Written by Jim Welsh
Macro Tides Weekly Technical Review 11 November 2019
Sentiment Warns of an Impending Correction in the S&P 500
Fear is a stronger emotion than greed which is why the majority of market lows are compressed in time as investors are spooked by negative news and falling stock prices. Market tops normally take more time than a bottom to form as a rising trend and supportive economic news converts negative or neutral investors into becoming bullish over time.
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The dynamics of how a top or bottom is formed is why sentiment is more of a coincident indicator of a low in stock prices, while sentiment is often early in signaling a high. Momentum indicators can help in identifying when the S&P 500 is running out of gas and on the cusp of a correction.
Longer term measures of sentiment, like the Weekly Investors Intelligence (II) survey, can be useful in trying to determine whether sentiment is indicating a short-term high, or a high that could last for months if forming. When the percent of Bulls nears or exceeds the percent of Bears by 40%, the potential for a more important high is greater. In last week’s II survey there were 39.0% more Bulls than Bears, which is higher than in late September and late April. Although last week’s number is less than the spread reached in July and in September 2018, it’s fair to say it is high enough to say this measure of sentiment is in the zip code of a high.
Click on any chart below for a large image.
A number of short-term sentiment measures last week also reached levels that are consistent with the notion that the S&P 500 is very near at least a short term high. The 10-day Call / Put Ratio jumped to its highest level since September 2018. On November 4 the S&P 500 traded up to 3085, and after 5 full days of trading, closed today at 3093 on Friday November 8. The S&P 500 only gained a whopping 8 points from Monday to Friday and yet investors got pretty excited about what amounts to a small move. This indicates that bullishness is entrenched and another sign of an approaching high.
The CNN Fear & Greed Index rose to 90 as of November 6 after soaring from Extreme Fear (29) one month ago, and is higher than at any time since late 2017.
Bullish investors expect the market to trend high which is why they have been buying a lot of Call options and why they have been chasing the market higher, as the Fear & Greed Index suggests. Investors also expect volatility to trend down as the S&P 500 trends higher. To profit from this expectation investors are short volatility through Volatility futures. Last week the number of VIX contracts sold short reached an all time high.
Every correction since September 2018 has been preceded by lopsided positioning in the VIX futures. If the S&P 500 does begin to correct in coming weeks the VIX Index will rise and pressure those short the VIX to cover in order to limit their losses. In February 2018, December 2018, and May 2019, the VIX spiked higher as the S&P 500 fell, which increased selling pressure and lower prices.
Each of the declines during the past year developed after the VIX Index broke out above the declining trend line which was formed as volatility fell and the S&P 500 trend higher (black trend lines). The VIX is close to breaking out (red down trend line), which could indicate that a decline is about to commence soon.
The National Association of Active Investment Managers Index (NAAIM) measures the level of exposure to the stock market from Advisors who utilize tactical trading. As of November 8 their exposure is nearing the highest levels of the past year.
These tactical investors have already moved from the sidelines into the market, so the potential demand from this cohort is already spent.
The NYSE Advance – Decline Line recorded a new high on November 4 which is an intermediate positive. Normally, it is more bearish if the S&P 500 is making a new high while the A/D Line is negatively diverging and failing to make a new high. However, there is a historically high level of concentration within the S&P 500. The 10 largest stocks based on capitalization comprise almost 24% of the S&P 500, which is the third highest in the past 30 years.
When so much ‘strength’ is so concentrated in just a few stocks, the overall market is more vulnerable should those 10 stocks begin to weaken. Apple is up more than 60% in 2019, and may be worth every penny of its valuation, but sooner or later it is going to give back some of its huge gains. Apple and the other 9 horses could be hit hard prior to the 2020 election if investors think a Democrat will be elected and promptly increase capital gains taxes. Although less likely, some investors may decide to book some profits prior to the end of 2019, just in case cap gains taxes are raised and rolled back to January 1, 2020.
Some Momentum indicators are weakening. Despite the new high in the S&P 500 the percent of stocks making a new 52 week high is lower than it was in July when the S&P 500 was 2.3% lower.
Although the A/D line has recently made a new high, the 21 day average of Advances minus Declines has been faltering. This thinning of participation (declining red trend line) has preceded a top in the S&P 500 prior to every correction since September 2018, and is doing so again.
Investors are expecting and positioned for a year-end rally. As noted in recent weeks, there is absolutely no chatter about the November 13 trade deadline between the U.S. and the European Union. It seems unlikely that President Trump will offer another 6 month extension to the EU unless there has been meaningful progress. The absence of any ‘leaks’ suggests there are no leaks to be had. It is certainly possible that President Trump may not levy the full 25% tariff on the $60 billion of autos imported into the U.S. from the EU, but might opt to place a 10% tariff instead.
Investors are also assuming that some sort of trade deal will be reached with China, which may represent some level of wishful thinking. Clearly, the market would be vulnerable in coming weeks to any negative trade news.
