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posted on 31 October 2016

Stocks: Sub Surface Deterioration

Written by

Macro Tides Technical Review 31 October 2016

Over the last 5 weeks, a review of the S&P makes it appear that not much has been going on. Since September 22, the S&P has only dipped -2.34%, which is not much of a decline over 5 weeks of trading. But that sanguine overview is masking what’s going on under the surface. While the S&P has only fallen by -2.34% since September 22, the Russell 2000 has lost -5.7%, 2.4 times as much as the S&P.

rotted.pilings.380x180

As I noted in the September 26 WTR,

“Last week, the Russell 2000 posted a new closing high, as did the Nasdaq 100. These sectors have been the best performing, but the new high in each index was not confirmed by its RSI. The RSI divergence on the Russell 2000 and Nasdaq 100 suggests that these leading sectors are starting to tire and becoming more vulnerable to a correction."

In the October 10 WTR I wrote,

“On Friday the Russell 2000 broke below its rising trend line connecting the June Brexit low and the low in early September (red line), before rebounding today. Sooner or later a test of the blue trend line near 1200 is likely."

Today, the Russell 2000 traded down to 1185. If the S&P drops below 2120 and 2100 as I expect, the Russell 2000 could trade down to 1150 in coming weeks.

Click on any chart for larger image.

welsh.tech.2016.oct.31.fig.01

The weakness in the Russell 2000 is not the only indication of internal weakness under the surface. The percent of stocks above their 200-day average has dropped from 81% on September 9 to 57% last Friday. Even as the S&P has been treading water, an increasing number of stocks have been selling off.

welsh.tech.2016.oct.31.fig.02

The percent of stocks on the NYSE and Nasdaq that have been making new 52 week highs has contracted significantly since early September. These measures are 21 day averages, so they don’t fully reflect the amount of deterioration over the past week. On Friday 48 stocks posted a new 52 week high on the NYSE, but 77 made a new 52 week low. The figures for the Nasdaq were far more negative as 142 stocks made a new low and only 56 stocks were able to make a new 52 week high.

welsh.tech.2016.oct.31.fig.03

Despite the deterioration in the broad market, the 21 day average of net advances minus declines is still not oversold. The deterioration in the percent of stocks below their 200 day average and the decline in the percent of stocks making new 52 week highs on the NYSE and Nasdaq certainly increase the odds that the S&P will break below its support at 2119, which I have cited for weeks. On Friday the S&P made an intra-day low of 2119. It is noteworthy that each bounce off this line of support is getting weaker, which means the market is setting up for a quick and sharp drop below this support

welsh.tech.2016.oct.31.fig.04

Of the 500 stocks in the S&P, just 5 stocks represent 11.85% of the index since it is weighted by capitalization. The 5 stocks are Apple, Microsoft, Amazon, Facebook, and Google, which have been performing well. The 64 stocks in the Financials ETF (XLF) represent 12.8% of the S&P 500. Combine this sector and the 5 technology behemoths, and these 69 stocks comprise 24.65% of the S&P, even though they are only 13.8% of the total 500 stocks.

The strength in these 69 stocks is why the S&P has been able to hold above its support at 2119. Sooner or later, the Big 5 will experience their own correction, and when they do, the rest of the market will slide right along with them. This set up suggests that when the break of 2119 comes, it will be sharp.

Since much of the market has already been correcting for 5 weeks, the decline in the Big 5 will likely signal the end of the correction, rather than the beginning as the overall market will be oversold and sentiment will turn bearish once the Big 5 sell off. If correct, the Call / Put ratio and the Option Premium ratio should spike higher if the S&P quickly drops to 2050 - 2070, as I have been anticipating.

welsh.tech.2016.oct.31.fig.05

welsh.tech.2016.oct.31.fig.06

As discussed in detail last week:

“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."

Today, oil prices fell by 3% and have declined by 7.3% since last Monday’s WTR. My guess is that oil could fall below $45.00 a barrel before a decent bounce takes hold. OPEC meets on November 22, so there is a short covering rally coming as those short cover, just in case OPEC does agree to cut production.

welsh.tech.2016.oct.31.fig.07

The Commitment of Traders report released on Friday October 28 continues to support my view that gold 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. Two weeks ago, I thought gold might bounce up to $1280, and it did rally up to $1285 after the FBI news about Clinton’s emails was announced on Friday. 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.31.fig.08

Last week I thought that there might be a little more upside left in the Dollar, after it reached 98.82 last Monday. On Tuesday the Dollar rose to 99.09 before reversing lower. It is too early to confirm, but my guess is that the dollar has at least made a short term peak.

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 94.00 for wave E. 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

welsh.tech.2016.oct.31.fig.09

In the September 19 Weekly Technical Review I assessed the potential for the 10-year Treasury yield to increase in coming weeks:

“The yield on the 10-year Treasury bond appears poised for a breakout above the blue horizontal line, although there is a gap at 1.635% that might get filled first. Either way, I think the 10-year yield is headed for 1.85% - 1.90%. Longer term, a test of the long term green down trend line, which connects the highs in 2007, 2013, and 2015 near 2.0%, is coming. That said, the increase in the 10- year Treasury yield will resemble a tortoise."

On Friday October 28, the yield on the 10-year Treasury rose to 1.879%. My guess is that the bond market is likely to rally in coming weeks, especially if the stock market sells off as I expect. Friday’s first estimate of third quarter GDP was boosted by an increase in exports that added 0.83% to the 2.9% due to a one-time surge in soybean exports. As discussed in the November issue of Macro Tides, GDP growth is likely to moderate in the fourth quarter, which would be supportive of the bond market. Although inflation is likely to climb above the Fed’s 2% target in the first quarter next year, Janet Yellen will continue to resist raising rates.

welsh.tech.2016.oct.31.fig.10

Tactical S&P Sector Rotation Portfolio Model: Relative Strength Ranking

The Major Trend Indicator has continued to weaken which supports the potential of a decline in the S&P to 2050 - 2070. As expected, the Russell 2000 has declined to 1200, which opens the door to a further decline to 1150. 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 may be 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.31.fig.11

welsh.tech.2016.oct.31.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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