Written by Jim Welsh
Macro Tides Technical Review 25 September 2017
The S&P 500 made a new high of 2508.85 last week on Wednesday morning before the Fed released its FOMC statement and Janet Yellen’s press conference before slipping to an intra-day low of 2496.54 on Friday. The range for the week was 12.31 points or 0.49% based of the September 18 close. The range of 0.49% for the week was the smallest since 1972. Such a narrow range would not have been surprising had it occurred during the 4 day trading period between Christmas and New Years Day. That it happened during the week the Fed announced the biggest change in its monetary policy since the financial crisis is remarkable.
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The dormancy of last week’s trading masked the dynamism of fierce rotation under the surface. On the plus side, the Russell 2000 continued to rally strongly after months of underperformance. After falling more than 7% between July 25 and August 18, the Russell 2000 made a new high today. The Russell’s RSI has moved from being oversold on August 18 to overbought, which suggests that the upside is likely limited in the short term. The Russell 2000 is also running into a trend line connecting highs in March 2014, June 2015, and four prior highs in 2017.
Click on any chart below for large image.
The DJ Transportation average shed 7.7% between its early July peak and August 24. For weeks the DJT failed to confirm the new high in the DJIA but has motored in the last three weeks and is very close to making a new high. It has moved from being oversold to being overbought as measured by its RSI. A trend line connecting prior highs is only 1.5% above its current level.
As money was flowing into the Russell 2000 and the DJ Transports, it was flowing out of big name technology stocks that overweight the Nasdaq 100. Last week, the Nasdaq 100 recorded a negative weekly key reversal as it made a new high for the week, reversed lower and traded and closed below the prior week’s low (blue arrows). Weekly reversals often occur at intermediate term highs and lows. During the week of June 9, the Nasdaq 100 experienced a negative key reversal which ushered in the correction that lasted until August 21. Last week’s reversal was followed by weakness today as the Nasdaq 100 fell by more than 1.1%.
The question facing investors is whether the rotation out of the big name tech stocks and into small cap stocks will continue, so the weakness in tech stocks that carry big weightings in the Nasdaq 100, Nasdaq Composite, and S&P 500 (Tech has the largest weighting in the S&P at 23.4%) can be contained. With the Russell 2000 overbought and approaching an important resistance line, the odds would seem to favor profit taking in the small cap stocks soon. I don’t think money will flow back into the big name tech stocks if the small cap stocks experience a setback. If the Nasdaq 100 closes below 5988 on September 29, it will record a monthly negative key reversal, which is relatively rare. If correct, the S&P is likely to pullback a bit more as it did last week despite the relative strength in the Russell 2000.
The strength in small cap stocks has spilled over into the S&P Equal weight ETF (RSP), which has caused its relative strength to the S&P to improve nicely since September 19. The downtrend in its relative strength is still intact (blue trend line) and wouldn’t signal a reversal until it rises above the red horizontal trend line. The short term trend is positive but the intermediate trend will remain negative until the red horizontal is overtaken.
The NYSE Advance/Decline line made a new high today which suggests any pullback is likely to be shallow i.e. 3% to 5%. Although the percentage of stocks making a new 52 week high is below the late July level, at 3.60% versus 4.46%, the current level is still quite healthy. The percent of stocks above their 200 day average on Friday was 63% and below the 67% recorded in late July. In June of 2015, the percent of stocks making a new 52 week high was below 0%, and the percent of stocks above their 200 days average was below 50%.
The current small divergences in the percent of stocks making a new 52 week high and above their 200 day average are short term negatives but not indicative of a market vulnerable to a correction greater than 7%. On average, the S&P has suffered a 5% correction on average three times a year since 1928. These modest divergences are normally seen before pullbacks of 3% to 5%, but there hasn’t been a 3% pullback since last November. This is long time span is a statistically rare event.
Treasury Bonds
Prior to the bounce in Treasury bonds on Friday and today, Treasury bonds had declined for 9 consecutive days. During the decline the yield on the 10-year Treasury rose from 2.034% to 2.289% while the 30-year Treasury yield rose to 2.836% from 2.651%. The high in yields was recorded on the day of the Federal Reserve’s FOMC meeting and yields have fallen to 2.22% on the 10-year and 2.760% for the 30-year. Last week I wrote,
“My guess is that bond yields will rise initially and then fall.”
From the bottom in the 30-year Treasury bond yield of 2.10% in July 2016, the yield rose to 3.20%, an increase of 1.10%. A 50% retracement targeted 2.65% which was reached on September 7 and followed by a sharp rise. This suggests that an important low in yields was achieved on September 7. Confirmation that the longer term trend is higher would occur when the 30-year Treasury yield closes above 2.89% and th declining black trend line.
