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posted on 20 November 2017

The Market May Struggle Higher

Written by

Macro Tides Technical Review 20 November 2017

Happy Thanksgiving!

In the 24/7 world in which we live it is easy to take the everyday blessings for granted and easier for our attention to dwell on what isn’t going the way we expected or hoped. Thanksgiving forces us to stop for a moment and remember all the good stuff that has come our way and express our gratitude. Family and friends always come first but I am also blessed to be doing what captivates and stimulates my intellect very day and provides lessons in humility to keep me grounded. I hope your Thanksgiving is spent with family and friends.

turkey.roast


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Market Weakens But Positive Seasonal Trend May Bring a New High

In the November 6 WTR I noted that since October 13 a number of technical indicators had weakened despite the new all time highs in the most of the major market averages and finished this assessment with a question:

“When all this is added up, what does it spell? C-O-R-R-E-C-T-I-O-N."

Since November 6 the S&P hasn’t corrected much but it hasn’t gone up either. Given that 2017 has set numerous records for the absence of corrections and the most shallow pullback in any year since 1914 (-2.9%), the drift lower counts as a correction as this 30 minute chart of the S&P illustrates.

Click on any chart below for large image.

As I discussed last week, the real news is what happened on the Nasdaq Composite during the week of November 6 through November 10:

“The Nasdaq Composite made a new all time high on Wednesday November 8 but only 124 stocks posted a new 52 week high while 95 stocks made a new 52 week low. On November 9, the number of stocks posting a new 52 week low exceeded the new highs by 68 to 92. It is rare for any market average to make a new high and the following day register more lows than highs. This indicates that a handful of large cap stocks are doing quite well even as a good number of stocks are actually declining. For the week, 352 stocks made a new high on the Nasdaq but a whopping 261 made new lows. Since 2003 this is the only third time the Nasdaq Composite has made a new high, while more stocks made a new 52 week low than high, and the Bull/Bear ratio in the Investor Intelligence survey was above 3.0. The other two instances were in December 2007, which was followed by a devastating bear market, and July 2015 which preceded a decline of -15.1% in the S&P 500 and -16.5% in the Nasdaq Composite."

This type of technical weakness has been quantified with some additional rules. When the Rules have been met Technicians (those who follow the dark art of technical analysis) refer to these specific signals as the Titanic Syndrome and the Hindenburg Omen. Since almost everyone has seen the movie Titanic or has heard the story I don’t need to remind you that it didn’t end well. The Hindenburg story is not nearly as well known as the Titanic. The Hindenburg zeppelin was completing its 63rd trip from Frankfurt Germany to the U.S. and approaching Lakehurst New Jersey May 6, 1937. With approximately 100 passengers on board disaster struck. The event was broadcast on radio by Herbert Morrison of WLS radio in Chicago and is one of the most dramatic live broadcasts ever heard. If you haven’t heard this broadcast it is memorable.

The image of the Hindenburg crashing was used as the cover for Led Zeppelin’s first album and came about in an unusual way. According to Wikipedia:

“Led Zeppelin's front cover, which was chosen by Jimmy Page, features a black-and-white image of the burning Hindenburg airship, photographed by Sam Shere. The image refers to the origin of the band's name itself: When Page, Jeff Beck and The Who's Keith Moon and John Entwistle were discussing the idea of forming a group, Moon joked, "It would probably go over like a lead balloon", and Entwistle allegedly replied, "a lead zeppelin!"

These are the rules for the Titanic Syndrome and Hindenburg Omen:

  • Hindenburg Omen: A sell signal occurs when NYSE new highs and new lows each exceed 2.8% of advances plus declines on the same day. On November 14, they totaled more than 3%.
  • Titanic Syndrome: A sell signal is triggered when NYSE 52-week lows outnumber the 52-week highs within seven days of an all-time high in equities. Stocks most recently hit a record on November 8.

As noted last week, on November 9, when there were more new lows than new highs on the Nasdaq Composite, the new highs on the NYSE totaled 73 and the lows were 70. On November 13 the new lows outnumbered the highs by 102 to 101 on the NYSE and 85 to 74 on the Nasdaq Composite. In fact the number of new lows on the NYSE and Nasdaq Composite exceeded new highs for three consecutive days (November 13, 14, and 15). With the major market averages so close to their all time highs, the expansion in new lows is not a healthy sign.

A little research shows that there have been false signals in the past, especially on the NYSE. In May 2013, Fed Chairman Bernanke ignited what would become known as the Taper Tantrum. Treasury bond yields soared and bond funds listed on the NYSE fell sharply and the number of new lows populated by municipal bond funds and high yield bond funds on the NYSE increased significantly. At the time a number of articles appeared announcing that a Hindenburg signal had been issued and warned readers to watch out below!

Knowing that there are a lot of bond type issues traded on the NYSE I checked the Nasdaq Composite and saw that no signal had been given. The current signals are more authentic since they occurred on both exchanges and bond yields are not near a high. Still, there must be a reason to sell as I pointed out last week:

“Since 2003 this is the only third time the Nasdaq Composite has made a new high, while more stocks made a new 52 week low than high, and the Bull/Bear ratio in the Investor Intelligence survey was above 3.0. The other two instances were in December 2007, which was followed by a devastating bear market, and July 2015 which preceded a decline of -15.1% in the S&P 500 and -16.5% in the Nasdaq Composite."

