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posted on 06 February 2018

A Permanently High Plateau

Written by

Macro Tides Technical Review, 05 February 2018

Stocks Can Go Down?

Now that the football season has officially ended many people need to find a replacement for their Fantasy Football League or football pool at their office. I’m going to suggest a simple idea for a pool. The winner will be the person who predicts the next day and time President Trump Tweets about the stock market. Note: The title today is a characterization published by the noted economist Irving Fisher a couple of weeks before the crash of 1929.


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In recent months the S&P 500 has set records for going the longest period without a 5% correction, 3% pullback or even a -0.6% dip. This was possible since investors have been conditioned for years to buy every dip no matter how small. As I noted last week:

“A modest uptick in interest rates is not going to dissuade the dip buyers until it doesn’t reward this ‘investment strategy’."

After the S&P fell by more than 2% from its high on January 26 last Tuesday, the dip buyers came in. On Wednesday morning the S&P jumped at the opening to 2839 only to fade. On Thursday the S&P tried to rally but wasn’t even able to get back to 2938, topping at 2835 before ending the day at 2822. On Friday morning the S&P gapped lower at the opening to 2796 as higher rates after the strong employment report caused Treasury yields to soar.

Last week the 10-year Treasury yield rose by 0.17% which is a huge move in the bond market. Those who bought the opening Friday were only in the black for an hour before the S&P rolled over and finished down -2.1% at 2762.

Click on any chart below for large image.

Foreign markets began today deeply in the red, influenced by Wall Street’s loss on Friday and in part by comments by Janet Yellen in an interview on 60 Minutes. In the interview Yellen said:

“Well, I don't want to say too high -- but I do want to say high."

In the first 2 minutes the S&P traded down to 2733 which was just above 2729. This just happened to be where the S&P would have corrected a full 5%. The dip buyers swooped in and within 90 minutes the S&P was actually up slightly at 2663. Within 2 hours the S&P crumbled and traded down to 2716 where the infamous 50 day averaged lurked, ready to give the dip buyers another chance to buy. Alas, after rally to 2733 in the next 30 minutes, the S&P plunged to 2638 before recovering at the close to 2649. It took 34 trading days for the S&P to climb from 2640 to 2873 and 6 days to give it all back. It’s far to say that dip buying has not been rewarded in recent days!

The good news is the dip buyers have learned that the stock market really is a two-way street, which is a valuable investment lesson and healthy for the market. Setting records for the longest period without even a modest setback breeds complacency, and the longer it persists, excessive risk taking.

The bad news is that the decline has inflicted meaningful technical damage that is likely to take time to repair and probably result in lower prices before a sustainable rally can take hold. Market breadth has been very weak with declining stocks outnumbering advancing issues by almost 9 to 1 on Friday and Monday. This has caused a sharp decline in the Advance / Decline line.

The number of stocks making a new 52 week highs has collapsed and the number of new lows has soared. Today 454 stocks on the NYSE made a new low certainly boosted by interest sensitive issues like bond funds. That’s why I check the number of new lows on the Nasdaq Composite during periods of higher interest rates since there are no bond funds traded on the Nasdaq. Today 207 issues on the Nasdaq made a new 52 week low, while only 22 made a new high. The percentage of stocks making a new 52 week high on the NYSE has simply dropped off the table.

As you can see on the charts above, the Advance / Decline line and the percent of stocks making a new 52 week high posted the highest reading for the rally in the week ending January 26. Historically, it is rare for the S&P to make a major top on peak momentum which I noted last week:

“The Advance / Decline line made a new high last week and the percent of stocks making a new 52 week high was very good. History suggests that it is very unlikely that the market would record a price high with such underlying strength."

As noted in the January 22 WTR and last week:

“The S&P broke out above the blue trend line connecting all the highs after the trading low in February 2016. As long as the S&P 500 holds above this trend line, the break out suggests higher prices are likely, even after any period of short term weakness."

At the close today, the S&P finished sitting on the blue trend line.

Given the downside momentum of the past two days, it would be surprising if the S&P didn’t fall below this trend line. The green trend line connects the low in November 2016 days before the election and the low in August and is near 2615. The S&P’s RSI is down to 27.8, the lowest since November 4, 2016. The market is oversold and near two trend lines that ‘should’ provide enough support to inspire a sharp rally which could begin as soon as Tuesday February 6. Ideally, it will commence after the S&P has dropped below today’s low at 2638.

