October 1, 2018
S&P 500 Cash Index
2897-2900, 2883-5, 2864-5, 2830, 2817 Support
2916-7, 2923-5 , 2945-6, 2960-3 Resistance
Summary: Stocks have continued to show resilience in recent weeks, bucking the trend of poor seasonal tendencies for mid-term election years, and ignoring much of the DC drama that many thought should be important in potentially derailing the rally. Markets now enter the seasonally bullish mid-term month of October, which has averaged 3.1% gains since 1950 (12 higher, 7 lower) and enter what's widely considered to be the best three-quarter stretch of the Election cycle. Data from this past weekend's Barron's shows that Q4 in mid-term election years combined with the 1st and 2nd quarter in third-term Presidential years has averaged a whopping 20.4% for the DJIA and 21.1% for the S&P over the last 70 years. (Whether to pay attention to these stats given that the mid-term performance far exceeded expectations is a different story) Europe meanwhile has slumped with the EuroSTOXX 50 barely positive for the month of September and both DAX and IBEX35 negative. Whether or not Europe can be counted on to show some mean reversion snapback as the ECB gets set to dial back QE at a time when Italy and Greece might face fiscal issues is a different story. But the real story is the extent to which global bond yields have begun to turn up sharply again while most Financials, both US and European, have not paid attention, and have indeed been moving steadily lower. The Dollar meanwhile looks to be at areas which might stall out and turn lower, which could help Emerging markets into end of year. With a little more than a month ahead of US mid-term Elections, investors seem fairly confident that gains can continue uninterrupted and markets have done little to prove this thinking wrong. Yet, the divergences have grown to some of the greatest levels all year, making the index strength a bit of a mirage to the underlying sector rotation and negative momentum divergences playing out. While right to stick with this trend until some evidence of shakiness arrives, this is starting to look increasingly likely as markets enter the notoriously volatile month of October. Overall, it's right to own implied volatility at these levels, and be particularly selective, with a keen eye on the 4-6 month uptrends for stocks. The chart below highlights the MSCI World index which has moved higher for its third straight month and while not at new highs, has not shown much signs of breaking the two-year trend from 2016 which will be important to pay attention to. Momentum has waned, as might have been expected following the lackluster rally following the big drawdown from late January, yet, its proper to respect this trend until given reason to doubt it otherwise.
Overview: The last few weeks have shown without any doubt that this is a market of a LOT of moving pieces, to say the least. While Financials fell to new relative lows of the year, other groups like Healthcare gained sufficient strength to take on the top spot in performance for a 1 and 3 month period, gaining rapidly on Technology. Transports and Small-caps have been losing ground lately, while Energy has been able to slowly but surely start to turn higher as both Brent and WTI Crude have begun to accelerate higher. Breadth has been lackluster as has momentum lately, but these are all concepts we've discussed before, and simply haven't amounted to much. While it's right to put more weight on actual price action than to make too much of lagging breadth, when the divergence grows as great as markets are showing now, with McClellan Summation index at the lowest levels since May and NYSE New highs having slumped to 54, the lowest levels since late June, it makes it important to pay attention.
The Media in many Financial publications this past weekend highlighted the simple fact that markets just "didn't care" about last week's ugly judicial panel hearings and instead are focused on bullish earnings and the economy. Unfortunately, it's always difficult to know when markets "care" and when they don't. Investors are very much tuned in to earnings and economic updates constantly, so this tends to be an excuse that is rarely one to lean on for why markets are moving higher, or lower for that matter. When corrections finally do arrive, investors will surely still be paying attention, yet most will likely scratch their heads as to why markets are falling until the latest narrative of the day is blamed for the decline. More often than not, market prices move in fairly well defined patterns that have more to do with sentiment, seasonality and market cycles than anything to do with politics, or even earnings and economic data for that matter. The second fallacy to take note of this week comes courtesy of Stock Traders almanac, the indispensable guide to having seasonal trends at one's fingertips. We're told that this coming month and nine-month stretch is sure to be bullish, given trends going back since 1950 (which i've mentioned above) However, should investors be paying attention as closely to this data to support their bullish leanings if the past few months simply have not worked as they should have with regards to mid-term election year seasonal tendencies. If anything, this suggests that we're in a very different time indeed, a strange period rife with reasons to be afraid based on tariffs, trade war and political upheaval, yet reasons to be optimistic given the economy and FOMC's rate hike plans given their rosy economic outlook.
