Written by Jim Welsh
Macro Tides Weekly Technical Review 29 October 2018
Last week’s WTR (Investors Join The Precariat) was subtitled ‘Indecision Reigns in Stocks, Bonds, Gold, and the Dollar’. There hasn’t been much movement in Treasury bonds, Gold, or the Dollar but Stocks have decisively broken down after many weeks of technical deterioration.
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The stock market has attempted to rally either at the open as it did today, or after a down opening. None of these rallies has been able to last more than a few hours. As I noted last week, this is a big change from how the market has traded for years:
“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.”
If there is one refrain that has been repeated ad nauseam in recent weeks is that the economy is fine and corporate earnings will keep rising. The only problem with this view is that the market doesn’t care. As noted last week:
“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.”
Click on any chart or graphic for large image.
In the October 1 WTR I discussed the high number of issues making a new 52 week low:
“The last time the net 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 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 in late September.
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. Here’s the scary part. As of Monday October 29, the 10 day average was 1.10 and the 21 day average was 1.05, so neither is close to signaling that a trading low is in place. Despite all the selling and carnage, the TRIN suggests there is no real fear yet.
Instead, institutional investors are buying Utilities, Staples, and Health Care. At a real low every sector is sold.
For years retail investors were reluctant to ‘Buy the Dip’. Not anymore. As the market has stair stepped lower in recent weeks, retail investors are only now buying the dip. This suggests there is a high level of complacency, rather than confidence, that will only be extinguished by a painful decline. How far could the S&P 500 fall?
From the low of 1810 in February 2016, the S&P 500 rallied 1130 points to 2940 in September. A 38.2% retracement of the rally would bring the S&P 500 down to 2510, while a 50% retracement would bring the S&P down to 2375. The low in February 2018 was 2532 so a bounce is likely to develop if the S&P 500 trades down to 2500 – 2550. However, given the way the market has been trading the risk of a waterfall decline must be respected which could bring the S&P 500 down to 2375 before a rally is sustainable. The trend line connecting the March 2009 low with the October 2011 low and February 2016 low comes in around 2250. This is a treacherous environment and until the selling into rallies abates and the S&P 500 retests the initial low, the downside must be respected.
As noted last week:
“There is a small chance the S&P 500 simply cracks 2700 and falls to 2600 quickly.”
That’s why I structured the recommendation to buy the S&P 500 with a tight stop and a trailing stop, just in case the S&P 500 suffered another failing rally.
“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 1.1% trailing stop until the S&P 500 achieves the prices targets.”
After the S&P 500 traded down to 2713 on October 23, it rallied up to 2754. The 1.1% trailing stop was triggered later in the day when the S&P 500 fell to 2723.
The following are excerpts from a number of Weekly Technical Reviews since September 4, 2018:
September 4 WTR – The six FAAMNG 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. 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. 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.
September 10 WTR – A Money Flow analysis by Bank of America Merrill Lynch illustrates just how crowded and extreme the Technology trade has become since October last year compared to the prior 8 years. The recent peak in money flow into Technology is more than 4 times as large as the highs in 2011 and 2014. Flows have begun to reverse and the recent price weakness is likely to spur more selling in the short term.
On Friday (October 7) the VIX traded as high as 15.63 but closed at 14.88 after higher wages in the employment report initially spooked the market. The next time the VIX trades above 15.00 it will close above 15.02 and signal a wave of volatility has begun that could bring the S&P 500 down to 2730 or lower. (The VIX closed above 15.02 on Tuesday October 11.)
In last week’s Investors Intelligence survey the percent of Bulls reached 60.0% and exceeded the percent of Bears by more than 40%. In 2017 this didn’t matter much since a reason to sell never materialized. That is not the case now as there are a number of reasons why selling pressure might pick up before Halloween.
The economy is in good shape so the risk of a classic bear market is low. That doesn’t mean the market is immune to a quick painful correction of 15% or more. This occurred even though the economy didn’t get close to a recession in 1987, 1998, 2011, or 2015-2016. The stock market is expensive and the Goldman Sachs Bull/Bear Market Risk Indicator is higher now than it was in 2007 or 2000.
Triggers That Could Close the Gap between U.S. Equities and the Rest of the World
The U.S. stock market has performed well based on the better economic growth compared to the rest of the world and the expectation the growth will continue at a healthy pace, and a surge in stock buybacks. If the US does slow, will the US stock market continue to positively diverge from the majority of equity markets around the world or close the gap by falling?
