Written by Jim Welsh
MacroTides Technical Review 11 September 2017
In the August 21 WTR I wrote,
“Although the S&P and other major averages declined to a lower low today, there are a number of signs that a short term bounce is coming. Despite the lower low, the 21 day average of net advances minus declines posted a higher low on Friday when compared to August 10 (green line). Short term sentiment has also become a bit over done as measured by the Call / Put ratio and is low enough to support a near term bounce.”
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At the close today, the 21 day average of net advances minus declines is now almost overbought (red trend line), which suggest the upside could be around 1%. This assumes that the S&P has a bit more to go in the next few days. The 5 times since last December the 21 day average of net advances minus declines has become fully overbought as noted by the green arrows, the S&P has stalled and traded sideways for 1 to 2 months. The high on February 13 was followed by a 2.7% push higher into the high on March 1. But by the end of April the S&P was back down to the 2330 level of February 13.
As of Friday, the Call/Put ratio was mid range, but today’s rally likely pushed it higher. This week is an expiration week, which often results in the C/P ratio rising. With short term sentiment muted, the S&P can rally another 1%.
In the August 21 WTR, I also made this comment,
“The more bearish outcome (and not expected) would be a rally to a new high which would put a cherry on the topping process. The divergences would be extreme and temp me to recommend a short position.”
The S&P made a new closing high today, but did not exceed its intra-day high of 2490.87. In terms of price patterns, I use intra-day data rather than closing data which I use to measure divergences. My assumption is that the S&P will rally above its intraday high of 2490.87 and probably will also make a higher closing high. But based on what we know today, the S&P’s new closing high was not confirmed by its RSI or by any other major average.
If most of these divergences remain intact and the S&P reverses lower, the topping process will be further confirmed. The red arrows indicate that after the three prior instances that the RSI did not confirm a new high, the S&P did dip albeit modestly. The odds favor this outcome, but the S&P has gone without a 3% pullback for one of the longest stretches since 1927. The market stopped being ‘normal’ months ago.
The thrust in market breadth, as measured by the 21 day average of the percent of net advancing stocks, is not even close to its prior thrust high of 8.1% on July 25. It closed today at 4.1%, but will continue to rise if breadth is positive in coming days. The percent of stocks above their 200 day average was 57% on Friday, and given today’s strong breath may have reached 60%. Even so, that is still well short of the 67% reading on July 26.
As noted last week, the S&P ran into real trouble in 2015 after the percent of stocks above their 200 day average fell below 50% (black horizontal line) in late May (left side of chart on pg. 1). That period of weakness was preceded by a flat S&P while the deterioration progressed. The probability of a 5% correction will increase if the percent of stocks above their 200 day average falls below 50%.
The bull market from March 2009 has often been called the most hated rally in history. That may have been true from 2009 through 2016, but retail investor sentiment has become fairly bullish since the election.
In August the Wells Fargo / Gallup Retirement Optimism Index reached its highest level since September 2000, (138 versus 147). The survey found that 68% of those polled were optimistic, tied for the highest percent in the 21 year history of the Index. The results are similar to the T.D Ameritrade Investor Movement Index (IMX). The IMX is a proprietary, behavior-based index created by TD Ameritrade and is designed to indicate the sentiment of retail investors. The IMX has soared since the election and is much higher now than at any time during its 6 year history. As a contrarian, this is a flashing caution sign.
I thought the decline last Tuesday was the start of another leg of the correction that began after the S&P hit 2490 on August 9, and that a test of 2430 was very likely. Today’s rally certainly delays that outcome! I’ve discussed the negative seasonal patterns that have caused market declines during September and October and especially in years ending in 7. The negative seasonal pattern received a fair amount of attention coming into September, so the rally into mid September may be the perfect setup. Just when investors think the seasonal weakness has passed and no longer a worry, maybe October will spook them.
Dollar
“Technically, the Dollar has done everything that was expected by falling below 91.88 and posting a new low that was unconfirmed by the Dollar’s RSI. Based on the instructions I provided, buying a 1/3 position when the Dollar dropped below 92.93, 1/3 below 92.54, and 1/3 below 91.88, the average cost is 92.44. For now, a stop on a close below 91.50 is recommended.”
After the ECB announced no changes to its QE program after its policy meeting last Thursday and Mario Draghi made no direct mention to the strength in the Euro during the press conference, the Euro jumped on Thursday and Friday. As I discussed in the September 6 issue of Macro Tides:
“The minutes of the ECB’s meeting on July 9 were released on August 18 and the strength of the Euro was discussed. “Regarding exchange rates, while it was remarked that the appreciation of the euro to date could be seen in part as reflecting changes in relative fundamentals in the euro area vis-a-vis the rest of the world, concerns were expressed about the risk for the exchange rate overshooting in the future.”
On July 9, the Euro was trading under 1.15 and last week traded above 1.20 an increase of 4.8%. Whatever concerns that existed on July 9 would be heightened by the recent increase and could represent the ‘overshooting in the future’ described.” The fact that the Euro rallied after the ECB’s meeting suggests that currency traders aren’t listening or paying attention. The odds are high that the ECB will be more explicit about the value of the Euro at the October meeting, or in speeches before.
