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posted on 29 August 2017

A Bounce - Followed By Indecision

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Macro Tides Technical Review 28 August 2017

As noted last Monday:

‘There are a number of signs that a short term bounce is coming. Despite the lower low, the 21 day average of net advances minus declines posted a higher low on Friday when compared to August 10. Short term sentiment has also become a bit over done as measured by the Call / Put ratio. The August 8 high in the S&P was 2490 and today’s low was 2417, so the decline covered 73 S&P points. A 50% retracement would allow for a rally to 2453 and 61.8% rebound would target 2462.’


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On Tuesday, the S&P gapped up and rallied to 2454.77. Since then it has been in a small trading range of .7%. A signal that this indecision has ended should be provided if the S&P climbs above 2454.77 or declines below 2430.

Click on any chart below for large image.

Corporate earnings rose 14% in the first quarter from Q1 in 2016, and were up 10% in the second quarter. About half of the 10% increase came from the energy sector and a quarter was due to multinational companies benefiting from a weaker dollar and better growth overseas. Third quarter earnings are guesstimated to be up 5%, so a clear deceleration in earnings is unfolding. The more important point has been the market’s reaction to companies which announced better than expected earnings.

According to FactSet, the stocks of S&P companies that surprised with better than expected second quarter earnings declined by -0.3%. This doesn’t sound like much of a decline and it isn’t. But it is the first time since the second quarter of 2011 that earnings surprises didn’t result in an increase of at least 0.3%.

In 15 of the 22 quarters since the second quarter of 2011, the post earnings gain was more than 1.0%. In the third quarter of 2011, the S&P declined -11.3%. Although the weak response to earnings surprises did not cause the decline, it did convey that the market could be vulnerable to negative news and an increase in selling pressure. The sharp decline was sparked by the debt downgrade of the credit rating of the U.S. from AAA to AA, and a debt ceiling deadline which was resolved on July 31.

When the DJIA made a new all-time high on August 8, the DJ Transportation average was -5.4% below its all-time high registered on July 14, and the ratio of Bulls to Bears in the weekly Investor Intelligence sentiment survey was 3.4 to 1. The last three times the Dow hit a new high, the DJ Transportation average was more than 5% below its prior high , and the Bull to Bear ratio in the II survey was above 2.0 was in 2000, 2007, and 2015. The first two times were followed by vicious bear markets and a 12.3% decline between July 2015 and September 2015.

As I have discussed often, corporate stock buybacks have been a boon to the stock market since 2010 as more than $4 trillion has been spent on buying back shares. Stock buybacks in the first quarter totaled $125 billion, but the year-over-year rate of change was down 20%. The message is that stock buybacks are still a plus, but not as big of a factor as they have been. This could be a problem if and when selling pressure rises since there will be less money on the other side of the sell orders.

In recent weeks I’ve discussed how the period between mid August and late October has been associated with market declines in years ending in 7. The nearby table was made by Jay Kaeppel, who has a blog ‘Jay on the Markets’. In four of the 11 occurrences since 1907, the DJIA has declined by more than 30%, with the smallest decline being -6.2% in 1947. The average decline was -19.7%.

The market is not going to decline just because it’s 2017. There must be a reason and with the ECB meeting on September 7, the Fed on September 20, a debt ceiling debacle that must be avoided, funding for subsidies for the ACA approved by September 30, and geopolitical risk from North Korea and terrorism the investors could be provided at least one reason to take profits or sell in coming weeks. The seasonal pattern suggest that surprises are more likely to be negative than positive.


I thought Mario Draghi was likely to take a victory lap at the Federal Reserve of Kansas City’s annual meeting at Jackson Hole WY, restate that the Eurozone economy still requires support, and not divulge a change in the ECB’s QE program. As expected Mario Draghi said the ECB’s bond buying program had been “very successful" and also said a ‘significant degree of monetary stimulus’ was still needed to support the Eurozone economy. He offered no insight as to what if any changes the ECB will discuss or make at its September 7 meeting.

Janet Yellen defended the financial regulation put into place after the financial crisis:

“The core reforms we have put in place have substantially boosted resilience without unduly limiting credit availability or economic growth."

I wonder if the 1,300 small and community banks that have closed since 2000 would agree with that selfcongratulating assessment by Janet Yellen. More than half of those closures occurred since 2007 while there are almost as many large banks as there were in 2007.

