Written by Jim Welsh
Macro Tides Weekly Technical Review 18 June 2018
As noted last week:
“The Nasdaq 100 and Russell 2000 have been the leaders and for the stock market is form a top these two sectors must stop moving higher. Absent news that causes an increase in selling pressure, these averages may hold up until the end of June due to “portfolio dressing’. Most money managers and mutual funds will be eager to show the world that they are invested in the winners. In addition, the annual rebalancing of the Russell 200 could also provide support for the Russell.”
The Russell 2000 continues to grind higher and based on how it has progressed, is likely to create 9 waves for wave 5, as wave 5 becomes an extension. The vast majority of advances consist of 5 waves, but it is not uncommon for an extension to develop near the end of a protracted move. The level of investor bullishness is high which is why every dip is bought. This was the case today as most averages made their price low for the day in the first 15 minutes of trading, with the Russell 2000 the first average to turn positive. Incessant bullishness allows a normal advance to extend to 9 waves and in rare instances develops 13 waves. If the Russell 2000 does hold up until the end of June, it would likely extend into 13 waves from the wave 4 low on May 29.
Click on any chart below for large image.
The Nasdaq 100 (QQQ) is likely to follow a similar path and at least extend into 9 waves, if it too holds up until the end of the quarter.
Despite the positive seasonal support for the Russell 2000 and Nasdaq 100 QQQ, the rise in bullishness shouldn’t be ignored. The Call/Put ratio reached 133 Calls for every 100 Puts last week, not far below the 140 level as the S&P 500 was topping in late January.
The allocation to equities by members of the National Association of Investment Managers (NAAIM) is at its highest level since late January. Last week it reached 103% which means some managers are comfortable in using leverage to increase their exposure to stocks. The strength in the Russell 2000 is also a reflection of speculation, as investors are comfortable in buying the more volatile small cap stocks as opposed to the more conservative large cap stocks.
The Option Premium Ratio is another sentiment indicator that helps identify tops and bottoms in the market. A high ratio develops near a market low, and a top occurs if the OPR falls to an extremely low level below near 0.50. Last week I presented the table above, which I have updated through June 15. The OPR fell to its lowest level going back to January 2010. In 8.5 years the OPR has only fallen to near 0.50 on five other occasions which were each followed by a correction of some magnitude.
The Advance – Decline line has continued to make new highs, which is normally a positive. However, as I discussed last week, the A/D line usually has a fairly high correlation with the percentage of stocks above their 200 day average. However, since the peak in January they have diverged. As the S&P 500 was peaking in late January, the A/D line was also making a high and 68% percent of NYSE stocks were above their 200 day average. Although the A/D line has risen impressively in recent weeks, the percent of stocks above their 200 day average has only climbed to 50% as of June 15.
The divergence between the Advance-Decline line and the percent of stocks above their 200-day average begs a question. How can the A/D line keep making a new all time high while the percent of stocks above their 200-day average is so far below the January high of 68%? The following table may help explain this anomaly. The A/D line peaked on January 23 and bottomed on February 8. During this 12 day decline, the declines exceeded the advances by an average of -825.7 issues, even accounting for the days there were more advances than declines. On average, the S&P 500 lost -21.5 points as the S&P plunged. As stocks were losing $2 or $3 on the worst days of the decline, each declining stock only subtracted 1 issue from the A/D line. The net result is that the A/D line only lost a total of -9908 issues while the S&P 500 plunged 258 points.
In the 87 days since the low on February 8 through June 15, the average stock has been going up pennies but has been adding more advancing issues to the A/D line. This has enabled the A/D line to gain 16,658 issues since the February 8 low. The Advance – Decline line has averaged a plurality of 191.5 issues on each trading days, as the S&P 500 increased an average of 2.3 points.
The New York composite provides a clearer picture of how the average stock on the NYSE is performing since is not cap weighted as the S&P 500. The 5 FAANG stocks comprise 12.5% of the S&P 500 and 38% of the Nasdaq 100. While the Nasdaq has been posting a new all time high, the S&P 500 has recovered 72.3% of its intraday loss from its January 26 high to the February 9 low, while the NYSE Composite has only recovered 43.2%. This further confirms that the apparent strength of the Advance – Decline line is overstated and not as significant as new highs in the A/D line have been in the past.
And additional confirmation comes from the 21 day average of the percent of stocks that have a made a new 52 week high. In January, 6.92% of stocks traded on the NYSE had posted a new all time high during the prior 21 trading days. As of June 12 only 2.61% of stocks had made a new high and that fell to 2.30% as of June 15. If the market is so healthy and strong, why is the percent of stocks making a new high less than half of January’s level?
The stock market can be compared to a car engine. When all the pistons are working in sync, the engine is running smoothly. In the stock market it is important that the major market averages make new highs together or within a reasonably short period of time. Last week the Russell 2000 made a new high as did the Nasdaq Composite and Nasdaq 100. However, at its highest level last week the S&P 500 was -2.85% below its peak, the DJIA was -4.56% lower, the DJTA was off -2.59%, and the NYSE Composite was a whopping -5.49% short of its all time high. The market will need a good car mechanic and probably sooner rather than later!
Anything is possible in the stock market and so it’s possible all the averages that have been lagging since the February 9 low will suddenly catch a second wind and sprint to new highs. Earnings have been terrific and are forecast to be up more than 20% in the second quarter, but the majority of averages are comfortably short of their highs. Although the market may hold up until the end of June, the market is likely to become more vulnerable to a decline in the third quarter. The potential remains for the S&P 500 to fall below the February 9 low of 2532 based on the S&P 500’s price pattern (wave (C). The high level of optimism and discordant action between the major averages reinforces this potential.
