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posted on 04 April 2017

Macro Tides Technical Review 03 April 2017

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The Dollar’s Coming Impact on Markets

The Dollar’s RSI fell below 30.0 on March 27, and as noted last week, the Dollar has rallied each time the RSI fell to 30 (green arrows chart below). I thought the Dollar was likely approaching a trading low soon. As it turned out, the low last Monday was the low, and the trading action since then has been constructive.

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The decline since the January 3 high appears to be 3 waves, so the potential of one more rally above 103.82 still exists. At a minimum I expect a rally in the Dollar back up to 101.50 - 102.20. A close above 102.25 would shift the odds in favor of a new high above 103.82 posted on January 3. A close below the March 27 low 98.85 (cash) and 99.33 (June futures) would be negative and pretty much eliminate the potential for a new high.

The upcoming rally in the Dollar could determine the long term outlook. When the Dollar tested the March 2015 high in November 2015, the Major Trend Indicator (MTI) was at a much lower level (red trend line chart below). This along with other technical indicators led me to expect a decline in the Dollar Index to near 93.00. The dollar bottomed on May 3 2016 at 91.88, and then rallied to a new high above 100.51 as forecast. As the Dollar failed to rally above the resistance at 102.20, the Major Trend Indicator was far weaker than it was in December.

Even if the Dollar does manage to rally above 103.82, the MTI is unlikely to surpass its December high. The technical picture will look even weaker if the Dollar only tests 101.50 - 102.20 and then turns lower. My guess is that the Dollar is likely to test the May 2016 low of 91.88 before the end of 2017. If correct, a number of markets are likely to be hurt in the short term from a rally in the Dollar to 101.50 -102.20, before benefiting from a 10% decline in the Dollar in coming months.

Emerging Markets

After the Dollar topped in late December, the Emerging Market ETF EEM rallied from $34.00 to over $40.00, a gain of almost 18%. However, as EEM was making a new high two weeks ago, its RSI was far lower than it was at the high it posted in mid February (red arrow chart below).

The same type of divergence occurred in April 2016 (red arrow chart below), which was followed by a 10.3% correction. EEM fell 6.35% to November 4, after a new price high was not confirmed by EEM’s RSI on September 22. After the election, EEM dropped another 5%, as the Dollar soared.

Last week’s RSI divergence suggests that EEM could decline between 6.35% to more than 10% in coming weeks, especially if the Dollar rallies as I expect. The first target is the March 9 low of $37.39, with the potential of a decline to $36.50 (green trend line). Longer term, EEM could experience a rally to $44.00 - $45.00, testing the highs of 2015, 2014, and 2013. A close above $45.00 would open the door for a move to the 2011 high near $50.00. As you can see, the Major Trend Indicator provided a timely Buy signal in February 2016.

Gold and Gold Stocks

Last week, I thought gold and gold stocks could come under pressure if the Dollar bottomed and rallied. So far, the Dollar has done its part, but gold and gold stocks have yet to break down and continue to hover near the recent highs. A close above the high on February 27 at $1268.10 (June futures) would turn the short term trend positive and probably rule out the decline below $1200 I have been expecting.

Gold has retraced 94.5% of the $70.40 decline after topping at $1264.9 on March 27. In contrast, the gold stock ETF GDX has only recovered 53% of the $4.57 loss it suffered after peaking on February 8 at $25.71. This shows that the gold stocks are relatively weak compared to gold which is often a negative indication for gold. A close above $23.56 on the gold stock ETF GDX would be positive at least short term and warrant putting the position sold above $25.17 - $25.25 in early February back on.

The 61.8% retracement of the $4.57 decline GDX experienced would allow GDX to rally up to $23.96. GDX has the potential to decline to $19.43, where a gap was created on December 23 (chart above). However, a close above $24.00 would reduce the odds of another large decline. Longer term, I think gold will rally above $1400, while GDX has the potential to rally to at least $31.00.

