posted on 29 November 2016
Written by Jim Welsh
Macro Tides Technical Review 28 November 2016
Sentiment Issues a Warning
Last week I noted that sentiment had jumped significantly from before the election through November 15. Since the market had continued to climb after November 15, I thought it was probably a safe bet that bullishness had increased further. It did. The percent of bulls in the weekly American Association of Individual Investors survey rose to 49.9% bulls as of November 22, the highest in two years, and up from the 23.6% bulls registered on November 8.
The net bulls in Investors Intelligence weekly sentiment survey rose to 34.3%, just below the 36.5% level reached on August 26 and days after the August 23 peak in the S&P.
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CNN’as Fear and Greed index has jumped from 33 one month ago to 72 on Friday and 70 today. The CNN Index is a composite of 7 different indicators that measure momentum, sentiment, and bond market spreads.
Sentiment can be a very helpful tool in identifying when the market may be vulnerable to a pullback, after sentiment reaches a bullish extreme, or a rally when too many investors turn bearish. But it is important to remember that markets don’t go down just because too many investors have become positive. Normally, it suggests that the upside may be limited in the short run, since investors put money into the market as they become more optimistic. This means there is less buying power on the sidelines to continue to push prices higher.
In order for the market to experience a meaningful decline, investors need to be provided a reason to sell. With the end of the year right around the corner, and tax policy changing in 2017, investors will want to hold off selling winners until next year so their capital gains taxes will be less. They will also want to own the ‘right’ stocks for what I call Trumpynomics, which are the stocks that have performed the best since the election. The majority of investors thus have two reasons not sell financials, small caps, and industrials before the end of 2016. This suggests that any correction in the short term is likely to be fairly shallow.
Although seasonality is favorable going into year end, in the last five years the S&P has experienced a correction in every year. Here are the results for each year: 2015 -5.2%, 2014 -5.1%, 2013 -2.4%, 2012 -3.4%, 2011 -5.0%. Most of the corrections occurred in the first half of December. My guess is, given the dynamics that are unique to this year any correction is likely to be closer to -2.5% than -5.0%.
There are two events that could prompt a correction. OPEC meets this Wednesday and expectations are high that they will announce an agreement to cut production. If they fail to deliver, oil prices could drop sharply and unsettle financial markets. My guess is they will package some kind of deal just to save face after announcing they would have an agreement last month.
In recent months a number of producers, Russia, Saudi Arabia, Iran, and others have increased production by an amount that is nearly equal to what they promised to cut. Even if OPEC announces a cut, it won’t mean much with production levels up.
Production in the U.S. has been creeping higher as more shale production comes back on stream. In the October 31 WTR, I wrote:
Oil fell to $42.95 on November 14, before rallying to $49.20 on November 22. If a deal is announced, oil could rally to $50.00 - $52.00. If oil does rally to that price range, a potential short trade could set up. Sooner or later, I expect oil to trade below $42.95 and eventually fall under $41.00.
Next Sunday, December 4, Italy votes on a referendum that its Prime Minister has vowed to resign if it doesn’t pass. The last published poll on Friday November 18 showed the No’s had a slight lead, but more than 20% of voters were undecided. Italian law prohibits polls 15 days before an election or referendum, which sounds like a good idea for the U.S. to adopt. Voters should make up their own minds rather than being influence by a poll just before they cast their vote.
As we know, bond yields in the U.S have risen sharply, with the 10-year Treasury yield jumping from 1.86% on November 8 to 2.41% on November 22. While that increase is amazing, it pales compared to the rise in Italian 10-year bond yields, which have soared from 1.042% on August 22 to 2.068% today.
Although the referendum is not a vote about Italy’s membership in the European Union, a no vote could lead to an increase in anti-EU sentiment in Italy. The Euro has declined from 1.129 on the night of the U.S. election to 1.052 on November 22, a decline of -6.8% in two weeks. This is an enormous decline for a major currency in such a short time and sentiment has become extremely negative toward the Euro. My guess is that the Euro will rally soon, which makes me lean toward thinking the referendum will pass. If I’m wrong and it doesn’t pass, I expect a spike lower and then a good rally as short covering plays results in a sharp rally.