The following seem important heading into this week:
1) Financials selling off to new relative lows for the year vs SPX
2) NYSE New 52-week highs are at 44 now, well below comfortable levels given new monthly closing highs
3) VIX holding up firmer than expected given push to new highs by Equity indices
4) Emerging markets have begun to show some outperformance and EEM is challenging key trendline resistance
5) McClellan's Summation index, fell to the lowest level on a weekly close since May.
6) Equity put/call ratio fell into the low 50's using a 5-day ma which seems overly complacent
7) Healthcare outperformance has carried this sector to #1 performer on 1 and 3 month basis
8) Europe sold off sharply on Italian election results, & DAX fell in the month of September
9) Energy managing to outperform as Crude moves higher- Good likelihood of Brent reaching high $80's
10) Cryptocurrency volatlity reaching very low levels as patterns reach the apex of triangles- Large move coming soon
SHORT-TERM / INTERMEDIATE-TERM TECHNICAL THOUGHTS ON SPX DIRECTION:
Short-term (3-5 days): The trend will remain bullish until 2886 is broken in SPX cash, 2883-S&P Futures. While the downturn in Financials is a concern, there hasn't been sufficient weakness in other sectors to justify any broad-based weakness, and we've still seen sectors like Healthcare and Energy come to the rescue to help keep the recent uptrend intact. The divergences in both breadth and momentum are also important and negative, but it's important to see that reflected in price, and thus far, indices have been able to push higher and ignore all these warnings. 2940 will be important on the upside for this week, representing 9/21 highs, and above that allows for additional upside to 2957-9. On the downside- under 2883 will lead to a test of September lows at 2864, with strong five-month uptrend line support near 2823.
Intermediate-term (3-5 months)- Bullish- The beginning of Q4 kicks off the most positive stretch for Equities seasonally within the four-year election cycle. Barron's notes this past weekend that combining the fourth quarter of a mid-term election year with the first two quarters of the 3rd year of a presidential term averages 20.4% since 1950. Mid-term Octobers also rank as top months for performance, with average gains in DJIA of 3.1% since 1950, with 12 of them being higher and five being lower since that time. Impressive seasonal stats for sure, however, the mid-term 2nd and 3rd quarter performance certainly deviated from the traditionally sub-par performance which happens during these years, and SPX has now strung together six straight positive months. Overall, given the monthly close at new all-time highs for US Equities, it remains difficult to be bearish on an intermediate-term view without any semblance of weakness heading into this seasonally positive time. However, the recent breadth deterioration, Financials weakness, and momentum waning combined with bullish sentiment are real concerns to those that simply argue a bullish tune based on price alone without studying the underlying weakness. Bottom line, it seems more likely than usual that October turns out to be far less positive than these seasonal stats suggest. A selective stance is preferred with overweights in Energy and Healthcare, keeping alert for evidence of any downturn that might change the thinking that dips are automatically bought. For now, price trends and seasonal factors outweigh the breadth concerns which have all been present for some time, with little to no effect.
Energy - Bullish and further outperformance likely in October- 5 key charts on the sector, followed by 5 bullish technical risk/rewards
XLE v SPX- Gradually turning higher, but no broad-based strength just yet. While WTI and Brent Crude have been showing very sharp acceleration higher lately, Energy as a sector has only gradually started to turn higher. OIH vs SPX broke out two weeks ago, but the chart of XLE vs SPX above is just arriving at its own "moment of truth" Given that technicals for Crude oil still point meaningfully higher in the weeks ahead, particularly for Brent crude, it looks likely that one should continue to position for further energy strength. Overweighting XLE looks prudent, and increasing this bet once XLE can manage to exceed this four-month downtrend. Overall, it looks right to position long here ahead of this move, and Energy likely can continue bucking its weak seasonal trend, as Iranian sanctions might be a bigger deal in terms of taking capacity away at a time when demand has not fallen off materially.
XOP, the Exploration & Production ETF, still looks like a better bet than XLE, or OIH for Energy exposure. This daily chart of XOP shows a gradually improving technical picture after the huge decline from 2014 into 2016 lows. Prices have tested the $45 level now twice and appear headed for this area yet again, which should help cause a breakout and drive this sector higher at a time when Crude still looks to move higher. Longs are favored and would be increased over $45 on a weekly close which would represent the highest weekly close since mid-2015. Upside targets lie at $50.62, with intermediate-term levels found at $53.05, the 50% retracement level of the entire 2014-2016 decline. Movement under September lows would be necessary to postpone this rally, ($39.41) and would cast some doubt as to a continued rise.
