Written by Jim Welsh
Macro Tides Weekly Technical Review 09 April 2018
The S&P 500 has tested its 200-day average on 6 separate days including the first test on February 9. Although it traded below the 200-day average an intra-day basis on 5 days, it still managed to close above the 200-day average every time. Normally, I would interpret a repeated assault on any price level including the 200-day average as a negative.
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Each time a price level is tested, demand is used up in defending it, and eventually that sets up a break down as supply swamps demand. Under normal circumstances this would increase the odds of an imminent plunge below the 200-day average and initiate the next leg lower. The market may be just a Tweet away from another swoon. However, a review of various sentiment indicators and momentum indicators suggest that the S&P 500 may rally in the short term, rather than fall apart.
Click on any chart below for large image.
In some ways the market is similar to where it was last week when I expected the S&P 500 to hold support and rally:
“It is slightly more probable that a short term rally off the long term trend line beginning tomorrow (Tuesday April 3) enables the S&P 500 to rally above the 200-day average at 2589. This could be followed by a move to 2640 – 2660, which includes the March 2 low of 2647. There is a small chance the S&P 500 could approach the March 27 high of 2674. Since the intermediate outlook is for lower prices, any rally is an opportunity to get more defensive, or short if the S&P 500 nears 2674.”
The S&P 500 did begin a rally on Tuesday and by Thursday had traded up to 2672. On Friday President Trump proposed more tariffs on Chinese imports and the S&P 500 tanked. At its low on Friday it traded down to 2586 before rebounding to 2604 at the close. The extraordinary day-to-day volatility has caused CNN’s Fear and Greed Index to fall to its lowest level since the intermediate low in February 2016.
The Exposure Index of the National Association of Active Investment Managers has fallen to its lowest level since May 2016. The NAAIM Index measures the level of exposure that active advisors have to the market. In mid December the NAAIM Index was 120.56 which meant they were so bullish they were using 20% leverage. Amid all the volatility and the decline in the overall market, these active managers have lowered their exposure to 49% two weeks ago and 55.5% last week. At the S&P 500’s low in February 2016 their exposure was below 25%.
CNN’s Fear and Greed Index and the NAAIM Index are contrary indicators since they are low near market trading lows and show a lot of optimism near market tops. The current readings are supportive of a short term rally. However, a continued move toward a trade war easily trumps sentiment since the economy could be meaningfully affected.
The Call / Put ratio is hovering just above 1.0 which is near the lows that have accompanied previous trading lows in the past year. It is not as low as it was just before the election in November 2016 or the February 2016 low.
Various measures of the market’s internal momentum have become less oversold as the 200-day average has been repeatedly tested. This can be taken two ways. The fact that internals are less oversold implies that selling pressure is waning even as the S&P 500 tests its 200-day average. Part of this is due to the overweighting the big tech stocks have in the S&P 500 and Nasdaq 100. As these stocks have continued to fall, they have exerted downward price pressure on the S&P 500 and Nasdaq 100, while fewer stocks were participating in the decline. On February 5, the 21 day average of advances minus declines was -546 and -514 on February 8. On March 23 it was -303 when the S&P 500 closed 3 points higher than on February 8. On Friday April 6 the 21 day average of advances minus declines was +16, which is dead neutral.
Although the numbers are different for the 21 day average of advances minus declines based for the Nasdaq data, the pattern is the same as the Nasdaq 100 has tested its critical support at 6350.
The percentage of stocks above their 200-day average has stabilized while the S&P 500 has tested its 200-day average and the chart support at 2580 -2600. Although the percent is not as overdone as it was in January and February 2016, it is the lowest in more than two years.
Coming into 2018 the positioning in Volatility futures was extreme with a record short position as traders were expecting volatility to at least remain low and potentially fall further. When the 10-year Treasury yield broke out above the March 2017 high of 2.62% on January 19, the S&P 500 peaked on January 26 and then rolled over. When the January employment report indicated that Average Hourly Earnings rose 2.9%, the selloff in the S&P intensified and volatility began to rise sharply.
The increase in the VIX futures forced those short to buy, which caused the VIX index to explode higher (VIX chart below). This created a cascading in selling pressure which contributed more to the decline in the S&P 500 than the increase in interest rates. Amazingly, the positioning in the VIX futures has swung from a record short position in January to a record long position in early April since 2008. In January traders were positioned for lower volatility, now they are positioned for higher volatility.
From a contrary point of view, these traders were off sides in January and are now potentially off sides with expectations for higher volatility, after the highest spike in volatility since 2016. It is interesting that as the S&P 500 has continued to test its 200-day average in recent weeks the level of volatility is far lower than it was in early February. It is a positive that even with the S&P 500 barely above the lows of early February, the VIX is far lower.
The fact that the market’s internals have become less oversold as the S&P 500 attacked its 200-day average and the Nasdaq 100 tested 6350 may be suggestive of another stronger rally, or it could be simply setting the market up for the swan dive below support that gets the market deeply oversold.
In order for the S&P 500 to be able to sustain a rally, the tension surrounding the issue of trade will need to dissipate. It is encouraging that trade ministers for Mexico and Canada have noted that talks have been making progress. Canadian Foreign Minister Chrystia Freeland said talks have entered an “intensive phase of engagement” that has yielded progress on the thorny issue of automotive rules of origin. Mexican chief NAFTA negotiator Ken Smith Ramos said:
“We’re still talking and figuring out the best schemes for each of the working groups to continue getting work done.”
The leaders of the three NAFTA nations are set to attend the April 13-14 Summit of the Americas in Peru. If significant progress is noted at the summit, or possibly a new NAFTA deal is announced, the stock market would be relieved.
