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posted on 25 October 2016

Slow Motion Torture

Written by

Macro Tides Technical Review 24 October 2016

Last week I thought a bounce in the S&P was possible as the market was slightly oversold, continued to hold above the September low of 2119, and the call/put ratio had dropped below 1.0. From the close last Monday at 2126, the S&P rallied to almost 2155 this morning. As discussed for a number of weeks, the more likely path in coming weeks is for the S&P to close below 2119 and be followed by a quick drop to 2050 - 2070. That said there is another pattern that must be monitored.

agony.380x200

Since topping on August 23 at 2193, the S&P has posted a string of lower highs. The trend line connecting the lower highs comes in near 2165. If the current rally tops below 2180 (B on the below chart), the S&P might be finishing wave D of a triangle pattern that has been forming since the August 23 high. This pattern suggests that after wave D completes, the S&P would fall below 2130 and possibly below 2119 in wave E. This type of triangle is noted for the difficulty in identifying the pattern until it’s almost complete, and for choppiness, which certainly describes how the S&P has traded during the last 2 months. Two times it looked as if the S&P was finally about to close below 2120, only to reverse higher. However, each rally attempt only managed to post a lower high. If the S&P does fulfill wave E, the low of wave E should be followed by a rally to a new high.

Since this type of triangle is most commonly found in wave 4, the wave 5 rally in this instance could reach 2260. That target is arrived at by measuring the width of the triangle 2190-2120) and adding the width to the top of the triangle. (2190+70=2260) This rally would likely complete the rally from the February low, and be followed by a meaningful decline.

So, as annoying and frustrating as the trading action has been during the past 2 months, wave 4 triangles, once complete, usually provide a clear road map of how the S&P is likely to trade in subsequent weeks / months. A close above 2180 would eliminate the triangle pattern and the potential of a wave E decline below 2130.

Click on any chart for larger image.

welsh.tech.2016.oct.24.fig.01

In the last three weeks, I’ve discussed the large wedge triangle that has been developing in the S&P, formed by the high in May 2015 and the low in February. The lower band of this triangle is defined by the blue rising trend line under the S&P, which comes in this week around 2150. I have expected the S&P to break below the trend line and September 12 low at 2119. The S&P traded down to 2115 on October 13, before rebounding. As you can see, the S&P closed below the trend line on three days last week, but no additional selling materialized. The lack of follow through to the downside is supportive of the triangle pattern interpretation, but also indicates that a close below 2119 is more important than the break of the trend line.

welsh.tech.2016.oct.24.fig.02

As the S&P has undergone a modest pullback, the percent of stocks on the NYSE that are making a new 52 week high has contracted from 7.44% on August 1 to 1.87% on Friday, while the percent of Nasdaq stocks making a new high has shrunk from 4.58% on September 8 to .69% on Friday.

welsh.tech.2016.oct.24.fig.03

http://econintersect.com/images/2016/10/52876605welsh.tech.2016.oct.24.fig.03.JPGThe contraction in the percent of new highs is also evident in the percent of stocks above their 200 day average, which has fallen from 81% on September 8 to 64% on Friday. These measures show that there is deterioration under the surface even as the S&P hovers just 2% below its all-time high. This is why a close below 2119 is still more likely than a rally to a new high.

welsh.tech.2016.oct.24.fig.04

As the market has rallied since last Monday, the Call/Put ratio has moved up a little, but it is still low and supportive of more upside in the very short term. A decline in the S&P, especially below 2119, would likely push it low enough to support a stronger rally.

welsh.tech.2016.oct.24.fig.05

The Option Premium ratio is not near levels (green horizontal line) that have indicated a good trading low during the last two years. It is closer to the red horizontal line, which has identified market highs.

welsh.tech.2016.oct.24.fig.06

Last week, the 21 day average of advances minus declines was modestly oversold. With the rally since last Monday it is now neutral. A decline under the green horizontal line has normally preceded solid rallies.

welsh.tech.2016.oct.24.fig.07

Technology, led by semi-conductor stocks, and small cap stocks have been the leaders since early July. Two weeks ago the Semi-conductor index (SOX), Nasdaq Composite, and Nasdaq 100 all recorded negative key weekly reversals. A negative weekly key reversal occurs when an index posts a higher high and lower low than the prior week, and closes down for the week. Weekly reversals are more important than daily reversals, and a 2 or 3 week reversal is more important than a 1 week reversal. The SOX posted a 2 week reversal, while the Nasdaq 100 and Nasdaq Composite registered 3 week key reversals.