Brent Crude still looks likely to rally to the mid-to-upper $80's with the first legitimate upside target near $90. While prices have gotten overbought, no evidence of any trend exhaustion has surfaced and should be at least another 5-6 weeks away. This is suggestive of possible strength into November, when the sanctions v Iran are expected to reach 100% and should allow for Crude to rally into this time before peaking. ETF's like BNO or USO could be considered for a short-time only but given the nature of the construction of these ETF and the futures roll affecting prices, one should be wary of underperformance vs Crude itself. BNO, based on Brent crude, is a likely outperformer to USO in the short-run.
The spread between Brent and WTI, as shown on this weekly ratio chart, still looks to widen out materially in the weeks ahead, which is depicted by the ratio of WTI CRUDE over Brent Crude. While it's widened out already from 2 to near 10 in the last few months, technical trends do not seem complete given last week's pullback to the lowest levels (widest) since June. This recent pullback last week to new lows without any accompanying exhaustion signals is likely to allow for a pullback down to -12, signifying a further spread widening and Brent outperformance over WTI.
Drillers preferred over Equipment/Services within Energy- Ratios of Equipment & Services stocks within Energy to Drilling show the recent break of support which had held on this chart since early 2015. This means that Equipment and Services names are still likely to underperform Drillers and could result in much more strength out of the Drillers relatively in the weeks ahead. A breakdown in this weekly chart of a pattern of this sort represents a multi-year Head and Shoulders pattern and until/unless recouped, means that the Drillers likely will show much better strength in the weeks ahead on a further rise in Crude while the Equipment/Svcs should underperform.
5 Technically Attractive Risk-reward Long Candidates within Energy
Cheniere Energy Inc (LNG- $69.49) LNG stands out as one of the better technical risk/rewards within Energy in the near-term given its recent push back to new weekly closing highs for the year. Additional strength looks likely, with upside targets near the highs made back in 2014/5 in the mid-to-upper $80's. the pattern from June itself is reminiscent of a minor Cup and Handle pattern, and the breakout last week should help this extend further without too much trouble. Volume expanded on the rise in the last couple weeks, and the consolidation over the last few months has helped LNG to avoid getting too overbought after its rise from 2016. Overall, LNG is seen as attractive and would be favored long until/unless prices get back under $64.70 which is not expected.
Whiting Petroleum (WLL- $53.04) WLL looks attractive given its recent resilience in holding up near the highs of its 2.5 year base from mid-2016. The stock has made several prior highs in the high $50's and has pushed up in recent weeks to test this area again. This adds to the probability of an upcoming breakout given Crude's ongoing ascent. Long positions recommended, looking to add to positions on the ability to exceed $56.50, near the highs from late June. Only on pullbacks under $45.91 would this thinking be reversed, and for now, it's right to expect a move to test this $56.50 area.
SM Energy (SM- $31.53) Further gains likely in SM given the strong near-term technical structure and its recent resilience in pushing up to the low $30's. SM had formed a lengthy downtrend line just from its latest intermediate-term peak in 2015 which was just exceeded over the last few months. The act of getting above this 3 year downtrend along with surpassing the minor Cup and Handle pattern since late 2017 were both bullish factors that allowed the stock to accelerate once it got over resistance at $28 which was right near the 50% retracement of SM's pullback from late 2016. Its rate of ascent has been slow enough not to generate extreme overbought readings, and SM still lies meaningfully off highs from 2014 and 2015, making this an attractive risk/reward. Upside looks likely to near $40,which would be a 38.2% Fibonacci retracement of the entire pullback from 2014 highs.
California Resources Corp. (CRC- $48.53) Bullish for move to the upper $50's. This stock continues to make steady progress in recent weeks after pulling back to test the area of its 2.5 year base breakout near $28 in mid-August. Its subsequent ability to rally back sharply managed to make the highest weekly close since 2015, arguing for further intermediate-term strength to the mid-to-upper $50's before any meaningful resistance. While CRC has gotten short-term overbought, weekly RSI only shows readings in the mid-60s and volume has been heavy on the recent move back to new highs. Overall, long positions are recommended, looking to buy any dips given the chance in the weeks ahead.
Hess Corp (HES- $71.58) Bullish for a move to $77 initially- HES recent success in breaking back out to the highest levels since 2015 has helped this stock's technical position to get better in recent weeks. The stock has exceeded not only Spring 2018 highs but also highs from mid-to-late 2016 which bodes well for its recent upward progress to continue. Upside targets lie near $77 initially, and any pullback down under $70 would create a very good risk/reward scenario to buy dips for gains to this key Fibonacci retracement zone. Overall, HES has been able to show some decent strength in recent months that makes this a stock to consider which is well positioned technically to be able to make gains as Crude works its way higher.