In addition, in terms of deposits, the ‘too big to fail’ banks are bigger today than they were in 2007, while the local smaller banks serving local communities have less deposits. Large banks have reduced leverage and have increased capital ratios so the financial system is stronger today than in 2007. Yellen did note that the regulation on small banks could be rolled back since they weren’t contributors to the 2008 financial crisis. Better late than never.

With Mario and Janet speaking at the Jackson Hole confab, I thought volatility in the currency market could pick-up and it did on Friday and today. The Euro rallied to a new high, and the dollar fell to a new low. This was expected:

“Ideally, the Dollar will post a lower low so that a divergence can form in its RSI. This seems increasingly likely given the nature of the Dollar’s rebound from the low at 92.548."

I suggested:

“taking a small long position in the Dollar (1/4 or 1/3) if it dropped below 92.93. The low in May 2016 was 91.92 so the risk is about 1%. Adding (1/4 or 1/3) on a decline below the 92.54 low makes sense since there should be an RSI divergence."

The Dollar posted a new closing low on Friday and today. Even though the Dollar closed at 92.21 today compared to 92.84 on August 3, the Dollar’s RSI is 32 versus 25 at the previous low. Sentiment is extremely negative and positioning in the futures market shows a heavy short position has built up in the Dollar. The large short position will provide fuel for a rally once the tide turns.

If the Dollar drops below 91.88, which was the intra-day low in May 2016, adding another ¼ or the final 1/3 to the position is appropriate. The Dollar has declined by more than 11.2% since January, so a rally of at least 3% to 4% is coming. A reversal of the downtrend in the Dollar could coincide with a reversal in a number of other markets that often benefit from a weak Dollar, ie oil, gold, and maybe ECB policy.


The positioning in oil futures contracts suggests WTI crude oil could drop to $42.50 and potentially to under $40.00 in coming months. As noted last week, oil broke down below the rising trend line from the June low, and then retested the underside of the trend line. This is a classic bearish trading pattern.

Gold and Gold Stocks

“I still do not think gold will breakout and close above $1306, as commercials have increased their shorts on each rally over the past month. A pullback below $1245 is possible."

Today, Gold traded convincingly above $1,306.00 and surely triggered short covering. After the close, news that North Korea launched a missile that flew over Japan pushed Gold up to $1,330.00. I will note that commercials increased their short position when Gold traded above $1,300, and assume they will be selling into today’s rally as well. Gold has a tendency to spike at highs, especially on news. A close below $1306 would be negative.

The Gold stocks had a great day today with the Gold stock ETF (GDX) rising 3.6%. Last week I noted that GDX may have closed slightly above the black trend line connecting the highs in February and April. Given the underperformance by gold stocks relative to Gold in recent months, I did not think this modest breakout was noteworthy. When GDX topped in early February, its RSI was 73.1. Today GDX’s RSI was 71.0 and implies that the upside may be limited. The early April high for GDX was $24.87, so a test of that level is certainly possible.

Treasury Yields

Two weeks ago, I recommended a partial short position through one of the inverse Treasury bond ETFs if the 10-year yield dropped below 2.20%, and the 30-year yield fell below 2.806%. The trading pattern in the 10-year and 30-year Treasury bonds suggests that the yield on the 10-year can drop below 2.103% (2.05%) and the 30-year could fall below 2.682% (2.64%) before yields reverse higher. Adding to the partial short position through one of the inverse Treasury bond ETFs is recommended if yields do make lower lows.

The long term projection is for the 10-year yield to break out above 3.0% and potentially reach 3.4%. Since the low in July 2012, the 10-year has had two moves higher in yield and both were about 1.3%. My guess is that something similar will develop over the next year and an equal rally of 1.3% from the June low at 2.10% will lift the yield to 3.25% - 3.4%. Buyers will certainly come in if the yield reaches 3.0% as pension funds increase their allocation to Treasury bonds.

Tactical U.S. Sector Rotation Model Portfolio 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 Tactical U.S. Sector Rotation Model Portfolio is 100% in cash. Any bounce in the short term is likely part of the topping process that began in earnest in early July. The weakening of the broader market, as measured by the Equal Weight S&P 500 and the Russell 2000, suggests that the topping process is continuing.


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.

Through July 31, the Tactical Sector Rotation program is up 8.52%. Jim Welsh

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