Written by Jim Welsh
Macro Tides Weekly Technical Review 04 September 2018
Correction Could be 3% to 5%
The NYSE composite is the broadest average, and although it isn’t close to a new high, it did breakout above resistance on August 27 that had contained it since February 27 (green trend line). As I noted last week, if the NYSE Composite reversed and closed below 13,000, it would be a short term negative. Today the NYSE is trading below 13,000.
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The percent of stocks above their 200 day average was 54% on Friday and well below the 68% in January. The NYSE is a better reflection of how the majority of U.S. stocks are performing and is not affected as much as the cap weighted S&P 500 or Nasdaq 100 are by the heavy duty weighting of FAAMNG.
Click on any chart below for large image.
The FAAMNG chart below is through August 17. These six stocks have a higher capitalization than the bottom 290 stocks in the S&P 500 and comprise 15.0% of the S&P 500. Through August 17, the FAAMNG stocks were up 28.4% compared to a gain of 5.42% for the S&P 500, and a loss of more than 8.0% for the All-World Index, after the six FAAMNG stocks were removed.
The spread between the FAAMNG stocks and the rest of the stocks around the world is remarkable. I don’t have the capacity to calculate a cap weighted performance figure since August 17. The price of all 6 stocks totaled $3,913.81 at the close of August 17 and was up to $4,141.69 on August 29, an increase of 5.8% when the S&P 500 set a record closing high. During the same period the S&P 500 rose 2.24% while the Equal Weight S&P 500 gained just 1.86%.
The Equal Weight S&P 500 affords each S&P stock a weighting of 0.2%, which means the 6 FAAMNG stocks represent just 1.2% of the Equal Weight S&P 500 compared to 15.0% in the cap weighted S&P 500. The outsized influence of the FAAMNG stocks has increased since August 17.
The S&P 500 is overbought based on its RSI. Since early June, the S&P 500 has experienced a pullback each time the RSI has approached 70 or modestly exceeded 70, as it did in late July and on August 29. As long as the S&P 500 holds above 2790, the short term trend is up. A close below 2790 would open the door for a decline to 2720 – 2750 which encompasses the low in the second half of June and the 200- day average (red line 2732).
The Russell 2000 tested 1708 three times (green horizontal trend line) before breaking out on August 21. Much like the NYSE Composite, it would be a short term negative if the Russell 2000 closed below 1708. A close below the rising black trend line (1692) would be more serious and suggest a decline to 1655 was likely.
At the new high last week, the Russell’s RSI failed to confirm the new price high and recorded a lower high and was below 70. Negative divergences when the RSI fails to reach 70 are more negative. In addition, it is possible to count a 5 wave rally from the low on April 2 as complete or nearly so. This suggests the risk of a modest correction to 1635 to 1655 is rising.
In addition, the relative strength of the Russell 2000 to the S&P 500 has begun to weaken and closed below the red short term moving average on July 30. When the black line is rising it indicates the Russell 2000 is performing better than the S&P 500, whether the averages are rising or falling. Despite the rally from mid August, the Russell 2000 has continued to underperform the S&P 500. This suggests the market is more susceptible to a correction or a period of congestion, as what occurred from March of 2017 into mid August 2017.
The six FAAMNG stocks represent 49.1% of the Nasdaq 100, so those stocks have almost as much of an impact as the other 94 stocks. Since late July Apple is up 15.7% while Amazon has gained 13.1%, which has enabled the Nasdaq 100 to overcome the weakness in Facebook and Google, and the volatility in Netflix. The strength in Apple and Amazon are masking the fracture that is developing within FAAMNG. If and when Apple and Amazon experience a bout of profit taking, the Nasdaq 100 won’t be saved by Facebook, Google, or Netflix.
In the early 1970’s the prominent investment theme was called the NiftyFifty, referring to the 50 stocks which were considered one decision stocks – the only decision being to buy. The Nifty-Fifty were pummeled in the 1973 -1974 bear market. Under the surface the Stellar Six are starting to lose some of their shine. A close below 181.0 (green trend line) on the QQQ’s could lead to a quick break to 172.00.
On August 8 the S&P 500 closed at 2858 and the VIX was 10.85. When the S&P 500 set a new record on August 29 when it closed at 2814, the VIX finished at 12.25 or 12.9% higher than on August 8.
Large Speculators (green line middle panel below) hold a bigger short position in the VIX than in early January, just prior to the volatility eruption in early February. Leveraged Funds (blue line bottom panel) have a short VIX position that is twice as large as it was in early January. These short positions are tinder for a brush fire if a trigger lights the match. The trigger appeared on February 2, when the employment report showed a much larger increase in Average Hourly Earnings and caused bond yields to surge.
