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posted on 16 October 2017

The Relentless Market

Written by

Macro Tides Technical Review 16 October 2017

More of the Same

As noted last week, we’re more than 75% through 2017 and the largest decline in the S&P has been a scary -2.9%. Since 1914 that is the smallest decline in any year, which means the odds of this occurring as we entered 2017 was less than 1%. The S&P has gone 338 days without experiencing a 5% correction, the longest stretch without a 5% correction since 1928.


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The S&P has moved up or down by more than 1% on just 8 days in 2017, the smallest number since 1972.

The daily range for the S&P this year is just over 0.51%, which is an all-time record low since 1928.

On October 5, the S&P registered six consecutive record high closes for the first time since June 1997, although the magnitude of the percentage gain was materially less. In 1997, the S&P rose 6.1% in its 6 record days versus just 1.8% through October 5. The recent record run is the smallest of the nine times it has occurred since April 1983. Since last Monday, the S&P has recorded two more record highs, bringing the total for 2017 to 45, but has advanced just 0.22% in the last 7 sessions.

In this week’s edition of Barron's the results of their ‘Big Money Poll’ survey of 140 money managers was released. When asked to describe their investment outlook through June 2018, 61% were bullish more than 5 times the 12% who were bearish. The Barron's survey was even more extreme than last week’s survey by Investors Intelligence which found 60.4% were Bulls four times the 15.1% of Bears.

Another question Barron's asked was “Will Congress enact legislation on the following issues in the next 12 months?" An overwhelming 87% believe Congress will pass tax reform. As I have noted many times in recent months, the prospect of a tax cut and the expected rally it would ignite is the main reason why selling pressure has remained so muted. Why sell if a tax cut is coming that will boost earnings and lead to higher stock prices?

And, as the Barron's survey confirms, institutional investors have not sold.

While tax reform may be the most important issue in the short term, the most important long term issue is entitlement reform. Without entitlement reform, the deficits from Social Security and Medicare spending could generate deficits that could approach $2 trillion in a year within the next decade. As the Barrons survey shows, virtually no one believes the Democrats and Republicans will have the courage to address entitlement reform. Granted, the question used a 12-month window, but even if it had been expanded to five years or ten years, I suspect the results would not be materially different.

As noted last week, the S&P became overbought in the week ending October 6, as measured by its RSI. After such a high reading, the S&P would be expected to make another new high with the RSI recording a lower high, before a deeper pullback could be likely. The S&P has indeed posted a new high and its RSI is lower. But with a reading of 74.5 today, that’s still pretty strong. Lower highs with the RSI below 70 have more value in anticipating the odds of a pullback.

Click on any chart below for large image.

The Option Premium Ratio is a good contrary opinion indicator, especially near market lows. In most markets it has done a good job of warning of market highs when it has fallen below the red horizontal line.

The allure of tax reform has allowed the market to run over numerous technical divergences that in the past have identified pullbacks of 5% to 7%. I discussed the percent of stocks making a new 52 week high two weeks ago and showed how well that indicator performed in 2004, 2005, and 2006 prior to 6 pullbacks that included 4 declines of more than 7%. The Option Premium Ratio last week dropped to a very low level as noted by the blue arrow. The last three times it has been this low the S&P either gone sideways for a number of weeks or backed off slightly.

The expectation for tax reform is focused on 2018 since it seems unlikely that Congress will be able to get it finished before the end of 2017. From an investment perspective, it means that most taxable investors will not want to sell winners before the end of 2017 since they expect capital gains tax rates to be lower in 2018. With most sectors positive for the year, this is another reason why selling pressure will remain low before year end.

Conversely, selling losers in 2017 will offer a larger tax benefit. This suggests that the sectors that have performed best in 2017 will face far less tax selling in 2017, while those that have performed poorly will experience more tax loss selling. The prime candidates for tax loss selling are retail and energy stocks which are down in 2017.


From the low of 91.01 (cash) on September 8 to the high on October 6, the Dollar rallied 3.25 points. A 50% retracement would bring the Dollar down to 92.62. The low last week was 92.75, which may be all of the correction or just the first wave a of an a-b-c correction. The bounce since last week’s low would be wave b, and be followed by a wave c decline that would likely undercut last week’s low by a small amount.