The Fed and Treasury Yields

Last week, I noted that the yield on the 10-year Treasury bond was approaching resistance between 2.31% and 2.33%, so a modest rebound in its yield was likely. A 50% retracement of the .267% decline in the 10-year yield from its high in mid December would target a rebound to 2.48%. From a low of 2.348% on March 27, the yield only pushed up to 2.427%, before dropping to 2.332% today. While the potential remains that the 10-year yield could reach 2.48%, the odds are increasing that the 10-yield Treasury yield will drop below 2.3% in coming weeks.

The Treasury bond ETF (TLT) marginally dropped below its mid December low and made a new price low of $116.49 on March 13, so it is possible to count the pattern from the price high last July as a 5 wave decline. This suggests that TLT will likely rally to at least wave 4 of lesser degree ($123). Since the low of $116.49, TLT rallied in a 5 wave pattern up to $121.97, which indicates it would rally after any pullback. (Chart above) TLT corrected the rally from $116.49 to $121.97 in three waves (a-b-c), which reinforces the expectation of more upside. From its high of $143.62 last July, TLT declined $27.13. A 38.2% retracement would lead to a rally to $126.85, while a 50% retracement would bring TLT back up to $130.00. A close above $121.97 could be followed by a rally to $125.69, if the next rally is equal to the $4.48 rally from the low at $116.49.

Stocks

In last week’s WTR, I discussed that the DJIA had fallen for 8 consecutive days and the RSI on the S&P had dropped from 82 to 42. Short term the market was modestly oversold and on Friday March 24, more puts than calls were purchased. I expected the market to rally soon. I noted the S&P had fallen 79 points from its high of 2401 on March 1 to last Monday’s low of 2322, which I think is wave a of a larger a-b-c decline. A 61.8% retracement of the 79 point decline would lift the S&P to 2370 or so for wave b. The S&P did rally and tagged 2370 on Thursday and Friday, before pulling back today.

The most important point is that the correction that began after the high on March 1 is not over. As I have noted, the S&P left three gaps as it marched higher during February. Traditional charting indicates that the gaps will be filled sooner or later. The S&P has filled the gap at 2371.54, and 2351.90. I expect the remaining gap at 2311.08 from February 9 to be filled during wave c.

That said a close above 2370 would open the door for the S&P to rally to a modest new high above 2401. Should the S&P push to a marginal new high, the technical divergences would be many and significant. I think the S&P is in Wave (5) of the bull market that began in March 2009, after wave (4) ended in February 2016. The current correction is wave 4 of (5) and should be followed by a rally well above 2401 before Labor Day.

If the internal strength of the market weakens noticeably during wave 5 of (5), the odds will increase that the bull market from March 2009 is ending. We’ll cross that bridge if and when the S&P makes a new all-time high and divergences materialize.

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

Technology stocks took over the leadership of the rally after the financial sector and small caps began to falter after peaking on March 1. On Friday and today, the Nasdaq 100 and Nasdaq Composite each made a new intra-day high before reversing lower and in the process created a daily negative key reversal today.

As discussed last Monday, the Nasdaq 100 and Nasdaq Composite each recorded Negative Weekly Key reversals for the week ending March 24. Both averages posted a new high above the prior week, a lower low, and then closed lower on the week.

Negative Weekly Key Reversals are often a sign of a trend change. This suggests that the current correction has further to go in both price and time. The Technology sector now represents 22% of the S&P 500, up from 20.8% on December 2, 2016. If bond yields continue to fall as I expect, the Financials could correct more than they have.

As the Technology ETF (XLK) made a new high last week, its RSI posted a lower high, which represented a negative momentum warning (Chart above). The same pattern is also evident in Consumer Staples, Health Care, and Consumer Discretionary (Charts below). These sectors represent almost 70% of the S&P 500. If they correct as the negative divergences suggest, along with more weakness in Financials, the S&P can close the gap at 2311 and potentially trade lower.

welsh.tech.2017.apr.03.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. The Russell 2000 Index is a small-cap 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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