Written by Jim Welsh
Macro Tides Technical Review 22 August 2016
What a difference a week makes! Not! For the last 31 days the S&P has not experienced a day when the trading range exceeded 1%. Between July 14 and August 1, the S&P had traded in a 1% range for 13 trading days, the longest, most narrow trading range in more than 40 years.
After a brief 3 day commercial interruption on August 2, 3, and 4th (during which the S&P plunged a bone jarring -1.42%), the S&P has traded in a 1% trading range for the past 11 days. Since everyone is waiting for Janet Yellen to give her Jackson Hole speech on Friday, the S&P may very well be able to extend the current streak to 14 days. Wouldn’t that be something!
I doubt Janet is going to tip her hand about what the Fed will do at the September 21 meeting, which will be followed by a press conference. I suspect she will acknowledge that the labor market is doing better after the last two employment reports, and that inflation is expected to trend up toward the Fed’s 2% inflation target. More importantly, she will discuss why the peak for the federal funds rate will be lower than history would normally indicate since there are number of longer term headwinds that could continue to weigh on growth.
Of course, her speech, when it is released at 10am on Friday, will be read under a microscope by every economist on Wall Street attempting discern something, anything that might shed the smallest ray of light on what the Fed may or may not do and when. In the upcoming September Macro Tides I will discuss how the Fed’s more than 10 year effort of providing forward guidance has been a failure and should be scraped.
Since reaching the price target of 2193 I discussed in the August 1 WTR, the S&P has done little. A close under 2168 should lead to a dip to 2150. If you look closely (binoculars optional) you may be able to discern the market’s pulse.
Click on any chart for larger image.
The 21 day average of advances minus declines measures buying and selling pressure and helps identify when the market has become overbought and oversold. As discussed in the August 1 WTR, the 21 day average of advances minus declines became overbought when it rose to 654 on July 12. Since then it has unwound the overbought condition without the S&P falling. This confirms the lack of selling pressure. The only negative is that the 21 day average of advances minus declines did not confirming the new price high in the S&P on August 15.
If this was occurring in a normal two-way market, the negative divergence would carry more weight than in the current environment which is best described as comatose elevation. It does support the potential for the modest correction I think is likely.
Another indication of how overbought the market remains is illustrated by the percent of stocks above their 200 day average. As of Friday August 19, 80% of stocks traded on the NYSE were above their 200 day average. The last time it was this overdone was back in June 2014. Until a crack in the market’s façade appears, the probability of a deeper decline in the short term is low.
Sentiment Suggests the Upside Is Limited
The Option Premium ratio continues to hover at levels that have coincided with at least a short term top in the market over the last two years, as noted by the blue arrows on the Option Premium chart.
As the S&P has effectively traded sideways with a very slight upward tilt since July 12, the percent of Bulls in the weekly Investors Intelligence survey has continued to climb. Markets don’t decline because there are too many bulls. They decline when a reason to sell appears that convinces some of the bulls that it’s time to lighten up. At this point a modest pullback of 3% to 5% is the most I would expect in the short term.
The Major Trend Indicator (MTI) is a proprietary measurement of how strong or weak the market is. Generally, the MTI will make a series of lower highs prior to a correction of more than 7%. In recent weeks, the MTI has flattened out and begun to marginally curl lower. This is supportive of a modest decline of 3% to 5% in coming weeks. The MTI has surpassed the high it recorded in April, which is a sign of strength. This suggests that a correction of more than 7% is unlikely in the next few months, until the technical underpinnings of the market deteriorate.
Tactical S&P Sector Rotation Portfolio Model: Relative Strength Ranking
The Sector Relative Strength Ranking is based on weekly data and used in conjunction with the Major Trend Indicator. 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.
As I have discussed since early July, the market was not oversold nor was sentiment negative when the S&P bottomed on June 27 after the Brexit vote. Although I had previously discussed the potential of the S&P dropping below 2000 in the weeks leading up to the Brexit vote, the lack of any normal bottoming signals convinced me that patience was the better part of valor under the circumstances.
In addition, after generating a total return in the first quarter of 8.9%, I thought waiting until the technical and sentiment indicators suggested a solid trading low had been established made sense. (Q1 return does not include management fees) Past performance is no guarantee of future results. Needless to say, the rally has exceeded expectations, which has been frustrating.
My other concern has been that since early July the sectors that have comprised the top 4 sectors in the Weekly Relative Strength analysis appeared vulnerable to a pullback. Since then, Consumer Staples and Utilities have dropped out of the top 4. Energy was able to bounce but could be vulnerable in coming weeks as oil prices work their way lower. Since January Iran has increased its oil production by 600,000 barrels a day and Saudi Arabia has added 400,000 barrels to daily production. These increases offset the decline in U.S. production of 1 million barrels a day.
In other words, the oil market is still beset by a modest imbalance between supply and demand. As noted in prior WTR’s, demand from refiners is expected to decline by more than 1 million barrels a day between now and early October. Positioning in the futures market shows that large speculators are still quite long.
If WTI begins to slip, the pressure on the large spec longs will intensify and lead to more selling, which is what I think is likely. A break below $44.00 should lead to another test of $39 – $40 a barrel. Should this develop, oil stocks are likely to correct more too.
As noted last week, I thought XLE would have trouble staying above $70.26. After spiking up to $71.00 XLE fell back below $70.00. If oil follows the script, XLE could retest the blue horizontal support line at $64.25.
As expected, the Utilities XLU found support just under $50, and have bounced.
Basic Materials has gone nowhere since mid July, and has started to fade in relative strength.
Normally, (unfortunately, these are anything but normal times), the stock market experiences a correction when it undergoes a leadership change. Just about every sector has been exploited during the rally, so most sectors are overbought and vulnerable to at least a short term pullback of 3% to 5%.
Small cap stocks have had a great run, but are extended. Potentially the Russell 2000 could rally another 2% – 3%, but the risk versus the reward of a quick spike doesn’t seem justified.