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US Markets diverging substantially from Europe

August 22, 2016


2164-6, 2151-3, 2139-43, 2119-20        Support
2191-2, 2210, 2214-6                             Resistance


S&P divergence vs other indices in Europe, such as Italy's FTSEMIB index, details the extent of the severe widening out which has happened since earlier this year, as SPX managed to recover back to new all-time highs, while most of Europe remains well off those highs, in many cases by 15-20% or greater.  This Divergence doesn't look to mean-revert in the immediate future and still suggests underweighting Europe as a strategy vs long US.


Key Takeaways

SPX remains largely range-bound with a slight bullish bias, and insufficient weakening to suggest any pullback is imminent.  After six of the last eight "UP" weeks, with just 2 "misses" failing to turn out positive returns by just 2 SPX points, the trend has been higher, and largely uninterrupted since late June.  However, as we all know, most of this move happened from 6/29 into 7/14 with the last month being extraordinarily challenging for both bulls and bears alike.  Given the less than 1% rise in the last month of trading, breadth has waned since mid-July, though with bullish sector rotation largely offsetting this minor.   Overall, given the lack of any real price deterioration, it remains correct to have a bullish bias given no weekly closes BENEATH the prior week's lows since late June.  Higher prices look likely into end of August before any peak

SPX continuing to outshine Europe, which is growing increasingly weak.  Most European indices fell nearly 2% last week (STOXX50) and have lagged the US since 2007, with the decline since the most recent peak from last Spring growing quite pronounced.  While SPX, DJIA hit new high territory in the last month, Europe remains down 15-25% from last year's Spring peak, and this trend doesn't appear to be reversing course anytime soon.  While UKX and the DAX are the two standouts, the majority of Europe and Asia for that matter remains in far weaker shape.  No evidence of mean reversion is apparent, nor is it right to fade this widening divergence in expecting an immediate snapback anytime soon.  For now, for those concerned about downside risk heading into the Fall, Europe still looks likely to fall faster to the downside, and the European benchmarks remain in downtrends and better risk/rewards to consider "shorting".

The move out of Defensives which began in early July looks to be nearly complete.  A few signals have appeared in the last week to suggest this should be in place by early September, arguing to buy dips in REITS, Utilities, Telecom, and Staples as August comes to a close.  Both on a relative basis along with absolute, many Telecom and REIT stocks are pulling back to important uptrend lines as part of their bullish uptrends.  The flow out of the Defensives has helped to embolden investors as to "why" stocks should be moving higher, with High percentage sectors of the SPX like Technology, Healthcare, Consumer Discretionary all showing above-average strength.  Conversely, we've seen huge underperformance in the last month out of most Defensives.  Even in the last week, Utilities and Telecomm dropped more than 1% a piece, while Staples also finished negative,  and in the bottom 5 sectors in performance.  Bottom line, the combination of counter-trend signals of exhaustion for the defensive groups as they approach key support should prove beneficial towards these groups bouncing, and also means our equity rally could be running out of steam as September approaches.  For now, another week of Defensive underperformance looks likely.

The decline in the US Dollar index has approached initial support, but still no evidence of this bottoming out, and both Treasury yields and US Dollar declines look to continue into September.  The failure of Treasury yields to rise as equities have pushed higher might be seen as a warning sign for stocks, yet if the resilience in JNK is any guide, it still looks early to fade the move in equities.  For now,  Treasury yields remain nearly as range-bound as Equities, and even more so of late.  Given the ongoing intermediate-term downtrends in place for yields and the lack of any complete Demark signs of weekly and/or monthly exhaustion, there remains a high likelihood that this consolidation in yields is resolved by a downside breakout.  Such a move would likely cause Financials to turn back lower into the seasonally bearish month of September, while providing a lift in the Defensive groups, which would bolster the argument made above regarding the yield sensitive sectors getting a lift. 


Short-term Thoughts (3-5 days) :  Bullish-  For this week, the ongoing deterioration in defensive sectors could extend one more week, while stocks still looks to complete their larger pattern with a move to the upside.  The rally has become more selective of late, and Technology and Discretionary have begun to slip in favor of Energy, Materials and Industrials with the US Dollar decline helping Commodity prices.  Given lack of any serious technical deterioration whatsoever, factors like bullish breadth and momentum should help keep equities afloat a bit longer.  The bearish factors of increasing optimism towards stocks along with less upside participation don't yet suggest to sell stocks.  Movement up to 2200 and over towards 2210-2215 remain legitimate upside targets to consider possible before S&P futures stall out.  Look to stay long and use any weakness that early week pullbacks offer to buy dips with thoughts of prices moving back to new high territory.

Intermediate-term Thoughts (2-3 months): Bearish-  The combination of the divergences in indices hitting new highs the uptick in bullish sentiment along with markets entering a notoriously bearish time seasonally makes it likely that any pullback over the final five months of the year likely takes place in August-October.  While momentum and breadth remain quite positive, most of the argument for fading stocks at this time is more of a counter-trend argument, which hasn't yet materialized in the form of index weakness.  However, Most cycles along with Demark indicators highlight the possibility of a stalling out/reversal in August.  Given the fact that indices have moved higher into this period argues that the upcoming turn should be a reversal from market highs, not lows.  Additionally, another intermediate-term concern which should be mentioned is the degree of deterioration in momentum which began last year into August lows.  Even a rally back to new high territory won't allow momentum to get anywhere near where it was back in late 2014/early 2015 and this is a 12-18 month concern.  For now, for this time frame, additional intermediate-term strength still looks possible into mid-August, with key targets at 2180-5 and then 2250.

Absolute charts of QQQ, TYX, Energy Sub-sector relationship charts, Breadth charts and commodity index CCI analyzed below.

