Written by Jim Welsh
Macro Tides Weekly Technical Review 02 April 2018
Tech Stocks Drag the Stock Market Lower
In the March 19 WTR I discussed a number of reasons why March 19 was a negative and decisive day for the stock market.
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One of the reasons was the Island Reversal that the Nasdaq 100 had created when it gapped lower on March 19 which was readily apparent on the chart:
“An Island Reversal can occur at a low or high and is created when a market average or a stock forms an island above or below recent trading with a gap on either side. On March 9 the Nasdaq 100 gapped higher and then traded the next 6 days in a tight range. Today (March 19) the Nasdaq 100 gapped lower leaving the 6 days of trading with no overlapping prices on either side of the gaps. Island reversals are unusual but typically show up at tops and bottoms that accompany an intermediate trend reversal. This increases the odds that the Nasdaq 100 made an important high last week and is likely to test or break below the February 9 low.”
Click on any chart below for large image.
Since March 19 the big cap tech stocks have led the market lower and are likely to continue to weigh on the market. At their peak on March 12, the Technology sector represented more than 25% of the S&P 500 and is over weighted in many institutional portfolios. The risk for the overall market is that the weighting of technology stocks in portfolios will be trimmed in coming months which will represent a headwind for the S&P 500 until institutions have rebalanced their portfolios.
The gap lower on March 19 also broke the rising red trend line connecting the February 9 and March 2 lows. The Nasdaq 100 also completed a 5 wave rally from its February 2016 low, which suggests that it is in the process of correcting the 3,178 point increase to its high in March 2018 (7186 – 4008 = 3178). If the Nasdaq 100 corrects 38.2% of the rally, it would fall to 5972 (green horizontal line). A 50% retracement of the rally from the February 2016 low would target 5600 (blue horizontal trend line).
From today’s close of 6388, the Nasdaq 100 could fall -6.50% to reach 5972 and drop -12.20% if it reached 5600. If the Nasdaq 100 loses another -6.50% or -12.2%, the S&P 500 would face a headwind of -1.5% to -3.0% from an additional decline in technology.
In addition to the FAANG stocks the semi-conductor stocks have also been real leaders. When the SemiConductor Index made a new high in early March I noted in the March 12 WTR that its RSI had recorded a lower high which was a cautionary signal:
“The Semi-Conductor Index (SOX) has recorded the second lower high in its RSI even though the price has broken out. A close below 1400 would negate the breakout and be bearish.”
In the march 19 WTR I noted that the Semi-conductor Index (SOX) had closed below 1400 and the February 9 and March 2 red trend line which were more reasons why March 19 was a decisive day. The SOX closed at 1277 today. A close below the important support at 1200 (black trend line) for the Semi-Conductor Index (SOX) would open the door for a quick drop to 1120 – 1140 and cause the Nasdaq 100 to fall potentially to the retracements of 5970 or 5600.
The decline from the January 26 high in the S&P 500 to the low on February 9 was clearly 5 waves which is labeled wave (A). This indicated that the decline was merely the first part of a larger corrective pattern. From its low of 1810 in February 2016 the S&P rallied 1063 points before topping on January 26 at 2873. If the S&P 500 corrects 38.2% of this advance, the S&P 500 would fall to 2470, while a 50% retracement would target 2340 for a low. The S&P 500 fell 340 points in wave (A). An equal decline for Wave (C) from the March 13 high at 2802 would bring the S&P down to 2462 which is close to the 38.2% retracement target of 2470.
Based on the projected retracement levels of 2470 and 2340, the S&P 500 has the potential of declining another 4.30% or 9.40% from today’s close of 2583. Longer term the expectation is that the S&P 500 will eventually fall to one of the retracement targets. How it gets there can be another matter.
If the S&P 500 makes a beeline to 2470 in the next week it will likely establish a decent multi-week trading low. There is the possibility that the S&P 500 may rally in the short term based on a number of technical indicators. The S&P 500 traded down to 2554 before closing at 2582 less than 7 points below its 200-day average.
At today’s low the S&P 500 tagged the black trend line connecting the February 2016 low and the early November 2016 low. This is an important trend line. A close below 2554 would likely lead to a quick drop to 2470. It is slightly more probable that a short term rally off the long term trend line beginning tomorrow 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.
On March 12, the Nasdaq 100 made a new all-time high but the S&P 500 and the DJIA failed to also make a new all-time high. This negative inter market divergence between the major averages was a warning sign of potential weakness. Today, the DJIA dropped to 23,344 below its low of 23,360 on February 9, but the S&P 500 was 22 points above its February 9 low of 2532. The Nasdaq 100, despite the weakness since March 13, only fell to 6,323 which is 2.6% above its February 9 low of 6164. This positive inter market divergence is supportive of a short term rally. The DJIA also managed to close above its 200-day average (24,424) after dipping to 23,344. In addition, when the S&P 500 closed at 2585 on March 23 its RSI was 28.6, but was 36.3 today, even though the S&P 500 closed at 2582. Although the difference in price is quite small the divergence in the RSI is fairly big.
The Call/Put ratio measures sentiment and is helpful at identifying short term lows, and if it gets low enough solid intermediate lows. It is now just above 1.0 which is where it was at the February 9 low.
However, it was below 0.90 just before the November 2016 election and subsequent multi-month rally and at the intermediate low February 2016. In other words, it’s low enough to support a short term rally but not low enough to support a sustainable rally. In addition, the market is not that oversold especially when compared to the February 9 low. The 21 day Advances minus Declines was a -546 at the early February low, but only -177 today. Short term this is a positive as long as the S&P 500 holds above its intra-day low at 2554.
If the S&P 500 does manage to rally to 2640 -2674, this indicator will become modestly over bought which will only set the market up for another decline.
Conclusion: The S&P 500 is likely to fall another 4% to 9% below today’s close of 2582 in the next few months irrespective of short term rallies.
Treasury Yields
In my February 26 Weekly Technical Review I refined the yield target for how far the 10-year Treasury yield might decline after peaking near 3.0%:
“The price pattern for the 10-year Treasury bond indicates that the high last week may have been wave 3 of the rise in yields since the low in early September. If this pattern is correct, wave 4 would allow the 10-year yield to fall below 2.80%, possibly as low as 2.74%.”
The 10-year Treasury fell to an intra-day low of 2.717% before closing at 2.732%. The decline in the 10-year Treasury yield was expected to be wave 4 of the pattern from the low of 2.034% early September. Once wave 4 is complete, the 10-year yield is expected to exceed its prior high of 2.943% on February 21.
Once wave 4 is over, the 30-year yield is expected to exceed its prior high of 3.221% on February 21.
After bottoming at 2.653% in early September the 30-year yield rose to 2.933% for wave 1. The 30-year yield fell to 2.956% today before closing at 2.970%. 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. This presents 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) using a stop at 2.930%.
The positioning in the bond futures suggested that bond yields were likely to fall after the 30-year reached 3.22% and the 10-year rose to 2.943% on February 21, which is why I recommended the purchase of the Treasury bond ETF TLT if it traded below $117.50. 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. The long Treasury bond ETF (TLT) has reached resistance which is expected to create a top.
Dollar
In coming months, the Dollar index has the potential to rise to 94.50 – 95.00. I would suggest establishing a partial position (up to 50%) in the Dollar ETF (UUP) now and add to the position if UUP trades below $23.15 in anticipation of a subsequent rally to $24.50 to $24.70 in coming months.
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
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 marches 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
My bias is that Gold is not likely to breakout to the upside. 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) improve modestly last week but has yet to signal that a sustainable period of relative strength has begun. 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 mardch 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 2554 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.
