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Rally still premature, but should be around the corner as fear starts to rise

October 22, 2018


S&P 500 Cash Index
2729-31, 2710-1, 2690-2,  2633-5    Support
2775-7, 2825, 2852, 2940                 Resistance


Summary:  Equities look to have begun the much awaited "retest" , which many concluded was highly likely after the first bounce off the lows.  While these pullbacks often turn out to be buying opportunities for Equities, it pays to wait for evidence of real "fear" to show up, as this was largely non-existent during the first wave of selling from early October.   Near-term, markets still show downtrends in place on daily charts as part of larger uptrends for equities, while interest rates continue to work their way higher on the long end and the Dollar has been stubbornly resilient.  Overall, It's not wrong to say that US equities definitely look to have joined some of the weakness which has been present in the last few months globally, as signs of Technology weakness coinciding with Financials drawdowns became too much for the US market to bear.  However, this didn't translate into European or Asian relative strength, as these markets also have been under pressure.  The chart below focuses on the Bloomberg World index, which broke a two-year uptrend as its pullback in the last two weeks fell to the lowest levels of 2018.  Near-term, this should lead to further selling pressure, as no real evidence of support is yet apparent.  While some might argue that seasonal strength is right to bet on as a reason to get long, it's important to mention that this worked miserably during Q2 and Q3 which historically have acted quite poor.  Stocks ability to rally through this period was seen as bullish.  So now that markets are into October and have turned down, it's difficult to cling too tightly to the opposite argument that stocks have to rise in Q4.   However, this likely will be the case heading into the final couple weeks of October given fear levels slowly but surely turning higher.  The first few days of this week however, don't seem particularly bullish just yet.  Thus some patience is still required while equities try to carve out bottoms and potentially embark on a larger retests of October lows before prices stabilize.  


Overview:  Markets have pulled back this past week, though largely in the last few days, as when looking at current prices, SPX still remains within 1 point of where it closed last week.  Volume and breadth however have been lackluster this past week, which generally is a positive sign on stock market retests of lows.   Yet, fear never really materialized during the first drawdown, and was thought to always be something that the market likely needed after giving up 5% over a 2-day span and down nearly an equal amount from mid-September highs (-5.5%-SPX )    For one, no real capitulation in volume was seen at recent lows as the TRIN registered a poor 1.4 reading, well below the 2+ or even 3+ readings seen at prior lows this year.   While there was an uptick in put volume, there surely wasn't much signs of actual fear.  Markets did register VIX backwardation which is another useful tool that often coincides with a bottoming price in Equities.   Additionally, Equity put/call ratios have been on the rise, and Total Put/call is now at the highest levels of the last couple months.   However,  in the short run, the breakdown of Technology does seem to be a broader concern, with Equal-weighted Technology having made a break of the two year uptrend from 2016.   Financials, meanwhile have been under pressure of late, going in exactly the opposite direction of long-term Treasury yields which is a source of real curiosity for many.   As we show below, however, there are now some evidence that Financials have shown the first signs of trying to stabilize after the recent washout which is considered to be a minor positive that merits watching closely and could lead to a bounce in this group into November.  For now, heading into this coming week, the shape and technical pattern don't seem too promising just yet with two straight down days, with prices having failed to make any early progress and then turned back lower.  Thus, despite the lower volume and negative breadth on this pullback, we'll need to see more out of NASDAQ and SPX to show some better evidence of stabilization before getting too bullish.   A bottoming process should be materializing over the next 1-2 weeks, as fear on the rise coinciding with intermediate-term uptrends in place is normally something to buy into.  However, on a 3-5 day basis, there remains insufficient proof and it remains right to have a defensive stance, at least early on in the week.  

Reasons for continuing a bullish intermediate-term Stance, thinking this pullback proves short-lived for now:

1) Lesser volume and better market breadth this past week   Flat breadth on Thur/Friday declines of last week vs the -8/1 of the prior week

2) Equity put/call rising more rapidly now than it did in early October and nearing prior peaks.  Formerly we argued that there was no real signs of fear. Now this seems to be changing as the early dip buying failed

3) Macro reasons for concern have materialized that are a big aid in turning sentiment negative more quickly that were absent the prior week.  Italy "Going it alone" on the deficit, and also the US pullout of the Saudi summit

4) Financials have shown their first signs of potentially bottoming on a RELATIVE basis.  Note, absolute charts remain weak and technically its still right to expect XLF to get to 26 and slightly below.  Yet, KRE seems very washed out and we've seen relative charts of XLF /SPX give counter-trend buy signals. 

5) Seasonality, as many say, is very bullish during this time, not just in Q4 Oct-December but also during this stretch of the mid-term election season.