Although the employment report on Friday could be market moving, it would have to be far above the expectations for an increase of 171,000 new jobs in November. A number above 225,000 might raise concerns of a more aggressive Fed after they increase rates at their December 14 meeting. A weak number, below 75,000, might actually cause stocks to rally, bond yields to fall, and the dollar to weaken.
Market Average Charts Last week I thought the S&P might run into some resistance near 2210, which is where the black trend line connecting the May 2015 high and August high at 2193 comes into play. The high last week was 2213, which was posted on Friday during a half session on low volume. The RSI for the S&P pushed to 71.9, the highest level since November 2014. After a brief dip and push to another new high in early December 2014, the S&P dropped -5.1% between December 5 and December 16. My guess is that the S&P could fall to 2140 - 2160 in the first half of December, before rallying into year end.
The Russell 2000 has literally gone vertical which pushed its RSI to 81.3, the highest level in many years. A quick pullback to 1290 - 1300 is possible. If the Russell has a dip and then rallies to 1355 or so, selling a little would make sense, especially in qualified accounts.
More than 90% of traders are bullish on the Dollar index, with expectations that the rally in the Dollar will continue into 2017. As noted last week, I think the Dollar is nearing a high in anticipation of a Fed rate increase on December 14. After a straight up move since the election, the Dollar index is giving the first signs that the run is nearing an end. The RSI, which reached 81 on November 18, has begun to roll over.
Although the Dollar may push modestly higher going into the Fed meeting or year end, the next bigger move is likely to be down. A positive reversal in the Euro would be necessary to cause the Dollar to drop since it represents 57% of the Dollar index.
Treasury 10-year Yield
Last week I thought the yield on the 10-year Treasury bond was nearing a high and that the Treasury ETF TLT was nearing a low:
On Friday November 25, TLT traded down to 119.71 and has since bounced. Although the low may be in place, given the potential for tax loss selling, another drop into this support zone is certainly possible. I think the economy is going to slow in the first quarter and the Fed is likely to make sure investors know they will be in no hurry to raise rates quickly, after they increase the Fed funds rate on December 14. This could create a window for longer term Treasury rates to fall.
On November 25, GLD traded down to $112.35 before closing at $112.61. GDX traded down to $20.14 on November 23 before reversing higher. We purchased GDX on Wednesday between $20.18 and $20.45. Today GDX closed at $21.40. Maintain the stop on GDX and lower it to $111.00 on GLD.
Tactical S&P Sector Rotation Portfolio Model: Relative Strength Ranking
Although the S&P made a new high, the Major Trend Indicator is still below the high it made in mid August as the S&P reached 2193. If this divergence persists in coming weeks, the market could set up a shorting opportunity in early 2017. Given the strong upside momentum since the election and the impact of lower taxes next year, selling pressure is likely to remain muted through year end in most sectors.
In the seven days after the election, $39 billion flowed in equity ETFs. This inflow was a record and is another reflection of how broadly the bullish sentiment has become in a matter of days.
In a conference call on the morning of November 9, I suggested that the Industrials and the Russell 2000 could benefit from the excitement about infrastructure spending and the perception that a pick-up in U.S. economic growth would benefit domestic small cap stocks. After Financials, those two sectors have performed well. Since the morning of November 9 through Friday November 25, the Russell 2000 ETF IWM is up 10.12%, while the Industrial ETF XLI has gained 4.95%. Since the morning of November 9 the S&P had gained 2.6% through Friday.
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. The Russell 2000 Index is a smallcap stock market index of the bottom 2,000 stocks in the Russell 3000 Index. The Nasdaq 100 is composed of the 100 largest, most actively traded U.S. companies listed on the Nasdaq stock exchange. All indices, S&P 500, Russell 2000, and Nasdaq 100, are unmanaged and investors cannot invest directly into an index.
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