As discussed last week, if the Dollar trades between 93.00 and 94.14 for a couple of weeks, the chart pattern will form a potential inverse head and shoulders. If it does, and subsequently closes above 94.26, a move up to just over 97.00 would be expected based on the neckline at 94.10 and the low of 91.01. If last week’s low of 92.75 was the end of the pullback, another rally of 3.25 points is likely which would bring the Dollar up to 96.00. Per instructions in late August and early September, a long position in the Dollar was established with an average cost of 92.44.

The rally potential in the Dollar may be greater than 96.00. I recommended going long the Dollar based on sentiment and positioning toward the Dollar and the Euro. In January sentiment toward the Dollar was extremely positive and positioning in the futures market showed that traders expected the Dollar to go up.

As I wrote in the January 9, 2017 Macro Tides,

“Surveys of currency traders have recently indicated that more than 90% of traders are bullish the Dollar, which means they have already bought the Dollar. The last two times bullish sentiment toward the Dollar exceeded 90% was in March 2015 and January 2016. The Dollar subsequently declined by more than 7% in the months following these two periods of ebullience."

In the April 9, 2017 I said,

“After the current rally runs its course, either stalling at 102.25 or after a new high, my guess is that the Dollar is likely to test the May 2016 low of 91.88 before the end of 2017."

In August and September posts I noted that sentiment toward the Dollar had become negative and quite positive toward the Euro as had the positioning in the Euro futures market. This suggested that the Euro was near an intermediate high and vulnerable to a large enough decline to force most of the longs in the Euro futures to sell. Despite the recent weakness in the Euro, there has been very little liquidation of long Euro positions.

This suggests that the Euro has more downside coming, which would give the Dollar a lift as the Euro represents 57.6% of the Dollar index. The Dollar’s upside may be greater than 96.00.

Treasury Bonds

The 30-year Treasury bond yield to rose to 2.91% - 2.94% as forecast (blue horizontal trend line), and then was expected to fall to 2.79%. The low on Friday was 2.808%, although a lower low is possible. After this modest decline in yields, a rise to near 3.0% is likely to follow probably before year end.

Emerging Markets

The Emerging Markets have been the best performing sector in 2017 which is probably why it is the most favored sector in Barron's Big Money Poll. Emerging markets were favored by 45% of the respondents followed by 29% liking Europe.

One of the reasons is the decline in the Dollar which many institutional investors expect to continue. A further decline in the Dollar would benefit Emerging Markets and European equities as it has so far in 2017. The almost universal embracement of Emerging Markets and Europe makes me leery of at least a correction in these two favored areas.

In the January Macro Tides I liked Emerging Markets based on the expected decline in the Dollar and the chart pattern in the Emerging Market ETF (EEM):

“If the Dollar weakens as I expect, the pattern in the Emerging Market ETF suggests that EEM could rally to $42.00 - $44.00 during 2017 in a wave C rally."

I have recommended taking some profits on EEM after it pushed above $43.00 in July in anticipation of a pullback which has yet to materialize. Although the Dollar has put in the expected bottom, EEM has continued to push higher. Maybe EEM will experience some profit taking if the Dollar does manage to climb above 94.25 as expected.

Gold and Gold Stocks

After Gold declined by more than $95 during the past 4 weeks, I thought a rebound that tested the highs in April and June near $1295 was likely, with a possible bounce to $1310. Today Gold traded up to $1305.72 cash. Not much has changed in terms of positioning in the Gold futures. It is bearish that the Commercials (red line middle panel) didn’t cover more of their short position during the recent decline, and the Large Specs didn’t sell more of their long position even after a 7% decline. If Gold does rally to $1310, an equal decline of $97 would bring down to near $1220. This process could take 4 to 6 weeks.

The relative strength of Gold stocks continues to trend sideways and today the Gold stock ETF (GDX) was down -1.59% while Gold fell far less. Until the relative strength improves, as it did in late December 2016, a protracted rally is unlikely.

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. The MTI continues to indicate that a bull market is in force.

Although the Major Trend Indicator is positive, the MTI has been posting lower highs since peaking in early March. Since late July, the odds of the S&P continuing the streak of no corrections of either 3% or 5% seemed quite low based on historical patterns and signals from a number of reliable technical indicators. As noted earlier, 2017 is so far the year with the lowest drawdown (the 2.9% pullback in the S&P in April) since 1914.

The Tactical U.S. Sector Rotation Model Portfolio has been 100% in cash since July 24 based on the probability of a 5% correction. In my judgment (so far incorrect), upside potential has been limited relative to the level of risk. Through September 30, the Tactical Sector Rotation program is up 8.52%.


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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