Those two declines were accompanied by a financial crisis in 2008 and in 2015 and early 2016 a precipitous decline in oil prices and a devaluation of the Chinese Yuan by China. The economy is on a much sounder footing than in 2008, oil prices posted a 2.5 year high last week, and the Chinese Yuan has strengthen in 2017. The ingredients for a decline of 15% or more are not present.

Domestic political risks are elevated since the Republicans must deliver on their promise of tax reform or the market will sell off since some of the strength in the past two months has been due to the expectation of lower taxes for corporations and individuals. By their nature geopolitical risks are tough to anticipate although geopolitical risks are now higher in terms of North Korea and the Middle East. Irrespective of the domestic political uncertainties and geopolitical risks, we can monitor the market’s internal strength.

The recent weakening in various technical indicators and the ominous signal from the Nasdaq Composite is instructive. The probabilities of the market experiencing a 5% decline are higher now than they have been in many months and the market is now more vulnerable to a decline that is more than 5%. All that is required for the growing under-the-surface weakness to become more apparent is a reason to sell.

This morning I came across a piece written by Jeff Saut who is the Director of Research at Raymond James that echoed one of my favorite investment rules: the need to manage risk. Jeff wrote:

To put it simply, as yet another discredited bear recently said, "You always forget how hot it gets in the summer and how cold it gets in the winter!" Now we are not saying the current market environment is going to end up like the 1920s, but we do want you to note on a short-term trading basis the momentum monkeys, the buy-the-dips, yield ignoring, always-recovering-to higher-highs, greed-over-fear characteristics continue to suggest caution in the short run. That is consistent with our intermediateterm model that flipped negative in August. More recently there have been other cautionary readings from the Hindenburg Omen and the Titanic Syndrome. Both of those technical indicators have registered sell signals. The first did so last Tuesday (11/14/17) and the second on Wednesday (11/8/17). But, if you listen to the message of the market you can certainly decide whether you should be playing the markets "hard," or not so hard. Indeed, as Benjamin Graham wrote, "The essence of investment management is the management of risks, not the management of returns." To be sure, the concept of "limiting losses" is one of the traits successful investors possess.

Dollar

As discussed in recent weeks, the Dollar index broke out of an inverse head and shoulders pattern on October 26. The breakout generated a measured move to 96.00 and maybe 97.00. Once a market average like the Dollar or the S&P 500 breaks out of an inverse head and shoulders, the one thing it is not supposed to do is fall below the neckline of the pattern.

On November 14, the Euro rallied strongly on good GDP reports from Germany, Italy, and France which caused the Dollar to fall below the neckline at 94.20. Based on the decline below the neckline, I sold my position in the Dollar ETF (UUP) at $24.43 after buying it on August 29 at $23.83. Based on WTR instructions, traders were long the Dollar cash index from 92.44 and told to use a close below 93.80 as a stop, which triggered on Friday when the Dollar cash closed at 93.66.

Euro

The Euro is pretty much the inverse of the Dollar and broke below the neckline of a head and shoulders top on October 26. As noted last week, the Euro had bounced and tested the underside of the neckline. A move below 1.15 seemed probable in the next few weeks, but this forecast will change if the Euro closes above 1.1685. On November 14 the Euro jumped convincingly above the neckline. As long as the Euro holds above the neckline, the Euro has the potential to exceed the September 8 high of 1.2092.

Treasury Bonds

A move up to 3.17% to 3.20% on the 30-year Treasury bond, the highs last December and in March is likely before year end or in the first quarter. It took nine months for the yield to rise from 2.20% to 3.20%. An equal move in yield and time suggests the yield on the 30-year Treasury could approach 3.75% by June of next year. Treasury yields remain tethered to yields in Germany.

Gold and Gold Stocks

I’ve thought the nature of the decline from the high of $1305.72 cash on October 16 left open the possibility that Gold could test $1306 - $1310 before falling below $1260. On Friday Gold rallied more than $18.00 to $1296.30 before giving back most of the gain today. The positioning in the futures market continues to suggest a decline below $1260 is likely. On October 27 Gold dropped to $1262.50 before rebounding to $1296.30 on November 17. An equal decline of $97 would bring Gold down to under $1200. This process could take 3 to 5 weeks.

The Gold stock ETF (GDX) looks like it is preparing to break below the blue trend line near $22.50. A close below $22.20 should usher in a new leg lower. If Gold does fall below $1260, my guess is that GDX will fall to the green trend line currently near $21.25. If Gold falls below $1220, GDX could drop to the black trend line near $20.70. The relative strength of the GDX to Gold continues to weaken which is not a good sign.

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. 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 Major Trend Indicator continues to hold above the green horizontal line which is another sign that the market is not yet vulnerable to a decline greater than 10% or a major trend change.

Since mid August I have tried to identify special situations that were uncorrelated to the stock market and oversold. On August 24 I purchased the Powershares DB Agriculture fund (DBA) at $18.66 and sold it on November 15 at $19.02. On August 29, I purchased the Dollar ETF (UUP) at $23.83 since I thought the Dollar was poised for a rally. This position was sold on November 14 at $24.43. On October 27, I purchased the VanEck Oil Services ETF at $23.67. This position was reduced by 40% on November 8 at an average price of $25.79.

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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