The performance spread between the S&P 500 and Emerging Markets has never been wider. Emerging Market equities as measured by the EM ETF EEM are down 20% from their January peak while the S&P 500 has managed to squeak out a new all-time high. Numerous EM currencies have experienced significant declines since the beginning of 2018, as U.S. rates rose and the Dollar strengthened. Fed Chair Powell’s Jackson Hole speech on August 24 reinforced the expectation the Fed will continue to increase rates.
Emerging market currencies and equity markets have come under renewed selling pressure after Powell’s speech. Currency weakness has set off a negative domino effect within a growing number of EM countries.
Italy will present its budget to the European Union on October 15 and it will exceed the EU’s 3.0% of GDP deficit rule by a wide margin. In mid May a draft by Italy’s coalition government was leaked that outlined plans to ask the EU to revise Italy’s EU budget contributions and debt relief of almost $300 billion from the European Central Bank. After the ‘draft’ was leaked, the spread between German 10-year bund yields and the Italian 10- year government bond yield spiked from 1.4% to almost 3.0%.
There is a high level of complacency toward the trade negotiations with China, even though there is no indication that China will acquiesce to any of the American demands. Whether the U.S. stock market will continue to ignore this issue is doubtful, if it begins to spill over into the emerging market disequilibrium.
September 24 WTR – The market continues to lose internal strength as measured by a number of momentum indicators. This suggests the market is now vulnerable to a sharp sell off if any reason to sell materializes.
October 1 WTR – The fragmentation discussed the last two weeks has continued. Although the S&P 500 exceeded it August 29 high, the Russell 2000, Nasdaq Composite, and NYSE Composite remain below their prior highs. The Nasdaq 100 managed to exceed its August 30 high by $0.01 on October 1 before closing .72% from the intra-day high. The longer these divergences persist, the more meaningful they become. The Russell 2000 has been especially weak and recorded a daily reversal on October 1. In June 2015 there were signs that the market’s internal strength was weakening. The percent of stocks making a new 52 week high fell below 0% and the percent of stocks above their 200 day average slipped below 50% (red arrow chart of NYSE below [not included here]). When China devalued its currency by 3% in mid August, it caused selling pressure to spike. Since the market’s internal strength was weak, the S&P 500 plunged 10% in just 4 trading days. The percent of bulls in the Investors Intelligence survey last week rose to 60.6% an unusually high level. This indicates that bullish sentiment is high even though the internal health of the market has been weakening for weeks. Should a decent reason to sell materialize, a quick sharp decline is possible, especially since there is a large short position in the VIX. Until a reason to sell shows up, the 6 market can continue to do what it’s been doing. In the past 5 trading days the S&P 500 has closed in the lower half of its daily trading range, which is another sign of distribution.
October 8 WTR – Stocks Find Support, Bounce Likely, But More Weakness Coming The fragmentation between major market averages I’ve discussed over the last three weeks reached a new extreme last week. On October 2 the DJIA pushed to a new all time high (green arrow [chart not included here]). As the DJIA was achieving this milestone, the Russell 2000 was falling to a 2 month low. This extreme fragmentation between the DJIA and Russell is rare. According to Jason Goepfert at SentimenTrader.com, this has never happened before. The only day that comes close is April 3, 2000, when the DJIA climbed to a twomonth high, while the Russell 2000 index dropped to a new two-month low. Although the DJIA closed at a new high on October 2, there were more than three times as many securities hitting a new 52-week low as new 52-week highs. As noted on October 1, “The S&P 500 came within 0.2% of a new all-time high on October 1, but the percent of stocks making a new 52 week high during the past 21 days is comfortably below 0%. The fact that this is occurring so close to the all time high is extraordinary.” According to SentimenTrader.com, the only other time the DJIA closed at a new all time high and there were 3 times as many new lows as new highs was on December 28, 1999. The stock market was in the process of forming a significant top between December 28, 1999 and April 13, 2000, which was followed by a bear market decline of more than 30% in the following 30 months. This is not to imply that a major bear market decline is lurking right around the corner. But it does highlight the degree of underlying weakness that is lurking below the headlines and tweets of new all time highs in the DJIA that investors were greeted with last week.
Institutional investors are not going to be net sellers of stock, if they believe the economy and earnings are going to improve in coming quarters which has certainly been the mindset. However, this complacency may be challenged when Q3 earnings are reported and companies offer guidance for the for the next 6 months that may not be as rosy as expected. In recent weeks the number of companies providing negative guidance has outpaced those providing a positive outlook by the widest margin since 2010. There are reasons to believe this trend may continue and may accelerate since more companies are facing more headwinds. Multi-national firms, which represent 43% of S&P 500 revenues, must deal with Dollar strength especially in developing countries. Since February the Dollar Index is up 6.7%, but Emerging Market currencies are down 12%. A stronger Dollar makes U.S. goods more expensive, so revenue growth may come in a bit softer than projected. In addition, the global economy has been slowing so the overall sales environment has become tougher since the beginning of 2018. The impact from tariffs has yet to fully felt and will increase significantly in the first half of 2019 if 25% tariffs on $500 billion of Chinese imports is implemented as currently planned. While tariffs will prove a headwind for GDP, they will have a greater deleterious impact on profits. This is another reason why 2019 may prove difficult for stocks.
