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posted on 06 September 2017

Market Internals Continue To Weaken

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Macro Tides Technical Review 05 September 2017

After rallying from a low of 2417 on August 18 to 2454.77 on August 21, the S&P traded in a 0.7% indecisive range for 4 days. Last week I noted:

“A signal that this indecision has ended should be provided if the S&P climbs above 2454.77 or declines below 2430."

The S&P traded below 2430 for literally less than 5 minutes after a gap down opening on August 29, before busting above 2454 on August 30. On light volume the S&P rallied to 2480 on Friday September 1, less than 10.5 points from the intra-day high of 2490.87 on August 8.

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On February 21, with the S&P trading at 2363, 72% of NYSE stocks were above their 200 day average. On Friday the S&P closed at 2476, 4.8% above its February 21 close, but only 58% of NYSE stocks were above their 200 day average. The red arrows in the chart below indicate how new highs in the S&P have been accompanied by lower highs in the percent of NYSE stocks above their 200 day average.

Click on any chart below for large image.

Two conclusions can be drawn. The upside momentum for a good number of stocks has deteriorated which is why fewer stocks are still above their 200 day average even though the S&P is up 4.8%. Secondly, with fewer stocks participating in the move higher, the S&P has been able to make progress because stocks with a larger weighting have been going up. Technology has the largest weighting in the S&P (23.5%) and big name Technology stocks (FAMANG) have been leading the charge. Health Care has the second largest weighting (14.7%) in the S&P and the Health Care ETF (XLV) made a new high on Friday.

In 2015, the S&P ran into real trouble after the percent of stocks above their 200 day average fell below 50% (black horizontal line) in late May (left side of chart above). That period of weakness was preceded by a flat S&P while the deterioration progressed. The probability of a 5% correction will increase if the percent of stocks above their 200 day average falls below 50%, as I expect will happen.

The Advance / Decline line continues to act well despite the deterioration in the percent of stocks above their 200 day average. The strength in the A/D line suggests that any correction will likely to be less than 7%. Prior to the corrections in 2015 and early 2016, the A/D line was weakening, which was another sign of weakness which is not yet seen here.

While the A/D line is acting well, it is possible some of the current strength is due to money moving into passive strategies which buy index ETFs like the S&P 500 ETF SPY or the Vanguard S&P mutual fund. When money flows into these funds, the buying is spread across all 500 stocks, which probably makes the A/D line perform better. Inflows also boost the weighing of the biggest S&P stocks so their impact in the S&P’s performance is increased. I have no way to measure the magnitude of this phenomena but it is a factor.

Today’s decline (Tuesday 05 September) is the start of another leg of the correction that began after the S&P hit 2490 on August 9. A test of 2430 is very likely. A close below 2410 would open the door to test of the 200 day average near 2365. Given the negative seasonal aspects I’ve discussed for weeks, surprises are more likely to be negative until late October.

Dollar

Technically, the Dollar has done everything that was expected by falling below 91.88 and posting a new low that was unconfirmed by the Dollar’s RSI. Based on the instructions I provided, buying a 1/3 position when the Dollar dropped below 92.93, 1/3 below 92.54, and 1/3 below 91.88, the average cost is 92.44. For now, a stop on a close below 91.50 is recommended.

Gold and Gold Stocks

The chart below reflects the positioning in the gold futures market. The red line in the bottom panel shows how Producers are positioned. As you can see, as of August 29 producers had a larger short position than last summer when Gold traded above $1360. Commercial activity is noted by the red line in the middle panel. As of August 29, they held the second largest short position in the last three years. They held a larger short position last summer when gold traded above $1300. Since the low in July, the Commercials have increased the size of their short position every week as Gold rallied.

In a normal market, Gold and Silver move together. When they don’t, the divergence can signal a potential trend change. Gold has rallied well above its May high of $1306, reaching $1347.50 today. Silver closed today at $17.91, 4% below the May peak, which is a very large negative divergence.

In recent months, the pattern in Gold has been difficult for me to quantify. The recent rally does offer a viable pattern which suggests Gold can rally to and probably slightly above last July’s high. From the low in December 2016, Gold rallied $180 in three waves to the mid April high just above $1300. It then corrected in a down-up-down sequence to the July low. An equal rally of $180 from the July low near $1215.00 would bring gold up to near $1400.00, and potentially complete a big A (up), B (down), C (up) rally from the December 2016 low. If Gold tops out near $1400, this pattern implies a fairly large decline in Gold would follow.

Gold has rallied smartly, driven in large part by North Korea. Bottom line, I didn’t see this coming. What’s interesting is that the Gold stocks have not begun to broadly outperform Gold despite their recent rally.

The ratio of Gold Stocks to Gold has continued to trend sideways, as opposed to decline as it did between late December and mid February when Gold Stocks really zoomed. The longer this relative weakness persists Gold stocks could be vulnerable to a sizable decline if Gold fails at $1400. The breakout above the black trend line on GDX turned out to be more meaningful than expected.

Treasury Yields

Three 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%. Last week, I noted that the trading pattern in the 10-year and 30-year Treasury bonds suggested that the yield on the 10- year could 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 (2.05% - 2.64%).

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.

Although the Major Trend Indicator is positive, the Tactical U.S. Sector Rotation Model Portfolio is 100% in cash based on the probability of a 5% correction. In my judgment, upside potential is limited relative to the current level of risk. 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 percent of stocks above their 200 day average, suggests that the topping process is continuing.

Through August 31, the Tactical Sector Rotation program is up 8.52%.

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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