A repeat may occur this Friday when the August employment is released and it could show that wage growth is picking up from the 2.7% rate in July. The short position in the VIX represents the potential for an increase in volatility. Sooner or later a trigger will appear, whether it comes from the employment report or something else. A close above 15.02 would raise the odds that a period of volatility was commencing.
The market is overly dependent on a small number of stocks that sport huge capitalizations which are extended and poised for at least a bout of profit taking. Not one of the 10 S&P 500 sectors has an RSI below 50 which means every sector has been exploited. This suggests there are no prime candidates for further rotation within the S&P 500, which has been the cornerstone of the market in 2018 since April 2.
Dollar
A pullback to 93.20 to 93.75 is likely in coming weeks. Given the positioning and sentiment this target may prove conservative.
Euro
A 38.2% retracement of the decline from the February high of 1.255 to the August low 1.130 targets an initial high near 1.179, which happens to be the Euro’s high on July 9. Last week I noted that this was probably a counter trend rally, so the Euro was likely to move higher in an up, down, up pattern. The initial up ended on August 28 at 1.1732 and the Euro has pulled back. Once this set back is complete the Euro should exceed last week’s high. A 50% long position was established in the Euro ETF FXE when it declined below $110.55. Sell half of the position at $112.85 and the other half at $113.95. Use a stop of $110.32 on the position.
Emerging Markets
On August 21 I recommended the Emerging Markets ETF (EEM), which closed at $42.93 after trading between $42.80 and $43.11 in the hours after I sent out the Special Update. In the wake of comments made by Fed Chairman Jerome Powell in his Jackson Hole speech on August 24, volatility picked up in a number of EM currencies on August 29. The renewed weakness in a number of EM currencies since Powell’s speech suggested the potential for an EM currency crisis was rising. On August 30 I recommended selling EEM since the risk of contagion was higher in coming weeks than it was on August 21. At the time of the August 30 email, EEM was trading at $43.14 and closed at $42.95. On September 4 EEM closed at $42.38.
Treasury Yields
As previously noted, the 10-year Treasury yield could test the March low of 2.715% and possibly the 2017 high of 2.63% in coming months.
On August 24 the 30-year Treasury yield fell to 2.963% just above the green trend line that is also the neckline of a potential Head and Shoulders formation. The 30-year Treasury may fall below the July 6 low of 2.925%. If it does, it would complete the potential Head and Shoulders top that has been forming since the February high at 3.221% and allow for a decline to 2.66%. (Head 3.24% – Neckline at 2.95% = 0.29% subtracted from the Neckline at 2.95%)
A 50% long position was established on September 4 when TLT traded below $120.30. Use a stop of $118.75. If the 30-year Treasury yield falls below the neckline of the Head and Shoulders pattern, TLT could rally to $127.30 – $128.15. If TLT’s range since early February (122.50 minus 116.85 = 5.65) is added to $122.50, the target is $128.15.
Gold – Major Bottom Forming
The positioning in Gold is extreme and sentiment is outright bearish. Looking out over the next 6 to 12 months and longer, Gold is likely forming a major bottom as this process extends in time. The only question is how much additional pain there will be in the short term. Gold could fall to $1123 which is the December 2016 low, although the odds of that are small given how constructive positioning and sentiment already are.
The key is Gold holding above $1173. The longer it holds the more likely a decline to $1123 will not occur. It would be a further sign that a bottom is in place if Gold climbs above last week’s high of $1214.10. Longer term, Gold is likely to trade above $1300 before the end of 2018 and above $1400 sometime in 2019.
I recommended buying the Gold ETF GLD in three steps and the average purchase price for the entire GLD position is $120.84. I will recommend adding to this position when the risk of a decline to $1123 is eliminated.
On August 16 the RSI for GDX fell to 14.2. Normally when something gets that oversold there is a retest of the initial low. Since it takes intense selling pressure to push the RSI to such a low level, the reasons for such selling pressure simply don’t evaporate over night. On September 4 GDX closed at a new low (red line GDX), but its RSI was much higher (green line on RSI). This is the first indication that a low may be forming. Another constructive sign would be an improvement in the relative strength of Gold stocks to Gold.
The relative strength continued to weaken as the Gold stocks bounced, so an improvement would represent a positive change. In all likelihood, the bottoming process will take more time and may require another bounce followed by another new low to set up a second positive RSI divergence.
A 50% position was recommended if GDX traded under $21.80 and a 100% position if GDX fell below $21.56. On July 17 GDX opened at $21.73 and opened at $21.50 on July 19, so the average cost is $21.62. I will recommend adding to GDX after the risk of a decline in Gold to $1123 is gone and the Gold stocks show an improvement in their relative strength.
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 which is still in effect.
Although the MTI remains well below its high from January, it rose to 3.26 today. Readings above 3.0 in a bull market suggest the risk of a meaningful correction greater than 7% are low.
Past performance may not be indicative of future results.
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.
