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posted on 30 May 2017

The Big Contradiction In The Markets

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Macro Tides Technical Review 29 May 2017

The Big Contradiction Most economists expect GDP to rebound nicely in the second quarter with an increase of 3.5% or better. If the economy was truly on track to deliver that kind of growth, sectors within the stock market would be expected to act accordingly. Investors would be embracing growth and cyclical sectors like technology, energy, financials, and industrials, but shunning defensive sectors like consumer staples and utilities. Technology stocks have been on fire led by the big five technology stocks, but the advance/decline line for the Nasdaq peaked on February 27 when the Composite was 6% lower. The strongest sector has not been supported by underlying market breadth for three months.


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The big cap tech stocks comprise almost 45% of the Nasdaq 100, which rose today for the 18th day of the past 21 trading days. To say the run up is getting over done would be an understatement. Despite this persistent strength, the RSI on the Nasdaq 100 has so far failed to confirm the recent highs. This suggests the upward momentum is slowing and is a precursor for a pullback soon.

Energy stocks continue to be weak, despite OPEC’s agreement to maintain production cuts. This weakness doesn’t jibe with the synchronized global recovery narrative.

A speed up in economic growth should be accompanied by an increase in demand for commercial and industrial loans. However, since the election loan volume has dropped sharply which isn’t good for banks and not a good sign for the economy in the short term. As I discussed in the May issue of Macro Tides, companies are waiting for clarity on taxes and regulation reduction. The president can tweet all he wants, but until legislation is passed the economy could simply tread water.

I have said that the Financials are one of the keys to the market, since a real breakout above 2400 will need the participation of the Financials. The Financials ETF (XLF) dropped to its prior low on May 17 and the bounce so far has lagged the market. The price pattern suggests the low on May 17 is likely to be broken and that XLF may fall to $21.70 in order to close the gap. If this weakness occurs when the technology flyers come down to earth a bit, the S&P could test the May 17 low of 2353. Without the participation of the financials, I doubt the move above 2400 will be sustained.

If the economy was improving as forecast and low unemployment was about to push up inflation, interest rates would be trending up, not down. Although the odds favor another rate hike when the Fed meets in June, inflation has softened and Treasury yields have been grinding lower.

Two weeks ago, utilities broke out and have made a new high, which shouldn’t be happening if growth and rates were headed higher.

Investors usually buy consumer staple stocks when the economy is heading for a recession and institutional investors, who need to be close to 100% invested all the time, buy them because they have a low beta.

If the domestic economy was really getting stronger, the Russell 2000 would be doing at least as well as the S&P. While the S&P has been making new highs, the Russell 200 has been lagging badly, which is not a good sign for the overall market.

In late February, the percent of stocks above their 200 day average topped at 72%. On Friday, it was down to 61%, despite the new highs in the S&P and Nasdaq averages.

The big contradiction is that sector performance inside the S&P doesn’t mesh with the story line that the economy is improving significantly in the second quarter. This suggests t market is getting set up for a correction. It’s just a matter of when investors confront the reality of less than expected Q2 growth and that the growth policies they enthusiastically embraced just after the election are somewhere off in the distance. With the underlying strength of the market continuing to weaken, the market is not likely to pick up the slack when the big name technology stocks falter. The odds are increasing that the S&P will test the May 18 low of 2352 before the end of June, and potentially the April 13 low of 2330.

Treasury Bond Yields

After being bullish in mid March when the 10-year Treasury was yielding 2.6%, I turned neutral on the bond market, after the short covering I expected drove the yield on the 10-year Treasury bond below 2.2%. I thought the yield on the 10-year could climb to 2.34% - 2.42%, and on May 11 it reached 2.423%. 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. When the stock market had its one day swoon on May 17, the 10-year Treasury yield fell by more than 10 basis points. The pattern in the 10-year yield supports the potential of a decline to 2.0%, which leaves open the possibility for another sharp decline in the stock market that may actually last for more than one day.

Gold and Gold Stocks

After turning neutral, the positioning in the futures market has became a bit more negative as Commercials and Producers increased their shorts when gold traded above $1250. Large Specs increased their longs from 126,724 contracts to 159,787 contracts on a relatively small move up in gold. The increase in bullishness by Large Specs suggests gold is vulnerable to another decline that could shake them out and bring gold down to near $1200. After some modest improvement, the ratio of the Gold stock ETF (GDX) to Gold deteriorated last week, and has moved further above the rising blue trend line. As long as the ratio is rising, it indicates that gold stocks are on balance underperforming. Prior to the rally in the first quarter, the ratio dropped below its moving average AND the rising thick black trend line.

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

The Sector Relative Strength Ranking is based on weekly data and used in conjunction with the Major Trend Indicator (MTI). As long as the MTI indicates a bull market is in force, the Tactical Sector Rotation program is 100% invested, with 25% in the top four sectors. When a bear market signal is generated, the Tactical Sector Rotation program is either 100% in cash or 100% short the S&P 500.

The MTI crossed above its moving average on February 25, 2016 generating a bear market rally buy signal. The MTI confirmed a new bull market on March 30, 2016. As discussed earlier, the MTI continues to indicate that a bull market is in force. The Technology sector (XLK) has been in the Top Four of the Sector Relative Strength Ranking since October 2, 2016, and has been in the number one position for weeks. The Financials (XLF) moved up into the Top 4 on October 28, just before the big run up after the election. In mid March I thought Treasury yields were likely to fall from 2.6% and drop to below 2.2%. This development would not be positive for Financials, which indicated analysis of the Financials ETF chart could be helpful, if XLF began to weaken. On March 17, the Financials ETF decisively broke below its rising trend line (chart below). The combination of fundamental analysis and technical chart analysis suggested reducing exposure to Financials was warranted.

The Industrials (XLI) made it into the Top 4 on November 18, 2016. The Russell 2000 entered the Top 4 on August 19, 2016, and remained in the Top 4 until it was replaced by Consumer Discretionary (XLY) on May 5.


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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