In coming weeks, trade talks with China will commence. If a path to a positive resolution to NAFTA seems realistic, investor’s would embrace the notion that a similar outcome might be achieved with China. The shift in sentiment would be enough to lift the S&P 500 above resistance at 2675, potentially approach 2730 – 2740, with an outside chance of testing 2800.
If the S&P 500 does manage to rally above 2675 and approach the higher targets it doesn’t change the bigger picture outlook. The expectation remains that the S&P 500 is likely to trade under 2500 before Labor Day.
Today the S&P 500 traded up to 2653 before selling off sharply in the last hour of trading when word that President Trump’s lawyer’s office had been ‘raided’ by the FBI. This represents another wild card. The level of intra-day volatility and the frequency of late-day declines suggests it would be negative if the S&P 500 trades under Friday’s low of 2586, or closes below the 200-day average of 2594. A close below the 200-day average after so many tests could lead to a waterfall decline.
Although measures of sentiment and market internals are supportive of a rally, the trading action has been poor with so much weakness occurring in the last hour of trading. In a good market, the S&P 500 doesn’t drop like a stone in the last hour of trading. The President of China is schedule to give a speech tonight in China. Although I think it’s unlikely, if he announces more tariffs, tomorrow could be an ugly day for stocks.
Treasury Yields
In last week’s WTR I wrote:
“The drop in bond yields since last Tuesday has been significant (10-year 2.841% to 2.717%, 30-year 3.084% to 2.956%). This suggests that Large Speculators who held a large short position have been covering in earnest. The next report on positioning will be available on Friday afternoon.”
I expected the Commitment of Traders report to validate that Large Speculators had reduced their large short position in 10-year Treasury futures and used up some of the buying power their short position represents. Imagine my surprise (more like shock) that they had increased their short position from -305,212 contracts to -375,365 contracts. This is a bigger short position than the -365,650 Large Speculators were holding on March 6, 2017, just before 10-year Treasury bonds rallied from 123.00 to 128.00 in September.
The smart money Commercials are long +566,052 so they are expecting yields to fall in coming months. I usually align my views with the positioning of the Commercials and against the Large Speculators since the latter are usually wrong at turning points.
The yield pattern for the 10-year Treasury still indicates that its yield should rise above the 2.943% on February 21, while the 30-year yield is expected to exceed its prior high of 3.221%. A rise in the yields would represent wave 5 and complete the rise in yields from the low in early September. After wave 5, a more significant decline in yields is likely to take hold which is consistent with the Commercials long positioning.
Last week I thought it was a good opportunity to short bonds by buying either the 1 to 1 short bond ETF (TBF) or the 2 to 1 short bond ETF (TBT). On Tuesday morning, TBF opened at $22.77 and TBT at $36.45. If the 30-year yield falls below 2.933% and over laps the high for wave 1, the pattern may be different than what I’ve presented. A decline below 2.933% should used as s stop for TBF and TBT.
Dollar
Last week I suggested establishing a partial position (up to 50%) in the Dollar ETF (UUP). On April 3 UUP opened at $23.64. I recommended adding to the position if UUP trades below $23.15. In coming months, the Dollar index has the potential to rise to 94.50 – 95.00 and lift UUP to $24.50 to $24.70.
Please note these instructions are for qualified accounts since UUP will send a K-1 for tax purposes in March 2019 for taxable accounts. For nonqualified (taxable) accounts that want to avoid the hassle of a K-1, the Profunds Dollar fund (RDPIX) tracks UUP closely and is a good alternative.
Euro
Not much has changed since the Euro continues to chop sideways in a trading range. On February 16 I established a partial short position in the Euro inverse ETF (EUO) which is leveraged 2 to 1 at $19.89. After Trump announced his decision to proceed with tariffs on March 1, I sold my position in the Euro inverse ETF EUO at $20.38. I reestablished the position on March 8 at $20.25. If the Euro rises to a new high I will add to this position. The trend line connecting the high in 2008, 2011, and 2014 comes in near 1.2630 which I expect to contain any Euro rally.
Gold
Still seems more likely that Gold will close below $1306 before it rises above $1368. If Gold fails to breakout, a close below $1306 would set Gold up for a decline to $1275 and potentially $1250. A close above $1368.00 would represent a breakout and likely be followed by a rally above $1400.00 and potentially up to $1450.00. Longer term I still expect Gold to rally above $1450 so the challenge is finding a good entry point, without enduring the pain if Gold does suffer a quick swoon to $1250. Go long if Gold does breakout and closes above $1368.00, with a stop on a close below $1356.
The relative strength of Gold stocks (GDX) to Gold has yet to strengthen, so a sustained rally in the short term is not likely. If Gold breaks out above $1368.00, GDX has the potential to rally above $23.15 and potentially reach $24.75 – $25.50, if the relative strength really improves. If Gold breaks out, buy GDX above $23.20 using a stop of $22.45. If Gold fails to break out and subsequently drops below $1306, GDX could decline to $20.50 and potentially to $19.43.
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. Based on the buy signal, a 100% invested position in the top 4 sectors was adopted. The MTI confirmed a new bull market on March 30, 2016. The MTI fell below the green horizontal line on March 29 which indicates that the bull market is in jeopardy. In the March 5 and March 12 Weekly Technical Reviews I offered this advice. If the S&P 500 trades above 2789 and you don’t like the idea of watching the S&P 500 subsequently fall to 2533 or possibly 2449, you should 1) hedge your portfolios, 2) do some selling, or 3) go short using a stop above 2840.
Past performance may not be indicative of future results.
The MTI has weakened significantly since peaking in late January. If the S&P closes below 2585 the MTI suggests the S&P could be vulnerable to a more significant decline than merely a retest of the intra-day low of 2533 on February 9.
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.