The Semi-Conductor index and Nasdaq Composite remain below the blue rising trend line connecting the June 24 Brexit low and the mid September low.

The Nasdaq 100 is dominated by a small number of stocks that carry a big weight in the index. With Microsoft, Google, Qualcomm and a number of other big cap Nasdaq stocks making new highs, the Nasdaq 100 posted a new high today. The percent of Nasdaq stocks making a new 52 week high provides a more accurate picture, and that continues to weaken.

welsh.tech.2016.oct.24.fig.08

welsh.tech.2016.oct.24.fig.09

The positioning in the oil futures market continues to show trend following large specs and managed money (dumb money) remain very long, while producers and commercials (smart money) are short almost as many contracts now than they were at the high in June and August. After bottoming in early August at $41.58 a barrel on the December contract, oil rallied to $50.59, a gain of $9.01.

From the recent low at $43.77, an equal rally of $9.01 would end at $52.78. The high last week was $52.22. If oil falls below today’s low at $49.62, the top is probably in place. The decline from last week’s high could be a small correction before one more rally above $52.22.

Although oil may briefly pop above $52.22, the next big move is likely down to $44.00 a barrel. A close above $53.50 would mean I’m probably wrong. Oil and stocks have been somewhat correlated in recent months. If oil falls as I expect that would likely pressure stocks as well.

welsh.tech.2016.oct.24.fig.10

The positioning in gold suggests it has either established a trading low or will do so on one more decline below the recent low at $1243. The recent decline has caused the trend following large speculators and managed money to cut back on their long positions, while the commercials and producers have significantly reduced their short positions. Although it is possible that gold has bottomed, I don’t think so.

Last week I thought gold might bounce up to $1280, and it did rally up to $1274. I still think gold will decline below $1243 before a low is formed. After the low is in place, a rally to $1300 is likely at a minimum, with a decent chance that gold will rally in coming months above $1380, which was the August high. This has the potential of being an intermediate low and a good buying opportunity.

welsh.tech.2016.oct.24.fig.11

In the September 1 Macro Tides I wrote, “I expect the Dollar to push above the high at 97.50 and potentially reach 98.50." Today the dollar rallied up to 98.82. Although there may be a little more upside left, my guess is that the dollar is nearing at least a short term peak.

Longer term the dollar is likely to rally above 100.51 and potentially to 106.00 to 110.00 in wave 5 from the low near 70.00 in March 2008. If it moves above 100.51 soon it will not likely rally to the higher range until later in 2017. So, from an intermediate term perspective the dollar is at an interesting crossroads. Since peaking in March 2015, the dollar has been trading in a large trading range between 92 and 100. There is a decent chance that the current rally is wave D of a triangle from the March 2015 high. If so, the current rally will top near 99.50, and then drop to near 92.00 for wave E.

welsh.tech.2016.oct.24.fig.12

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.

The Major Trend Indicator has continued to weaken which supports the potential of a decline in the S&P to 2050 - 2070. As discussed in recent weeks, a decline to 1200 on the Russell 2000 seems likely.

There is a smaller chance that the S&P could experience a deeper decline, based on the price pattern. As discussed previously, the February low probably is wave 4 from the March 2009 low. This suggests the S&P has the potential to rally to 2360 or so in coming months, before the bull market ends. It’s possible that the rally from the Brexit low was wave B of a larger A-B-C correction, which would end after the S&P had finished wave C below the Brexit low at 1991 on the S&P. All of this is a moot point until the S&P closes under 2119 and the rising blue trend line.

welsh.tech.2016.oct.24.fig.13

A quick review of the Tactical Rotation U.S. Sector rankings shows that the majority of sector weakened last week even though the S&P was up .38%. The only sectors whose relative strength improved were Technology, Utilties, Consumer Discretionary, and Consumer Staples. Small Caps and Technology have been realtively stronger since early July. Utilities, and the Consumer stocks have been quite weak since early July, which underscores the degree of rotation that has occurred since early July. The need and search for income has not gone away, so at some point sectors with decent dividends will catch a bid again. In other words, for investors needing income, it will be important to monitor these sectors, especially if the market suffers a decline. These sectors are not likely to lead the market higher, as they did in 2015 and the first half of 2016.

welsh.tech.2016.oct.24.tact.table

Disclosure

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices, S&P 500, Russell 2000, and Nasdaq 100, are unmanaged and investors cannot invest directly into an index.

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