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Positive divergence a plus, yet much damage has been done

October 25, 2018
Mark Newton CMT, Newton Advisors, LLC- Contact: info@newtonadvisor.com

SPX Cash index
SUPPORT-  2640, 2623-5, 2615, 2589
RESISTANCE- 2710-8, 2744


LINK TO TECHNICAL WEBINAR from last Thursday 10/18: https://www.youtube.com/watch?v=BJeYb8vRVAI&feature=youtu.be

SPX - (3-5 Days)- Expecting stabilization,Trend reversal and bounce which should begin between today and late Friday, but lots of damage has been done, and necessary to Rally ASAP by Friday into November to avoid further damage.  Area at 2623-30 should help to stabilize prices.  Below that there is not much until 2521-50.  On the upside, getting above 2710 is VERY important for Bulls.. sooner than later. 

EuroSTOXX 50- Bearish- Near-term weakness limited to near 3100 nearterm, where stabilization should occur.   this marks a 6 year minior bull uptrend and is strong support, so the next 1-2 weeks likely coincide with this trying to bottom.   

HSCEI- Neutral -HSCEI still holding up much better lately than US or Europe.  Prices still largely unchanged from the last few weeks -Shorts aren't as great of a risk/reward here.  Dips should be bought at 9970-10000.  Above 10500 is bullish 


Trading Longs: CME, WMT, TBT, MRK, VZ, MCD,  D, FE,  DIS, ZION, I, DISCA, WMT, CASY,  PFE, HSY

Trading Shorts:  GCI, VGK, FEZ, RHT, AMBA, KMB, JEF,AMP,  PH, WYNN, SGMS, LVS, MNK, M, JWN, R, VMC

 

US Equities are likely to begin a process of stabilization, and reverse back higher in the short run, (3-5 days)  as prices have successfully retested mid-October lows, and the retest as discussed in recent days, has been happening on less negative breadth, and fewer stocks hitting new low territory.  This is often the case on retests, where the percentage of stocks trading above their 10 and 50-day moving averages holds at much higher levels on the retest.  Additionally, we see that yesterday's -3.5/1 breadth was far better than that seen during the week of 10/10-11 decline when -8/1 was registered.  Meanwhile, we seem to be finally starting to register some signs of capitulatory volume as TRIN hit 1.87, the highest we've seen since late May.   As discussed prior, it's typically a very good sign during a violent decline when an abnormally large amount of volume occurs on the downside vs Upside.  it happened in early February, as well as early April, when TRIN readings hit 2.5 and above and even registered readings north of 3.   Thus, on a 3/1 negative breadth day  (3 times as many stocks declining as advancing, the volume into down stocks registers a 9/1 ratio, or nearly all the volume on the downside)  In recent years, this has been a key part of the puzzle towards identifying market lows, particularly when the Equity Put/call spikes and we start to witness VIX backwardation.  


In this case, the trend is most definitely down(bearish) in the near-term.    However, the Equity put/call still isn't really as high as necessary to have conviction that a low is in place.  In fact, the Put/call registered a .71 reading for 10/24, well below the 1.35 seen in early October.  thus, on this pullback, we've seen a lesser push to buy puts than what happened initially in early October when rates spiked and stock indices began breaking uptrends.  For now, we're seeing positive momentum divergence, as RSI is registering a 25 reading, vs the 18 reading we saw in mid-October, and this drawdown is happening on lesser poor breadth and less negative momentum.  Thus, all the makings of a scenario which typically rewards the "hold your nose and buy" strategy.  But for the first time this year, we've seen a real "head turner" type decline which has surprised many who believe that earnings and economic data drive stock prices.  As we've tried to discuss, cycles and sentiment tend to be important in the short run, and while fundamentals are certainly important, selloffs like these are normal in markets, except that they haven't occurred in the US in some time.  As of yesterday, DJIA broke its 200-day moving average for the first time since 2016, setting a record for the longest stretch without having broken its 200-day.  While a washout seems to be underway, the divergences are indeed important and historically have been in limiting the amount that indices usually fall when they appear, particularly when fear is on the rise.  In this case, some trends from 2016 have been broken in recent days, yet most are still intact.  Thus, we have a scenario where the economy and earnings are in good shape and longer-term trends are also fine.  Yet the near-term trend is strongly bearish and momentum has been rolling over while fear is on the rise.   9 times out of 10 these scenarios create good buying opportunities.  Since we've been negative for at least the last 2 months, for good reason, it looks close to a time when one can try to buy dips and participate in a good rally.  Some evidence is necessary of a reversal before getting too optimistic.  Yet this next two day period looks important time-wise and my thoughts are it should coincide with at least a minor bottoming in stocks.  ON any lift, strong breadth and momentum is necessary to have conviction. In this case, rallies out of out-of-favor sectors like Financials are likely necessary to help stocks stage a good recovery, along with some evidence of Tech starting to gain some footing and participate.

 

ACTION PLAN-  

Long XLF, adding on close over 26.31
Long KRE given pullback to Fall 2017 lows - Expect bounce to high 50s
Covering QQQ short, looking for a rally, with regaining 167.81 making the case to add to longs on a close
Covering XLK and plans to buy on any close back up over 67.10
Covering XLI short


 

Additional charts and thoughts below.

below.gif

S&P's decline in breaking under mid-October lows looks to have created a possible 5-wave down, in Elliott-wave terms.  This would signify that markets are close to reversing course in the near-term, but might have difficulty moving back to new highs.  Overall, the area at 2623-5 is important support and under there lies nothing until 2581 that was hit back in February.  This can't be ruled out given the momentum acceleration of late, but would signify a huge plunge that would then turn the weekly and the monthly trends down to negative, suggesting a very difficult time in keeping this bull market ongoing.  For now, one can make the argument that the ability to rally within the next few days could help regain some of the damage done.  However, for SPX the trend from 2016 was violated on this past week's selling.  so it's a must to regain 2710-2 sooner than later which would help with the counter-trend bounce.  Positive divergences are rampant here, with regards to breadth, momentum while a lot of damage was done to the 2-year charts as a result of this past week's selling.  Some evidence of a snapback is necessary to help the trend stabilize quickly given the extent of the selling. 
 

selling.gif

SPX monthly charts show the breakdown of the trend from 2016, in one deft fell swoop this past week, violating the two-year trend and if not immediately recouped, argues for a lengthier correction down to the longer-term uptrend from 2009.   Given the daily positive divergence and uptick in fear, a rebound is likely in the days/weeks ahead.  However, failure to mount a very strong rebound would argue for a further pullback, despite markets being in the seasonally positive mid-term period for gains.

gains.jpg

Breadth indicators like Percentage of stocks trading above 10 and 50-day moving averages are at higher levels than seen during mid-October, one bullish piece of the puzzle that argues for an upcoming bounce.  This divergence directly dovetails with what's being seen in positive momentum divergence on daily charts on this retest.