Some minor evidence of NASDAQ 100 starting to stall out in the last week, as seen by prices attempting to push higher repeatedly and failing while counter-trend Demark indicators showing exhaustion appear on daily charts.  Momentum has begun to roll over as seen by commonly used Technical indicators such as MACD.  While it's still possible that a final push higher could happen this week, QQQ in particular looks in dire need of consolidation following its advance.  Daily closes back under 116.43 would warn of a pullback getting underway, and one should hold off on immediately looking to buy dips.  Until this happens, however, the trends here for QQQ remain bullish, but stretched.


The Percentage of stocks trading above their 50, 150, 200 day moving averages remains quite constructive for stocks given their move to multi-year highs with no meaningful signs of turning back lower.  While there has been some minor evidence of the Percentage of stocks > 50-day ma coming down from very extreme levels reached in April/May, this doesn't represent a "sell" signal by any means.  Important to see the degree to which these big moves in momentum earlier this Spring led the market higher, providing positive divergence to the lift back above November/December highs.  A severe plunge in these Percentages would be problematic if stock indices remained near highs, but for now, with all three gauges registering readings over 70%, there doesn't look to be much deterioration in the Breadth surge which happened earlier this Spring which would warn of an impending pullback.



McClellan's "Summation index" has dropped off since mid-July and threatening to break its 50-day moving average for the first time in nearly two months.  This gauge is a cumulative tally of the McClellan Oscillator readings for breadth and typically tends to show divergence at both highs and lows which can often precede index turns.  The flattening out in stocks in the last month is largely responsible for the weakening in this gauge, but given the high level in being well above former troughs for June, can't be looked upon all that negatively.  For now, a resolution to this trading range in the indices in the next couple weeks by a move back over 2200 which doesn't cause this to turn back higher and challenge highs might be considered a minor negative.  However, ideally, to have any type of bearish stance, this Average would need to get back under lows made in June.



This closeup of another Percentage study (the percentage of SPX above its 10 and 50-day Moving average) is another chart to watch carefully in the weeks ahead. To reiterate earlier comments, the peak and stalling out is not something to view that negatively as of now, but would be expected to move back higher as SPX moves up out of this range to the upside.  The lack of any followt-hrough higher in this gauge and/or weakness during times of Equity index strength could be a problem for September, but remains premature to grow overly concerned about at present.



30-Year Treasury yields remain locked in range-bound consolidation as part of this ongoing downtrend.  Technically speaking, it's difficult to see this recent triangle as anything but bearish given just a minor Yield rise before this range began to form.  A pullback to test and break early July lows near 2.1% looks likely in the next 1-2 months before any recovery.  Breaks of 2.20% would be an important and bearish development, while any move back over 2.35% would postpone the decline.



Sector-wise, Energy is continuing to gain ground, and this chart shows the performance of the Exploration and Production ETF, (XOP) vs the OIl Services ETF (OIH) which in relative terms broke down hard late last year into early January 2016.  The subsequent rebound has been sharp, and recently has moved back up to challenge the initial resistance created by June highs.  The quickness with which this rose back up to recent highs is a positive development technically after just a minor drawdown into July.  The rally in the last couple weeks is suggestive of a larger move in Exploration and Production stocks, which should continue to gain ground once it exceeds former June highs.  Overall, the XOP looks to be a sub-sector to favor within Energy and should be overweighted for outperformance in the weeks and month ahead.



XLE vs OIH is showing signs of peaking out in the last couple weeks after a sharp two months of rally by the Integrated Oils vs Oil Service stocks.  This ratio has reached an area of resistance that has held upward progress all year long, and now has made what appears to be the second unsuccessful stab to the upside of this triangle pattern.   Pullbacks in XLE vs OIH should be expected between now and mid-September, which translates into OIH outperformance.  Thus, when breaking down the subsectors and how to play Energy, XOP looks to be preferred initially, followed by OIH and then XLE as the relative laggard.



The Continuous Commodity index looks increasingly to be bottoming in the short run which looks to have directly coincided with the US Dollar turning back lower in recent weeks.  Energy has led this move higher while Precious Metals and grains have lagged in this regard. When looking at this chart, a couple things are clear.  The uptrend in Commodities from lows this past January doesn't seem to be complete.  Most of the churning in the last month has occurred right near key trendline support, but should lead to CCI lifting to at least challenge former highs from early July.   Unless there were to be a breakdown under 415 in the index, which looks unlikely with a declining US Dollar index, the trend in commodities continues to point higher, but has merely stalled in the last month, not dissimilar from precious metals.



Telecomm took a sharp downturn in the last couple weeks and now has fallen to the lowest levels since February of 2016 in relative terms to the SPX.  This move has been bearish near-term, but appears temporary given the bullish structure in intermediate-term weekly charts of T, VZ.  While another 1-2 weeks of undeperformance could happen, it's worth buying into this decline as the market approaches the month of September, as this relative decline is starting to get stretched now to the downside.


Long High Momentum and Short Low Momentum clearly hasn't worked in 2016, and particularly since early July.  This index above is the DJ US Thematic Market Neutral Momentum index (Bloomberg) which reflects the performance of a strategy of being LONG high momentum and short the low momentum names in the market. In the next 1-2 weeks this should be nearing this area of trendline support that would suggest fighting the trend that's been in place since early this year.  However, given the extent of the decline from early year highs and how this fits into the larger pattern, it's important to be on the lookout for a larger breakdown in this trend over the last few years.  For now, this appears unlikely right away, and between now and early September, this style index still shows long high momentum stocks/shorting low momentum stocks in actual practice to be an underperformer.




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