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posted on 16 August 2016

The Market: Comatose Elevation

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Macro Tides Weekly Technical Review 15 August 2016

One aspect that is striking, after almost two weeks of traveling, is how little prices have changed in most markets. On July 29, the S&P traded up to 2177 compared to 2193 today, gold is trading at $1345, down slightly from $1349 at the end of July, while the 10-year Treasury yield has moved from 1.46% to 2.55%.

S&P 500

As noted in the August 1 WTR, the S&P had traded in a 1% range for 13 trading days, the longest, most narrow trading range in more than 40 years. Based on the width of the trading range (2176 - 2159), a breakout to the upside would be activated if the S&P closed above 2178 and would target a rally to 2193. The S&P closed above 2178 on August 5 and reached the target of 2193 today. The rally from the low on June 27 either ended today or will shortly.

A correction that allows the S&P to test its Breakout Support at 2110 - 2130 seems likely in coming weeks. Since mid July one of the key ingredients has been the complete lack of selling pressure, which has been held in check by constructive economic news (July employment report), central bank actions (BOE cutting rates), and the prospect of future fiscal stimulus to boost global economic growth (Japan).

Click on any chart for larger image.

The 21 day average of advances minus declines measures buying and selling pressure and helps identify when the market has become overbought and oversold. As discussed in the August 1 WTR, the 21 day average of advances minus declines reached a very overbought level of 654 on July 12. Since then it has unwound the overbought condition without the S&P falling. This confirms the lack of selling pressure. The only negative is that the 21 day average of advances minus declines is not confirming the new price high in the S&P. If this was occurring in a normal two-way market, the negative divergence would carry more weight than in the current environment which is best described by comatose elevation. It does support the potential for the modest correction I think is likely.

Another indication of how overbought the market remains is illustrated by the percent of stocks above their 200 day average. As of Friday August 12, 78% of stocks traded on the NYSE were above their 200 day average. The last time it was this overdone was back in June 2014. This reading was followed by a sharp dip in the S&P in August 2014. This decline proved a warning that presaged the deeper correction which followed in September and October. Notice how the percent of stocks above their 200 day average was much lower as the S&P made a new high in early September. Until a crack in the market's façade appears, the probability of a deeper decline in the short term is low.

Sentiment Suggests the Upside Is Limited

The Option Premium ratio continues to hover at levels that have coincided with at least a short term top in the market over the last two years, as noted by the blue arrows on the Option Premium chart.

The weekly National Association of Active Investment Managers (NAAIM) survey registered their highest allocation to equities this year on July 27, and the third-highest reading since 2013. Although the allocation has dipped since then, it remains elevated. Active investment managers are predominantly tactical and trend following in their approach.

As you can see, they lowered their exposure to the market as it fell in August and September last year, increased exposure after the market rallied in October and November, and then jumped out as the market fell in January and February this year. The last time the reading was this high was in May 2015, after which the S&P made no net progress. In the weeks following the high in May 2015, the market's internals weakened, which set up the sharp decline during August and September. The market's internals are still quite healthy, so one of the keys in coming weeks is whether they begin to deteriorate. The high NAAIM reading indicates that these managers have already moved into the market, which suggests there is less sideline

money from this contingent to move the market higher. As I noted in the August 1 WTR, the market can hold up and push higher, until the market is given a reason to sell.


The Major Trend Indicator (MTI) is a proprietary measurement of how strong or weak the market is. Generally, the MTI will make a series of lower highs prior to a correction of more than 7%. This does not preclude a modest decline of 3% to 5% in coming weeks. The MTI has surpassed the high it recorded in April, which is a sign of strength. This suggests that a correction of more than 7% is unlikely in the next few months, until the technical underpinnings of the market deteriorate.

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.

As I have discussed since early July, the market was not oversold nor was sentiment negative when the S&P bottomed on June 27 after the Brexit vote. Although I had previously discussed the potential of the S&P dropping below 2000 in the weeks leading up to the Brexit vote, the lack of any normal bottoming signals convinced me that patience was the better part of valor under the circumstances. In addition, after generating a total return in the first quarter of 8.9%, I thought waiting until the technical and sentiment indicators suggested a solid trading low had been established made sense. (Q1 return does not include management fees) Past performance is no guarantee of future results. Needless to say, the rally has exceeded expectations, which has been frustrating.

My other concern has been the sectors that have comprised the top 4 sectors in the Weekly Relative Strength analysis. In the June 8 issue of Macro Tides I assessed the outlook for oil prices and concluded that oil prices were likely to head lower from $50. In the July 25 WTR I noted that oil had broken below $44.00 and was on its way to $40. On August 1 WTI oil traded under $40 a barrel and I expected oil to get a brief bounce from the chart support near $40 a barrel. I think the bounce is over.

Some of the recent strength has been predicated on OPEC and Saudi Arabia coming to an agreement on production, which seems unlikely. Demand from refiners is expected to decline by more than 1 million barrels a day between now and early October. The chart displays the annual seasonal pattern in refinery demand, which bottoms near week 41 each year, or in the first half of October.

From its high on June 8, oil fell $13.43 before bottoming on August 2. A 50% retracement of that decline projected a high of $45.97, which is just cents away from today's high of $45.93. The 61.8% retracement would be $47.56 a barrel, and given the bullish sentiment about OPEC, WTI could spike to that level. Irrespective of where oil tops, I expect another decline of $13.00 a barrel that eventually drops oil down to near $36.00 a barrel or lower before early October.

In the August 1 WTR I thought the oil stock ETF (XLE) would probably bounce at its support near $64.25 (blue horizontal line), and it has. If I'm correct about oil prices, XLE will have trouble staying above $70.26, and should retest the blue horizontal support line. My guess is that XLE will not hold support and will subsequently drop to $60.00, if oil follows the script.

As I discussed in the July 25 WTR, the Utilities are very expensive and could be vulnerable to a sharp pullback. The Utilities have underperformed during the post Brexit vote rally, as investor's embraced risk in sectors like Technology and Biotechnology. The Utility ETF XLU has now declined by -5.4% since July 6.

XLU is approaching support just under $50, so a bounce is likely.

I also noted that Consumer Staples were also overvalued as yield seeking investors have bid the sector up to one of its highest valuations in history. Since July 6, the Consumer Staples ETF has dipped -.90%, and fallen out of the top four sectors. Basic Materials has gone nowhere since mid July. Even though it is still number one, it has started to fade in relative strength.

Normally, (unfortunately, these are anything but normal times), the stock market experiences a correction when it undergoes a leadership change. Just about every sector has been exploited during the rally, so most sectors are overbought and vulnerable to at least a short term pullback of 3% to 5%. Small cap stocks have had a great run, but are extended. Potentially the Russell 2000 could rally another 2% - 3%, but the risk versus the reward of a quick spike doesn't seem justified.

Jim Welsh

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