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posted on 09 May 2017

How Thin Can An Advance Be Before It Folds Over?

Written by

Macro Tides Technical Review for 08 May 2017

Stocks

The S&P 500, Nasdaq 100, and Nasdaq Composite all made a new closing high today. As noted in the past two WTRs , five stocks (Apple, Amazon, Facebook, Google, Microsoft) represent 41% of the Nasdaq 100 and 17.1% of the S&P 500. Sooner or later, the ‘Jive with the Five’ dance will take a break.

flat.stanley

When these five stocks exhale, the S&P and Nasdaq 100 will suffer a correction. While these averages made a new high today, the Russell 2000, the Midcaps, DJIA, and the DJ Transports did not. The underlying technical indicators suggest that a breather could happen soon.

Market breadth was actually negative today, with more stocks down than up on the NYSE and Nasdaq Composite. The NYSE Advance / Decline line declined by about 300 issues, and the Nasdaq A/D line dipped by 270 issues. In isolation, this is not a big deal, but combined with the loss of upside momentum in a number of other indicators, the negative breadth today is just one more hint that the market is becoming more susceptible to a correction, despite the new highs in the S&P and Nasdaq averages.

Although the NYSE A/D line is just below its prior high, the cumulative net volume line is comfortably below the high it recorded in early March (red line). Prior to the modest 5% pullback in September and October last year, the cumulative volume line was weakening. In 2015, the weakness was far more pronounced and for a more extended period, before the sharp correction in August and September shaved 12% off the S&P. This indicates that while the S&P hovers at its all-time high, there has been a modest increase in selling pressure, which is why net volume is falling.

Click on any chart for a large image.

The Nasdaq 100 is 4.6% higher than it was on March 1, but the Nasdaq A/D line has not made a new high. In fact, the Nasdaq A/D line appears to have potentially made a double top. The divergence between the Nasdaq 100 and the Nasdaq A/D line shows how much influence the top five stocks are exerting, and why a quick pullback will occur when (if) these stocks correct.

Another indication of the narrowing of the rally in the Nasdaq Composite is the decline in the percent of Nasdaq stocks that have made a new 52 week high over the past 21 trading sessions. In early December, 8.48% of Nasdaq stocks were making a new 52 week high. Today, just 3.46% of stocks were achieving that mark.

Another way to measure the upside thrust behind any move to a new high, is to look at the net advances minus declines over the prior 21 trading days. Ideally, a new price high will be confirmed with a strong 21 day net number of advancing stocks, near or above the red horizontal line. Today’s new high shows a fairly limp amount of upside momentum.

The market has absorbed a lot of news in the past two weeks, with most of it being fairly positive. The French elections were not the negative surprise investors worried about, earnings have come in better than expected, and last week’s employment report was solid. Investors don’t have much to look forward to, and despite the good news, most stocks are churning, as measured by the A/D lines and number of stocks making new 52 week highs. The one ingredient that’s missing is a reason to take some profits in the Five Jive stocks or the overall market.

Since the election, the inflation trade theme has bolstered the market. Investors anticipate that lower taxes and infrastructure spending, will lift GDP growth well above the 2.0% quicksand of the past 7 years. Investors have not been paying attention to China, which is interesting since China has been the engine of global growth for a long time. The PBOC has lifted the Overnight SHIBOR rate from 2.1% in January to 2.85% at the end of April.

This has caused 5- year corporate bond yields to soar from 3.35% in October to 5.2%. The tightening of monetary policy has started to impact China’s economy and the PMI has dropped the past two months. Given what’s already happened with short term rates and corporate bond yields, the Chinese economy is going to slow in coming months. Industrial commodities have begun to reflect this weakness, with the prices of copper, steel, rubber, and iron ore each falling sharply in the recent weeks.

