specter of raising rates, the market will sell off, not because it fears higher rates, but from weariness due to Fed speak whipsaws.

Stock Market

In last week's Review I noted that the Volatility Index (VIX) had soared from 14.64 on Thursday June 9 to 20.97 on June 13, an increase of 43.2%, as the S&P fell just 1.7%. The surge in the VIX seemed disproportionate to the size of the decline in the S&P and suggested traders might be anticipating a big decline in the next two weeks that may not turn out to be as large as they are anticipating. I also said that if the VIX held above 16.50 on any rally in the S&P, it would increase the odds of another leg lower before a good low was established.

As the S&P traded at 2101 this morning, the low on the VIX was 16.59, and closed today at 18.37. If the market rallies on comments by Janet Yellen or the failure of Brexit and the VIX does close below 16.50, the odds of the S&P pushing to a new high above 2134 will increase. I don't expect this outcome and would prefer to look for a spot to short the S&P since a decline below 2026, and probably under 2000 is the more likely path.

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. I think that the first part (wave 1) of wave 5 from the February low ended on June 8 when the S&P reached 2120. Before the second part (wave 2) of wave 5 finishes, 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.

On Friday the average of the 10-day Call/Put ratio was 1.078, which suggests the market is likely to decline in order to bring the ratio below 1.0. As the chart below illustrates, the C/P Ratio has fallen comfortably below 1.0 before the S&P has bottomed in the last year as the arrows highlight.

The 21 day net advances minus declines closed today at +235, so it isn't even close to being oversold.

The Option Premium was .93 on Friday, and likely fell after today's rally, so it's nowhere near 1.30.

The chart below is the 21 day average of up volume minus down volume. The most striking aspect is how there has been less up volume flowing into the market since this indicator peaked on March 7. When the S&P topped on April 20 at 2111, the net up volume was 187 million compared to 287 million on March 7. When the S&P topped on June 8 at 2120, net volume was only 141 million. Up volume is the fuel that powers a rally in the stock market. Given the decline in net volume since April 20, the market appears to be running out of gas.

If I'm wrong about a decline below 2026, it should be obvious, since the market will be entering wave 3 of wave 5. Wave 3 is the strongest part of any advance so the S&P 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 .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%.

Since early mid March the S&P has not made a lot of upside progress, but it sure has bounced around based on the latest Fed comment or Brexit poll. Sometimes the most difficult thing to exercise is patience. So far my patience has been rewarded. 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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