The bull market is still intact as long as Treasury yields do not rise above 3.03% on the 10-year Treasury bond and 3.20% for the 30-year.

The other potential risk is how the trade negotiations proceed with Canada and Mexico regarding NAFTA, and whether trade discussions with China degenerate and increase the risk of a trade war. The economy is in good shape, and the Federal Reserve is not likely to over react by increasing interest rates more than a couple of times between now and June, especially if the stock market is woozy. The Fed wants inflation to move up to 2.0% and will tolerate inflation above 2.0% for a time after 5 years below their target.

The severity and intensity of the decline on Friday and today is due in large part to an enormous short position in the volatility (VIX) futures. As volatility became progressively more compressed in the last two years, hedge funds and other investors have piled into the short VIX trade since it was very profitable. The net result is this is a crowed traded. When the S&P closed at 2873 on January 26, the VIX closed at 11.06. As the S&P began to slip last week, the VIX rose more sharply than would be implied by the small percentage of decline in the S&P 500. During the 4 day period from January 26 and February 1, the S&P dropped just 1.77%, but the VIX had jumped by 21.8%, closing at 13.47 on February 1.

The sharp increase in the VIX began to pressure those who had shorted the VIX below 11.0 in October, November, December and early January. On Friday the VIX closed at 17.31 or 56.5% above the January 11 close and after a decline of just 3.9% in the S&P 500. Some of the VIX instruments employ leverage of 2 or 3 to 1, while the VIX futures have leverage of more than 15 to 1. The forced liquidation of VIX positions is leading to margin calls. Those who are short the VIX need to come in with more money to maintain their position, or need to sell other investments to meet the margin call. One of the short VIX ETFs is SVXY which rose from $105 in mid December to $138 on January 26 before plunging to $71.82 today.

With volatility remaining so low for so long and the absence of a decline of any magnitude, some investors have implemented leveraged ETFs to amplify returns on the S&P 500, DJIA, Nasdaq 100, and Russell 2000. These leveraged ETF use leverage of 2 to 1 or 3 to 1. Life has been a bowl of cherries as the major market averages only went up.

In the last two days investors in 3 to 1 ETFs have absorbed losses of 7% or more on Friday and 12% today. As these losses piled up, investors have sold their leveraged ETFS either due to margin calls or out of fear. The ETF providers are then forced to sell the stocks in the indexes ie S&P 500, DJIA, Nasdaq 100, and Russell 2000, which is why the market has closed near or at the lows of the day on Friday and today.

When a large bomb is dropped the shock wave emanates outward, which is what the VIX positioning represents. Since last week, it has spread out to engulf the major market indexes and their associated leveraged ETFs. The problem is no knows how much leverage could be forced out of the market in the short term since these type of declines have the potential to take on a life of their own until the liquidation has spent itself.

In the wake of similar declines ie the flash crash in May 2010, the downgrade of U.S. debt in August 2011, the China devaluation in August 2015, and even the Crash in October 1987, the S&P made a low, bounced and then dropped to a new low or at least tested the initial low. This is the process that is likely to play in coming weeks.

Interest Rates

I have thought the 10-year Treasury yield would breakout above 2.63% and then run up to near 3.0%, while the 30-year Treasury yield was expected to rise to 3.15% - 3.2%. The RSI on the 10-year Treasury yield was 80 on Friday which indicated it was oversold. Given the weakness in the stock market on Friday, and how fast yields rose in the wake of the employment report, I sold 40% of my short Treasury bond position in the 1 to 1 ETF TBF at $23.19. When the S&P 500 dropped below this morning’s initial low at 2733, I sold the remaining 60% of TBF at $23.18. The position was purchased when TBF was trading at $21.73.

Gold and Gold Stocks

As discussed last week, I am not positive Gold or the Gold stocks.

Dollar & Euro

I expect the Euro to exceed 1.2536 before a top is in place, and the Dollar to fall below its low of 88.44 before it bottoms.

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. Past performance may not be indicative of future results.

The rally since mid November has been strong and has pushed the MTI to a level that suggests a meaningful correction in the S&P (greater than 7%) is likely months away.

The Super Bowl was a great game and fun to watch and a wonderful way to end the season. There were a lot of commercials. This one is my favorite.


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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