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posted on 07 November 2016

The 'Which Way Is Up?' Market

Written by

Macro Tides Technical Review 07 November 2016

As Expected, S&P Breaks 2119 and Negative Sentiment Spikes

But then we had a big rally today (Monday).

nervous.nelly.380x240

The analysis from last Monday’s WTR is worth repeating:

“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."

Although the S&P only dropped to 2084 last week, negative sentiment did spike to levels that have signaled at least a short term trading low. The Call / Put ratio fell to its lowest level since January (green arrow) as investors bought puts to hedge portfolios prior to the election, or bet on a market decline if Trump wins.

The FBI’s announcement on Sunday clearing Hillary Clinton ignited a large rally today, as many investors were caught offside. Undoubtedly, short covering played a role as the market gapped higher this morning, and then ground higher during the course of the day. I suspect the majority of investors have been sitting on the sidelines until the uncertainty surrounding the election was clarified, and took the FBI’s statement as clearing the way for a Clinton win.

Had there been no FBI announcement, today’s rally probably would have occurred on Wednesday, if Hillary Clinton is the winner. This increases the odds that a Hillary win may not result in much more upside, since some of the rally has already been priced in with today’s big move up.

Click on any chart for a larger image.

welsh.tech.2016.nov.07.fig.01

By the close on Friday, the Option Premium ratio had jumped slightly above the spike after the Brexit vote in June, although it was still well below its high in February of this year and September of 2015.

welsh.tech.2016.nov.07.fig.02

After topping on October 24, the S&P fell for 9 consecutive days, the longest streak since December 1980, which certainly contributed to the sharp increase in negative sentiment. The big difference was that in 1980 the S&P lost -9.4% during that nine day slide, versus a drop of just -3.1% through Friday.

As discussed last week, the broader market has been far weaker than the S&P. During the 9 day decline, the Russell 2000 lost -5.7%, almost double the S&P’s loss. The NYSE TRIN measures the relative amount of buying pressure in advancing stocks compared to the amount of selling pressure in declining stocks. When buying and selling pressure is balanced, the TRIN is 1.00. The market is often near a short term trading low when the 10-day moving average rises above 1.40 (green horizontal line), which it did in August 2015 and January of this year. Intermediate trading lows are more likely when the 40-day average (red moving avg.) of TRIN climbs above 1.20 (red horizontal line).

As you can see, the 10-day moving average of TRIN at Friday’s close was .972, nowhere near 1.40, and the 40-day average was .994. After today, the 10-day was .868 and the 40-day TRIN was .965. These levels are more indicative of a trading high than a trading low.

welsh.tech.2016.nov.07.fig.03

When the moving averages of TRIN climb above their respective horizontals lines, it is an indication that selling pressure is imbalanced relative to buying pressure. While this may seem counter-intuitive, an imbalance in selling pressure is one symptom of forced selling or panic selling when it occurs after a protracted decline. Despite the 9 consecutive days of decline in the S&P that captured headlines, the fact both moving averages of TRIN were below 1.00 at Friday’s close suggests there was no imbalance in selling pressure as the low in prices were recorded.

While a rally to a new high can’t be completely ruled out, the lack of evident selling pressure suggests that the current rally is more likely to fizzle out than represent the start of a sustained advance in the market.

The August high in the S&P was 2193 and Friday’s low was 2084, a decline of 109 points. A 50% retracement of the 109 point decline would target 2138, while a 61.8% rebound would target 2151. In addition, the October 24 high was 2155, and the red down trend line connecting the August high with highs in September comes in near 2160. As impressive as today’s rally was, it would have been healthier had the gains been spread out over 3 trading days and not in response to a news report, which the FBI statement represents.

The key in coming days is whether the S&P can follow through and punch above the cited resistance. I’m skeptical since Trump doesn’t strike me as a good loser. The potential for dysfunctional government and rampant rancor could be the headline by the end of this week, rather than pictures of democrats and republicans linking arms and singing kumbaya.

welsh.tech.2016.nov.07.fig.04

For many weeks I’ve discussed the need for the market to get oversold as measured by the 21 day average of advances minus declines. Short term trading lows have been established whenever the 21 day average of advances minus declines has exceeded -400 (as indicated by the green up arrows on above chart). On Thursday, the 21 day net reached -450, so the market was finally oversold enough to support a decent rally. At today’s close, the 21 day average of advances minus declines was -288, which suggests the market is likely to push up to 2140 - 2160 in order to burn off more of the oversold condition that developed last week.

welsh.tech.2016.nov.07.fig.05

As I wrote last week,

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

The low last week was 1156. The Russell 2000 led the market into to the recent correction and declined more, so its performance in coming days could prove instructive. Today, the Russell was up 2.5% compared to the 2.2% gain for the S&P. It would be positive for the market if today’s outperformance continued. From its high on September 22, the Russell 2000 dropped from 1263 to Thursday’s low of 1156, or 107 points. A 50% retracement of the decline would bring the Russell 2000 up to 1210, while a 61.8% recovery would target 1222. The low on September 13 was 1206 and 1209 on September 14.

The recent decline accelerated after the Russell 2000 closed below 1210, so the area near 1210 is important resistance. The October 24 high was 1232 which preceded the subsequent selloff. The Russell 2000 closed today at 1192, so there is an additional 2% upside potential before the Russell 2000 encounters stiff resistance.

welsh.tech.2016.nov.07.fig.06

If Hillary Clinton does win, two of the determinants of whether this rally is merely a countertrend rebound, or a rally to new high in the A&P above 2193, will come from monitoring the Call / Put ratio and the Option Premium ratio. If investors continue to buy puts, especially after a Clinton victory as the market rallies up to resistance, the odds of a new high will increase.

Oil

As discussed in detail two weeks ago,

“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. 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."

Oil did sell off last week, which added to the selling pressure on the S&P. Oil posted a low of $43.57 on Friday November 4. OPEC meets on November 22, and I expect a short covering rally as those short cover, just in case OPEC does agree to cut production. A rally to $47.00 to $48.00 a barrel is likely, before another decline unfolds.

Gold

I still think gold will decline below $1243 before an intermediate 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. The coming low has the potential of being a good buying opportunity.

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

The Major Trend Indicator is positioned to post a lower high whether the current rally stalls between 2140 - 2160, or the S&P makes a modest new high. If this occurs, the market could set up a shorting opportunity. In other words, a failing rally would increase the potential of a decline below 1991 in coming months. No matter what, volatility will move higher as the market attempts to determine how the election will truly affect the economy and corporate earnings in 2017.

welsh.tech.2016.nov.07.fig.07

Technology and Financials were the only sectors that strengthened relative to the S&P 500 last week, which underscores how much the broader market has been lagging behind the S&P in recent weeks. If the odds of a new high are to increase, more sectors will need to begin to outperform the S&P. If the rally doesn’t broaden out with more sectors performing better than the S&P, the odds of a decline below 1991 will increase.

welsh.tech.2016.nov.07.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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