A quick decline of -5% to -7% to 2850 or lower is possible based on the high level of bullish sentiment and the loss of momentum. A 20% short position is recommended if the S&P 500 trades above 3097 through the purchase of the 1 to 1 short S&P 500 ETF (SH). A stop of 1.5% should be used.
If a decline materializes in coming weeks, the subsequent rally will provide valuable insight as to what to expect in the first half of 2020. If the Treasury bond analysis is correct, the S&P 500 could experience a large decline in the first half of 2020.
Treasury Bonds
As discussed in recent weeks, the ongoing assumption has been that the decline in global bond yields and Treasury yields remains intact. If this outlook is correct, Treasury yields will drop and make another lower low in coming months. Within that context the low yield of 1.429% in the 10-year Treasury bond was wave 3 down from the high of 3.248% last November. The rebound since the low of 1.429% to 1.903% would be wave (a) of wave 4, since the rebound in yields last week overlapped the low of 1.635%. The overlap suggests the recent 3 wave drop in yields (a, b, c in blue) was wave (b) of wave 4. This suggests that the 10-year year could rise above 1.903% to complete wave (c) of wave 4. If wave (c) of 4 is equal to wave (a) (1.903-1.429 = 0.474), the 10-year Treasury yield could reach 1.98%.
On November 7 the 10-year Treasury yield reached 1.971% so it has achieved the minimum expectation by rising above 1.903%. My guess is that Treasury yields will exceed the highs of November 7 before a trading low is established. If this pattern analysis is correct the 10-year yield will test or drop below 1.429% in the first half of 2020.
As noted in the October 28 WTR:
“The pattern in the 30-year Treasury bond yield is the same as the 10- year. If wave (c) is equal is wave (a), the 30-year Treasury yield could push up to 2.48%, and is poised to move above 2.378% soon.”
On November 7 the 30-year Treasury yield rose to 2.443%. My guess is that Treasury yields will exceed the highs of November 7 before a trading low is established. If this pattern analysis is correct the 30-year yield will test or drop below 1.905% in the first half of 2020 to complete wave 5 from the high last November.
Treasury Bond ETF (TLT)
As discussed in the October 28 WTR:
“If wave (c) is equal is wave (a), TLT could drop to $133.90 as it completes wave 4, which may provide a good trading opportunity. If the pattern analysis is correct, TLT would then rally above $148.67 as the 30-year Treasury yield drops below 1.905% in coming months.”
A 50% trading position in TLT is recommended if TLT trades under $134.00 using $131.40 as a stop. This trade is risking less than 2% to potentially make 10.8% or more.
Dollar
The Dollar is expected to fall to 96.00 or lower in coming weeks.
Gold
As noted last week, a close below $1480 would likely open the door for a decline to below $1456. On November 11 Gold fell below $1449. Although Gold may briefly bounce, sooner or later Gold is expected to drop under $1420, where a short term trading low may set up. Gold dropped $100 from $1556 to $1456 and then bounced to $1516. An equal decline would target $1416 to potentially complete an a-bc correction from $1556, and allow Gold to subsequently rally back to $1500 – $1520.
Gold Stocks
GDX has bent but has not broken after violating the important support at $26.50. It has traded down to just above $26.00 on a number of days and continues to hold up better than Gold. If Gold does spike down to $1420 in coming weeks, GDX may provide a trading opportunity especially if its RSI falls below 35 and ideally 30. GDX has been expected to decline below $25.50 as Gold drops below $1420, which should be enough to lower its RSI into an oversold condition.
Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking
The MTI generated a Bear Market Rally (BMR) buy signal on January 16, 2019 (green arrow) and climbed above the green horizontal trend line on February 26 confirming the uptrend. The progressive weakening in the technical structure of the market since late April led me to reduce exposure.
When the S&P 500 was trading at 2877 at 7am on May 16 I lowered the exposure in the Tactical U.S. Sector Rotation Model Portfolio from 100% to 50%. I lowered exposure to 25% in the Tactical U.S. Sector Rotation program on June 11 after the S&P 500 gapped up to 2903 at the open. I lowered exposure to 5% from 25% at the close on Wednesday when the S&P 500 was 2913. I sold the 5% position in Technology ETF (XLK) shortly after the opening on July 1.
I established a 25% short position in the S&P 500 through the purchase of the 1 to 1 inverse ETF SH on July 23, when the S&P 500 traded above 2995 (SH $26.09). The short position was increased to 40% on August 8 when the S&P 500 was trading at 2930 (SH $26.69). The short position was reduced to 20% on August 28 when the S&P 500 was trading at 2882 and SH was sold at $27.09. The remainder of SH was sold on September 25 at $26.03.
When the S&P 500 traded up to 3040 on October 28 I purchased a 20% position in SH for my managed accounts at $25.59. SH is the 1 to 1 short S&P 500 ETF that gains in value when the S&P 500 declines. My expectation is the S&P 500 has the potential to drop to 2830 in coming weeks.
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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