In the U.S., measures of consumer and business confidence have soared since the election, but consumers haven’t been spending and corporations are waiting until they know the details of the tax cuts and investment incentives. The net result is that the U.S. economy may not strengthen in the second quarter as much as economists are projecting (3.5% to 4.5%), if consumers and businesses continue to wait for Congress to actually pass any legislation. As China shows more signs of slowing, and Congress fiddles a dissonant tune in coming months, investors may become impatient or worried about growth in the U.S.

FOMC Meeting

As expected, the Fed made sure the markets know that a rate increase at the June meeting is still on the table. After the FOMC statement, the odds of a June hike jumped to over 90%, and hit 100% after the strong employment report.

The Euro: A New High and Then a Reversal

The Euro jumped on April 24 and 25, after the initial French election narrowed the field to two candidates. During the next 6 trading sessions, the Euro traded in a narrow range, forming a triangle in the process. In anticipation of a Macron victory, the Euro rallied on Friday and overnight on Sunday, after the results were announced.

It promptly reversed lower today, putting in an outside day in the process. The Euro has made at least a short term high, and if it closes below the late April low, may set up a decline to 1.060. The Euro’s RSI (yellow line) did not confirm the new closing high on Friday.

Since the Euro comprises 57.6% of the Dollar index, the Dollar spiked lower overnight, and then rebounded. Notice the Dollar’s RSI did not confirm the new closing low on Friday, and the spike down tagged the declining trend line connecting the price lows since January.

With the Dollar’s RSI near 30, a bounce is coming. The key is whether the Dollar can exceed the prior high, so that the pattern of lower highs and lower lows can be broken. A rally up to the April 10 high near 101.30 is likely. The ‘big’ picture will be clarified if the Dollar is able to close above 102.25. Until it does that, the odds of a new high are low.

Treasury Bond Yields

After the yield on the 10-year Treasury bond dropped below 2.2% and the short covering I expected had run its course, I turned neutral on the bond market. As I noted three weeks ago, I think yields are likely to drift higher with the yield on the 10-year climbing to 2.34% - 2.42%. Today, the 10-year Treasury yield traded up to 2.39%. If the yield on the 10-year Treasury is going to fall below the April 18 low of 2.177%, it will be due to surprisingly weak economic data, which I don’t expect, or an event that causes a rush to safety..

Gold and Gold Stocks

The positioning in the futures market still suggests that the path of least resistance for gold and silver is down. Overall, gold stocks continue to underperform, although they did firm up a bit on Friday. Silver fell for 14 consecutive days through Friday, so a bounce in the metals is overdue.

Last week, I thought GDX would, at a minimum, test of the early March low in the gold stock ETF (GDX) at $21.14. On Thursday, it traded down to $20.89 before rebounding. As noted previously, there is a gap on GDX from December 23 at $19.43 that I still expect to be filled. There is also a gap at $20.31 from December 28, so GDX and the relative strength of the gold stocks to gold will need to be monitored if GDX closes that gap.

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

Three weeks ago I noted that the Financials ETF (XLF) had fallen to support (black horizontal line) on April 13 and its RSI was oversold at 28.0. This combination suggested that the Financials were primed for a bounce. I thought XLF might reach 24.00. On April 26, XLF traded up to $24.09 before fading and closing at $23.87. On May 4, XLF traded up to $24.07 before closing at $23.88. So far the highest close has been $23.89 on April 25.

I still think one of the keys to the market is XLF, and it being able to close above $24.00. The participation of the Financials would add weight to any close in the S&P above 2401. A close below $23.53 would likely lead to a test of low at $22.90. A close below the low of $22.90 would likely signal that XLF will make a run at the gap at $21.70 and the S&P will correct more.

Since March 31, of the top 7 sectors, only Technology and Consumer Discretionary have strengthened. Discretionary includes Amazon, which has a weight of 14.6% and has rallied 12.6% since March 27. It is interesting that the defensive sectors - Utilities, Health Care, and Consumer Staples - have strengthened relative to the S&P since March 31. The rotation out of some sectors and into others is why the S&P has been trending sideways, rather than rallying or correcting.

welsh.tech.2017.may.08.tactical.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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