Oil prices rose materially during Q3 rising from $65 a barrel to over $72 a barrel, which means every company that uses oil has seen their costs rise. Short term and long term interest rates have increased a lot since Q3 in 2017, so interest expense is higher. Although wages haven’t gone up as much as the Fed has expected, the cost of labor is up and represents another squeeze on profit margins. Many companies are likely to cite one or more of these reasons as they provide guidance for Q4 and beyond, as justification for lower earnings estimates. The Fed and Chairman Powell have made it pretty clear that they are going to raise rates in December and lower earnings guidance is not likely to dissuade them from following through.
October 15 WTR – Although the sharp selloff last week shook up investors, the Call/Put Ratio suggests sentiment has not become negative enough to support and sustain an intermediate rally. The Call/Put Ratio compares the number of calls purchased each day to the number of puts traded. When investors are bullish, they buy far more calls than puts and the C/P Ratio climbs well above 1.0. After discussing the fragmentation between the major market averages in the September 24 WTR, I noted that despite technical negatives investors were more bullish than in June, which was not a healthy sign:
“The Call/Put ratio indicates that investors were more bullish last week than in June, even though a number of major market averages failed to confirm the new highs in the S&P 500 and momentum and measures of the market’s internal strength were weaker.”
The C/P ratio was one piece of technical evidence suggesting that the market was becoming vulnerable to a decline.
When selling pressure becomes overloaded, the TRIN rises above 1.0. At a minimum, the 10-day average will rise above 1.3, and at intermediate bottoms the 21 day average will also get above 1.30. The Trading Index is not perfect but does a better job of identifying lows in the market than highs. In AugustSeptember 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 Friday October 12, both were below 1.0, which is hardly an endorsement that a trading low was formed last week. The TRIN indicator increases the likelihood that the S&P 500 will test lasts weeks low in coming weeks.
Dollar
The Dollar is likely to exceed the August 15 high of 96.98 in coming months. Last week I noted:
“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.”
If the S&P 500 continues to unravel, the Dollar may weaken as the outlook for GDP growth softens.
Emerging Markets
As expected the Emerging Markets ETF EEM is falling as the S&P 500 declines. EEM closed below $38.00 and could test the lows under $35.00 reached in late 2016.In the October Monthly Macro Tides I noted that Emerging Markets could become a value trap:
“On a valuation basis Emerging Markets looks cheap especially when compared to the U.S. The forward Price/Earnings ratio for the U.S. is 17.0 and only 10.9 for EM, which implies that EM is selling at a 35% discount to the U.S. The 29% discount to Developed Market equities in general is not much more than the historical 22% discount. EM growth is not likely to improve in 2019 and the Federal Reserve is planning on increasing the federal funds rate once more in 2018 and 3 times in 2019. There is a definite risk that EM could be a value trap in coming months, even though it is cheaper than an expensive U.S. market.”
Gold
It is encouraging that Gold continues to hold above $1214. This keeps the potential of a rally to $1250 – $1265 alive. 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.
Gold Stocks
The Gold stock ETF GDX was smashed on October 25 after Gold Corp and Newmont Mining report lousy earnings. It is encouraging that there was no follow through after the 1 day selloff. If Gold rallies above $1250, GDX could test $21.00.
Treasury Yields
Despite the decline in stocks Treasury yields did not fall on October 29. This is another indication that the level of fear in the stock market is not high enough to cause a flight to quality. If the S&P 500 closes under the February intra-day low of 2532, the 10-year yield could dip under 3.05%.
If the S&P 500 closes under the February intra-day low of 2532, the 30-year Treasury yield could dip under 3.26%.
TLT has the potential to rally up to $116.50 – $117.00 (red trend line).
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, the odds of a new high will decrease. The subsequent rally is likely to be a ‘failing rally’ that registers a lower high in the S&P 500 and in the MTI. This is what occurred after the S&P 500 rallied in October and November 2015.
The current decline would be labeled wave A, and a subsequent rally would be wave B. It would be expected to retrace 50% to 61.8% of wave A’s decline and provide the opportunity to sell at a higher price than now. It would also create the opportunity to establish a short position prior to wave C, which would be expected to record a lower low than reached during wave A.
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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