Prior to the Fed meeting last week, I thought the Fed’s dot plot had the potential to move markets if it indicated that the long term peak in the federal funds rate would not drop below 2.5% as some economists had forecast. The Fed’s dot plot for 2019 was 2.75%, down slightly from the 2.88% forecast in June. The Fed’s projection of three rate increases in 2018 and one more at the December meeting caught the bond market by surprise, which is why yields initially rose.
One of the reasons U.S. yields are likely to go up only modestly is the relative value trade with European bonds that yield far less. According to the ECB, European investors bought $192 billion of foreign bonds in the 3 months ending in July. That was the largest sum in any three month period on record. The linkage between yields in Europe and the U.S. is why I have thought an increase in German Bund yields will spur an increase in U.S. Treasury yields. The ECB meets in late October and is likely to announce its plans to pare its QE program starting no later than in early 2018. Global investors are not going to wait until the change is implemented to sell European bonds. As I noted in the September Macro Tides:
“When the Fed and ECB wanted to repress interest rates they could enlist the help of market participants to ride their coattails since investors would profit from the collaboration. Unwinding negative real interest rates and curtailing bond purchases will cause interest rates to rise and create losses for bond holders. Rather than being coconspirators, market participants will be combatants with the central banks and more importantly with each other. The potential is that it won’t be a Taper Tantrum but more like a stampede with every investor acting in their own best interest. It’s not a question of if this is going to happen, just when.”
Dollar
The Dollar has increased the odds that an intermediate low was recorded when it traded down to 91.01 on September 8 but has yet to trade above 92.94. As noted the last two weeks:
“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.”
I expect the Dollar to rally a minimum of 4.5 points and maybe 7.5 points from 91.01 or whatever price low marks the trading low. I’m still long the Dollar ETF UUP.
Emerging Markets
Another hint that the Dollar is turning the corner is how the Emerging Markets ETF (EEM) traded today, which was down -1.70%. Today’s decline broke the short term green trend line from the July low and sets up a test of the blue intermediate trend line from the December 2016 low. I thought EEM was poised to break below the blue intermediate trend line if the Dollar reversed higher as I expected.
As I discussed in the September 6 Macro Tides:
“On the five separate occasions since 2011 (red arrows), the rally in EEM has run out of steam just above or below the black trend line. The weekly RSI is more overbought now than at any time in at least the last 10 years, and did not confirm the recent new high in price. The rising blue trend line on EEM from the low in December is still intact and comes in near $43.50. Until EEM closes below this trend line, the intermediate trend is still up. The odds seem high that a break of this trend line is coming. Selling into strength makes sense, rather than waiting for EEM to drop 5% and break the trend line.”
On September 7, EEM closed at $45.17.
Gold and Gold Stocks
I thought Gold was vulnerable to a correction after it broke out above $1305 in July based on how aggressive the Commercials were in shorting Gold as it rallied. With Gold down to the area of the breakout ($1295 cash) and near a round number $1300, a bounce seemed likely. Gold rallied to above $1310 today on North Korean news. Gold fell about $60 from its recent high, so a bounce of $24 to $30 is reasonable. If Gold closes below $1295 as I expect in coming weeks, a decline under $1260 is likely. A drop to under $1225 is possible. The source for the Gold chart is down which is why there is no chart.
At the next good buying opportunity in Gold stocks, I would expect the relative strength of the Gold stocks to improve significantly as it did between late December and mid February. That improvement was a great indication that the Gold stocks were really ready to rally strongly. Today’s strength should be reversed if Gold falls to near $1260 as I expect.
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.
For the three weeks through Aug. 10, the closing levels of the S&P 500 never had a daily swing of more than 0.3 percent, which had never occurred since 1928, which is as far back as the data goes. Through today, the average daily trading range for 2017 has been 0.534%, the lowest ever. The S&P hasn’t experienced a 3% decline in 323 days the fourth longest stretch on record. The S&P hasn’t had a 5% correction since June 28, 2016 455 days ago. It is the longest period without a 5% decline since 1995, and the third longest since 1950. Since 1928 the S&P has averaged three 5% declines per year, so this streak is truly amazing.
Although the Major Trend Indicator is positive, the MTI has been posting lower highs since peaking in early March. A number of other technical indicators that I discuss regularly such as the percent of stocks above their 200 day average, the percent of stocks making a new 52 week high, as well as sentiment indicators like the Call/Put ratio and Investors Intelligence percent of bulls have all flashed warnings of a 5% correction in recent months.
Since late July, the odds of the S&P continuing the streak of no corrections of either 3% or 5% were quite low based on historical patterns and signals from these reliable technical indicators. Records are made to be broken, but I don’t manage risk or money expecting a new record to appear when the probability of one is extremely low.
The Tactical U.S. Sector Rotation Model Portfolio has been 100% in cash since July 24 based on the probability of a 5% correction. In my judgment, upside potential is limited relative to the current level of risk.
The Tactical U.S. Sector Rotation Model Portfolio has been 100% in cash since July 24 based on the probability of a 5% correction. In my judgment, upside potential is limited relative to the current level of risk.
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.