An overshooting of the Euro is a double negative. It makes European exports more expensive which is particularly hard on the southern countries (Italy, Portugal, Spain, France) which are far less productive than Germany. The Euro is up more than 12% in 2017 so even Germany won’t be immune to the headwind. Euro strength will weigh on GDP growth in coming quarters.
Secondly, a strong Euro puts downward pressure on inflation which is already well below its 2.0% target. As Draghi noted in the press conference:
“At the same time, the recent volatility in the exchange rate represents a source of uncertainty which requires monitoring with regard to its possible implications for the medium-term outlook for price stability.”
What’s to monitor? The implication for the medium-term outlook for price stability from a strong Euro is obvious. It’s not helpful and probably untenable.
The Dollar sold off and closed below 91.50 on the cash. This triggered the stop at 91.50, which was probably tighter than necessary since a trading low in the Dollar is still very likely. Despite the new closing low, the RSI divergence is intact, and sentiment is still lopsidedly negative toward the Dollar.
For the record I did not sell my position in the Dollar. If the Dollar trades below Friday’s low of 91.01 it would provide another opportunity to go long. A move above 92.94 (61.8% of the decline from 94.14 to 91.01) would increase the odds that the low is already in place. A move above 93.35 would break the pattern of lower highs and lower lows and suggest a change in trend has occurred.
Gold and Gold Stocks
The rally in Gold last week above $1350 resulted in large Speculators holding their largest long position in gold futures since the high last July. Conversely, Commercials increased their short position to the largest since last July (middle panel) while Producers have a bigger short position than last July (bottom panel). The aggressiveness of Commercials to short Gold as it broke out above $1306 suggested that chasing Gold was likely not a good idea.
In addition, Silver had not confirmed the move up in gold by exceeding its April high as gold was breaking out above its April-May highs. Trends in the metals are confirmed as Gold and Silver agree by making new highs or lows together. When they diverge, as they have in recent weeks, it is often a warning of a trend change. A close below $1306, the breakout level, would negate the breakout and suggest Gold was vulnerable to a further decline.
The ratio of Gold Stocks to Gold has continued to trend sideways, as opposed to decline sharply as it did between late December and mid February when Gold Stocks really zoomed. Today’s weakness in the Gold stocks pushed the ratio higher. The longer this relative weakness persists Gold stocks could be vulnerable to a sizable decline, especially if Gold closes below $1306.
Treasury Yields
“Three weeks ago, I recommended a partial short position through one of the inverse Treasury bond ETFs if the 10-year yield dropped below 2.20%, and the 30-year yield fell below 2.806%. Two weeks ago, I noted that the trading pattern in the 10-year and 30-year Treasury bonds suggested that the yield on the 10-year could drop below 2.103% (2.05%) and the 30-year could fall below 2.682% (2.64%) before yields reverse higher. Adding to the partial short position through one of the inverse Treasury bond ETFs is recommended if yields do make lower lows (2.05% – 2.64%).”
On Friday the yield on the 10-year Treasury bond fell to 2.034%, tagging the blue trend line in the process.
Today, the yield closed at 2.125%. The 30-year Treasury yield dipped to 2.651% on Friday and closed today at 2.738%.
In the March 13 WTR, I wrote:
“A 38.2% retracement of the decline in July 2016 from $143.62 to the low of $116.80 in December 2016 in the Treasury bond ETF (TLT) would lead to a rally to 126.00 or so, while a 50% retracement would bring TLT back up to 129.00.”
On Friday TLT traded up to $129.56. In mid March when the 10-year Treasury yield reached 2.62% and the yield on the 30-year Treasury bond touched 3.201%, I thought bond yields were more likely to decline than go up as was widely expected, and why I recommended TLT when it was trading below $117.50. In the June 26 WTR, I recommended selling at least half of the position:
“This morning TLT traded as high as $128.57 so it is near the 50% retracement level of $129.00. The yield on the 10-year Treasury could fall to 2.0% as I have discussed (June 5 WTR), but it is certainly time to sell at least half of the TLT position.”
After bottoming at 2.10% in July 2016, the yield on the 30-year Treasury bond rose to 3.20% in March 2017, an increase of 110 basis points. When the yield fell to 2.65% on Friday, it had dropped 55 basis points from the high of 3.20%, an exact 50% retracement of the increase of 110 basis points. It is now possible to label the move up from 2.10% to 3.20% as wave A, and the decline in yields as wave B. This suggests that over the next 9 to 12 months, the 30-year yield could reach 3.75% in wave C if wave A and C are equal.
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 Tactical U.S. Sector Rotation Model Portfolio is 100% in cash based on the probability of a 5% correction. In my judgment, upside potential is limited relative to the current level of risk. Any bounce in the short term is likely part of the topping process that began in earnest in early July. The weakening of the broader market, as measured by the percent of stocks above their 200 day average and the relatively weak thrust off the August 21 low, suggests that the topping process is continuing.
Through August 31, the Tactical Sector Rotation program is up 8.52%.
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.
