Written by Jim Welsh
Indecision Reigns in Stocks, Bonds, Gold, and the Dollar
From Wikipedia:
In sociology and economics, the precariat (/prɪˈkɛəriət/) is a social class formed by people suffering from precarity, which is a condition of existence without predictability or security, affecting material or psychological welfare.
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After reviewing a number of indicators uniformly showing that the market was oversold last week, I was looking for a bout of weakness on Tuesday or Wednesday that would retest the low of 2710 on October 11:
“The short term pattern (30 minute) in the S&P 500 suggests that the S&P 500 will test or fall below 2710 on October 16 or 17 for wave 5 from the high at 2841. Once this 5th wave occurs, the S&P 500 may begin the rebound up to 2800 – 2825. Aggressive traders can buy the S&P 500 ETF (SPY) if the S&P 500 trades under 2713, using 2685 as an initial stop.”
After Adobe announced great earnings on October 15, the whole technology sector caught fire last Tuesday and the rest of the market followed. Rather than falling, the S&P 500 rallied to 2817 on Wednesday and right to the target range of 2800 – 2825. So the S&P got to the expected price target but just took a different route to get there.
The rally from the low at 2710 appears to be 3 waves suggesting it is a retracement of the 230 point decline from 2940 to 2710. From the high of 2817, the S&P 500 fell to a low on October 22 of 2750. The 67 point drop from the high last Wednesday is 62.6% of the 107 point rally from 2710 to 2817, and it is also clearly 3 waves.
This pattern (wave a up to 2817 from 2710, wave b down from 2817 to 2750) opens the door for a wave c rally that would lift the S&P 500 above 2817 and possibly as high as 2850. Even if the S&P 500 rallies up to 2850, it would not eliminate the odds of a retest of 2710.
Click on any chart below for large image.
As noted last week:
“The 21 day percent of net Advances minus Declines dropped to -19.7%, a relatively rare occurrence and well below the threshold of -15.0% (green horizontal line). This is only the fourth time this indicator has become so oversold since November 2014. In the three prior times, the S&P 500 enjoyed a decent counter trend rally (3 weeks, 2 weeks, 6 weeks), before falling again to test the initial low in September 2015, February 2016, and March 2018.”
The rally from 2710 to 2817 lasted only 5 trading days so it seems much too short to comprise the entire rebound when compared to the 3 prior oversold bounces. In September 2015 the 21 day percent of net Advances minus Declines rose to +5.1% (purple horizontal line) after getting oversold in August, and up to +2.6% on January 26, 2016. The initial wave a rally from the August 2015 low lifted the S&P 500 by 6.7% while the January 2016 wave a gained 5.8%. The initial wave a rally in February 2018 was 10.1%.
The rally from the October 11 low lifted the S&P 500 by less than 4.0%. So far the rebound has been weak but another rally that lifts the 21 day percent of net Advances minus Declines to a bit above 0% can’t be ruled out.
The big move up on October 16 was likely aided by options expiration on October 19. The S&P 500 was comfortably under 2800 on October 11 and 12, so anyone who had sold call options was in good shape since the odds favored the S&P 500 holding below 2800 and those options expiring worthless. That changed on October 16 when the S&P 500 soared from 2751 on October 15 to 2817 on October 17.
My guess is that short covering played a role in the huge move up on October 17. The fact that the market gave up those gains so quickly reinforces that likelihood. Since October 17 early morning rallies have quickly melted which indicates that there is selling into the rallies, rather than buying the dips, which has been the pattern for years. That’s a change worth noting.
After not confirming the new price high in the S&P 500 on September 21, the Advance – Decline Line has continued to act poorly. It is close to breaking below its low on October 11, even though the S&P 500 has not yet tested the closing low of 2728. The S&P 500 is trying to hold above the black trend line connecting the February 2016 low, the pre-election low in early November 2016, and the low in March 2018. Given the way the market has been trading, the S&P 500 may quickly drop below 2710 before a rally takes hold.
The Trading Index (TRIN, ARMS Index) measures the amount of buying and selling pressure (volume) relative to market breadth (advances and declines). Near market highs, or the onset of a consolidation after a large advance, the TRIN will fall well below 1.0, as it did in January 2018 and recently.
When selling pressure becomes overloaded, the TRIN rises above 1.0. At a minimum, the 10-day average (black line) will rise above 1.3, and at intermediate bottoms the 21 day average (red line) will also get above 1.30 (above chart). The Trading Index is not perfect but does a better job of identifying lows in the market than highs. In August-September 2015, January 2016, April 2017, and March 2018, both the 10 day and 21 day moving average of TRIN rose above 1.30.
As of Monday October 22, the 10 day average was 1.03 and the 21 day average was 0.99, so neither is close to signaling that a trading low is in place. The TRIN indicator increases the likelihood that the S&P 500 at least tests the October 11 low and potentially tests the green trend line near 2690 in coming weeks.
By all accounts, earnings have been quite good but that hasn’t helped the stocks of companies that have reported so far. The average stock has declined by –0.71% on earnings day. This is the first time in 5 quarters stocks have responded negatively. This suggests institutional investors are selling into the good news.
In the October 1 WTR I discussed the high number of issues making a new 52 week low:
“The last time the percent of stocks making a new 52 week high was below 0% with the S&P 500 within 2.5% of its high was in mid June 2015 (red arrow). The fact that this is occurring so close to the all time high is extraordinary.”