A 15% short position is warranted if the S&P 500 trades above 2792.00. Increase it to 30% if the S&P 500 trades above 2805, using 2832 as a stop.
Federal Reserve
When the FOMC met last week the percent of investors expecting the Fed to increase the federal funds rate four times in 2018 had fallen to 30%. Based on the low unemployment rate, members of the Fed who still believe in the Phillips Curve and the efficacy of the Non Accelerating Inflation Rate of Unemployment (NAIRU) on wage growth, and that the Personal Consumption Expenditures index (PCE) is hovering just below the Fed’s 2.0% target, I concluded:
“There is strong economic data to support a tilt toward a fourth rate hike within the Fed. If just one of the 6 members who expected 3 increases upgrades their assessment of the economy and inflation and now supports 4 rate hikes, the Dot Plot will show 7 members favoring 4 increases and 5 who support 3 increases.”
There are now 7 members of the Fed forecasting 4 rate hikes in 2018 and 5 who support 3 increases. The probabilities of a fourth hike has jumped from 30% to 51.7%.
Treasury Yields
Last week I offered this assessment:
“From its high of 3.115% on May 17, the 10-year yield fell to 2.759% on May 29. A 78.6% retracement would allow for the yield to retest the prior high of 3.035% before falling below 2.759%. If this pattern develops it would complete an a-b-c rally from the high at 3.115%, and potentially offer a shorting opportunity.”
After the FOMC increased the federal funds rate to a range of 1.75% to 2.0% at their June 13 meeting, the yield on the 10-year Treasury spiked up to 3.009% before retreating. Eventually the yield is expected to dip below 2.759%.
The 30-year Treasury yield dropped from 3.247% on May 29 to 2.954%, a decline of 29.3 basis points. After the FOMC increased the federal funds rate, the 30-year Treasury yield popped to 3.123% and then fell. It is likely to at least challenge the 2.954% low on May 29 in coming weeks.
I recommended buying TLT at $116.50 in anticipation of a rally to $121.00. In the May 29 WTR I wrote:
“I would recommend selling half of the TLT position tomorrow since it closed at $122.24 (on May 29) and has more than achieved the price target.”
On May 30 TLT opened at $121.00. In the June 4 WTR I suggested using a stop on the remaining position at $118.25, and to
“Sell the remaining 50% if TLT trades above $122.52 the high on May 29.”
On June 6 TLT traded down to $118.42. I suggest raising the stop to $119.50 and selling the remaining half if TLT trades up to $122.10.
Dollar
I thought the pullback from the May 29 high in the Dollar at 95.02 was likely wave 4 which could bring the Dollar index down to 93.00. The Dollar posted a low of 93.19 on June 14 and then quickly rallied to a new high of 95.13. I expected the Dollar to exceed the prior high at 95.02 to complete wave 5. Although it is possible that the rally from mid February is ready for a time out, it must be noted that wave 1 lasted 10 trading days. So a 1 day rally for wave 5 seems too short. This suggests that wave 5 is likely to last longer and implies the Dollar will push above 95.13 before wave 5 is complete. If wave 5 is equal to wave 1 it would target a high of 95.87 and tag the trend line connecting the highs for wave 1 and 3.
Gold
Market bottoms are formed as the veneer of bullishness is diminished until capitulation becomes dominant. Gold is progressing toward capitulation but Large Speculators keep trying to pick a bottom at each lower trend line. When Gold fell below $1300 and traded down to $1282 on May 18 and May 21, it held an important trend line connecting the December 2016 low and December 2017 low. (Solid trend line on chart below.)
Large Speculators saw this as a potential bottom and increased their long position from 90,957 contracts on May 22 to 115,130 contracts on May 29. This attempt at bottom fishing led me to conclude that Gold was likely to drop below the $1282 low to shake them out. On June 11, Gold traded below $1282 but held above the lower dashed trend line near $1273. Rather than shaking them out, Large Speculators increased their long position to 120,240 contracts. This suggests that Gold will fall below the June 11 low of $1275 in coming weeks. A Dollar rally to near 95.87 could provide the pressure to push Gold down $1250 so it tests the lower solid trend line.
I expected Gold to rally to $1310 – $1325 at a minimum, but it only was able to reach $1308.89 before falling to $1275.58. In the May 14 WTR, I recommended:
“Buying a 50% position in Gold or the Gold ETF GLD, if Gold trades under $1301.”
On May 15 Gold traded under $1301 and the Gold ETF GLD opened at $122.82. Add another 25% to Gold or the Gold ETF GLD if Gold trades under $1264.
Gold Stocks
The relative strength of Gold stocks to Gold has continued to flat line, which suggests that GDX will eventually decline enough to bring its RSI down under 35 and probably close to 30. Today the RSI finished at 46.5. Per instructions provided in the May 14 WTR:
“A 50% position is recommended if GDX trades under $22.10 in coming days.”
On May 18 GDX traded under $22.10. In the June 11 WTR I recommended a sell level and established a stop for GDX:
“Place a stop on this position at $22.22. If GDX trades above $23.00, raise the stop to $22.60. Sell half of the position if GDX trades above $23.24 and the remaining half if it trades above $23.40.”
GDX traded up to $22.67 before triggering the stop on June 15 at $22.22. A 50% position is recommended if GDX trades under $21.56. I’m going to wait until the RSI is under 35 before making any recommendation for adding to this position.
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 remains well below its high from January. The relative strength of Technology has weakened since the low on May 3, which is another sign that Technology may be nearing a high as the chart of the Nasdaq 100 QQQ implies.
Past performance may not be indicative of future results.
The Sector ranking report is not available this week. For months Financials have been recommended by almost everyone I’ve heard on CNBC. Despite the heavy sponsorship, the Financial ETF XLF has done poorly. Perhaps it is over owned?
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.