On October 3, the S&P traded up to 2939.86 just barely below the all time high of 2940.91 on September 21, there were 262 issues that made a new 52 week low. The 262 new lows represented 8.7% of all the issues traded on the NYSE. This phenomenon is more rare than I realized. Since 1970, there have only been 3 other instances where the S&P 500 was near an all time high (less than –0.50% from the high) and yet there were more than 5% of NYSE issues making a new 52 week low. After the April 1970 and December 1999 instances, the S&P entered a bear market. After its high in July 2015, the S&P 500 fell for 7 months and lost -14.6%.
The level of risk has increased and the market is coming to grips that the Fed is not likely to come to the rescue just because the stock market tumbles. As I said last week, Chairman Powell is no Janet Yellen. The S&P 500 may test 2710 or briefly dip under 2700 in the next two days. The Call/Put Ratio fell to 1.00 on Friday and likely dipped below the green line today. I expect the C/P Ratio will fall further under 1.0 before a trading low occurs, just as it did in August 2017 and January 2016. If the S&P declines in the next few days and tests 2710 or dips under 2700, the C/P Ratio will become more supportive of a rally back to near 2817.
Aggressive traders can buy the S&P 500 ETF (SPY) if the S&P 500 trades under 2713, using 2680 intra-day as an initial stop. Sell 33% if the S&P trades up to 2770, 33% at 2790, and the final third at 2812. If the S&P does trigger the trade use a trailing 1.1% trailing stop until the S&P 500 achieves the prices targets. There is a small chance the S&P 500 simply cracks 2700 and falls to 2600 quickly. If this occurs the odds of a new high would be greatly reduced. If the S&P 500 holds near 2700, rallies to 2825 – 2850, and then retests 2700, the odds of a new high by year end or early in 2019 will remain alive. That’s why buying a retest of 2700 now makes sense with a tight stop.
Dollar
From its February low, the Dollar Index rallied in a clear 5 wave pattern. This suggests that irrespective of any near term squiggles, the Dollar is likely to exceed the August 15 high of 96.98 in coming months. On October 9 the Dollar traded up to 96.15. The Dollar is likely to exceed the 96.15 high soon, but not break out above 96.98. Sentiment and positioning still show there are too many bulls.
The wild card is Italy. If the Italian 10-yield soars on a downgrade of Italian debt or if Italy is put on a negative watch by Moodys or S&P, the Euro could sell off sharply. That would boost the Dollar. If the Dollar tops out without trading above 96.98 and then pulls back to 94.00 as I expect, Gold should be a beneficiary as well as Emerging Markets in the short term.
Emerging Markets
If the S&P 500 manages to bounce to 2817 or higher, the Emerging Markets ETF EEM has the potential to rally up to $41.50 – $42.00 and near the red horizontal line. If the S&P 500 subsequently retests the October 11 low in a few weeks, EEM may provide a better buying opportunity for a trade as it retests its low under $39.00. China is becoming more aggressive in its attempt to boost growth after GDP was reported to have grown 6.5% in the third quarter.
Gold
The outlook would become far more positive if Gold were able to close above $1236 and then hold above $1190 on any pullback. This would lower the risk of a retest of the August low of $1161 significantly. Any close below $1180 would promptly lead to a test of $1161 and maintain the potential of a decline to near $1120. Positioning in Gold futures suggests that a major rally is coming to above $1300 and possibly above $1400 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. If Gold rallied above $1230, GLD could trade above $116.50:
“Sell 33% of the position, if GLD trades above $116.50. GLD could subsequently fall below $111.00 in wave 5 and possibly as low at $107.00 which is why selling a portion at $116.50 makes sense. It may be easier to add to this position if wave 5 does develop.”
On October 15, GLD rallied up to $116.53, which might have completed wave 4 from the January peak. If GLD trades up to near the blue trend line sell 16% of GLD at $117.70. Given how constructive the positioning is in Gold futures, Gold may just blow through $1240, so selling is a risk. But the pattern from the January high is still intact as is the risk of a meaningful retracement.
Gold Stocks
The Gold stock ETF GDX rallied from $12.40 in January 2016 to $31.79 in August 2016. A 78.6% retracement of this rally could bring GDX down to $16.55. The relative strength of the Gold stocks has improved, but this extreme downside target can’t be dismissed. The average cost for the recommended position in GDX is $21.62.
Two weeks ago I recommended selling 33% of the position if GDX traded above $19.00. GDX traded above $19.00 on September 20 and September 24. GDX may try to push up toward the red horizontal trend line just over $21.00. Sell 16% of GDX if it trades up to $20.80. If Gold pushes up above $1240 and then corrects down to $1190, GDX may pullback to under $19.30 and test the high of $19.23 on October 3. If this pattern unfolds it will allows us the opportunity to add to GDX.
Treasury Yields
If the S&P 500 rallies back up to 2817 or higher and Treasury yields rise, a buying opportunity may develop, if the S&P 500 looks like it will subsequently retest 2700 in a few weeks. Positioning suggests the potential for yields to come down, but that is probably dependent on a decline in stocks or weaker economic data.
TLT has the potential to rally up to $116.50 – $117.00 (red trend line), if the S&P 500 tests 2710.
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.
Past performance may not be indicative of future results.
The MTI has weakened significantly since early October. If the S&P 500 does fall to 2600 in the next few weeks, the odds of a new high will decrease. If that develops the subsequent rally is likely to be a ‘failing rally’ that registers a lower high in the S&P 500 and in the MTI. It would also increase the risk of a bear market. Conversely, if the S&P 500 continues to hold above 2690 in coming weeks, the odds favor a rally to a new all time high. Basically, we’re at the point where the market will tell us what comes next.
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.
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