6) Intermediate-term uptrends on SPX, NASDAQ and DJIA are intact and in far better shape than Europe. 



Short-term (3-5 days):  Mildly bearish- Similar to last week, we enter post October expiration week thinking that a bit more weakness is likely in store but should be close to bottoming out by end of October.  While breadth and momentum have lessened on this pullback over the last week, there's insufficient proof of markets having bottomed to justify a bullish stance in the next 3-5 days.  Equities closed right near lows of the day both on Thursday and Friday of last week, and the most likely outcome could bring about a deeper retest or even minor break of prior lows near 2710-2 before a bottom is in.  Fear seems to be on the rise, so this is a positive from the perspective of thinking that this first selloff from September is growing closer to being complete.   Ideally one would like to see Equity put/call spike over 1, while the TRIN gives a 2+ reading with much more volume on the downside than upside vs the overall Advance/Decline.  These last two factors have been noticeably absent, but seem close as both showed signs of inching higher to end last week.   Overall, any test of lows should be a chance to cover shorts and start to buy into this decline, thinking that a bottoming process has begun.   Over 2816 in SPX would be constructive, and last Wednesday's highs are an area to watch.  Similarly, movement down to 2710-2 coinciding with a further lift in fear should be something to buy into, not one to avoid stocks.  Until more definitive signs of long-term trends being broken is "front and center"  near-term weakness coinciding with long-term trends being intact should be something to buy into.

Intermediate-term (3-5 months)-  Bullish-  It's thought that the current pullback could be complete within 1-2 weeks while longer-term charts have not been meaningfully affected thus far.  While momentum has begun to turn lower and there is ample evidence of negative momentum divergence, broader market peaks take time.  We'll need to see market indices show more signs of trend damage, as opposed to just daily charts.   Key concerns involve not just momentum weakness, but what looks to be a real change in leadership and Technology accounting for 26% of SPX has rolled over in a very bearish manner.  However, given the seasonally bullish period underway during this mid-term election year, it's right to initially use near-term weakness to buy and then see the extent to which rallies can attempt to carry prices back higher.  Watching participation closely will be key in Q4.  Until trends from 2016 are  broken in all major indices and SPX, NASDAQ and DJIA close down under their respective 10 month moving averages and see these averages start to rollover, the first decline is typically one to buy into given a lack of long-term trend damage.   

10 Charts of US indices, Treasuries, FX, Sectors, both absolute and relative 


NASDAQ 100 still weak technically but a test/break of 6900 would initially be buyable, but also would cast some doubt on the ability to get back to highs right away.   This daily chart of NASDAQ 100 index puts the near-term trend into perspective. The drawdown violated 7400 which was key in the short run as this turned the trend bearish.  Prices found minor support near the 2-year trend at 6900 which also happened to be an exact 50% retracement of the most recent rally from February.  The last week's gains look to have stalled and failed mid-week, followed by a down Thursday and Friday where prices closed all the way down at the lows of the session on both days. Momentum remains bearish and we haven't seen any evidence of counter-trend exhaustion that could help NASDAQ to bounce.   This doesn't give much confidence for early this week and the best case scenario calls for a further pullback that holds 6900 before bouncing.  If NASDAQ and XLK were to violate trends from 2016, this would postpone the larger rally back to highs.  Bottom line, near-term trends remain negative and a further pullback looks likely early in the week which faces a key test near former lows at 6900.  To have any real confidence a low could be in, we would need to get back up over last week's 7311 highs, but in reality, exceeding the last serious low from early September is key, at 7400.  Until then, a near-term bearish bias is prudent.


SPX down to critical two-year trendline support- SPX weekly chart shows prices having pulled back to test this important uptrend from 2016 which intersects just under 2750.  Any break of the lows from two weeks ago, 2710-2 would be negative for SPX, with the next prominent area of lows which could act as support found near 2550.  Weekly momentum indicators like MACD have turned negative, and at a lower level than where SPX peaked out in January (RSI shows the same) while prices managed to eke out another 50 points higher into mid-September.  Overall, this area will be a real make-or-break for SPX for the next couple weeks.  Violating 2710 would be a structural negative, but given the uptick in fear gauges and low volume/breadth over the last week, selling might prove temporary in the short run before at least a minor bounce attempt.   The divergences are something which are worth monitoring for US equity indices going forward and the longer these persist the more negative these would be for any sort of longevity on rallies in the months ahead.  


Treasury yields breakout still looks to extend -Treasury yields continue to show bullish trends following the recent breakout of prominent resistance and look early to fade, despite equities having turned down recently.  This positive correlation between equities and Treasuries is something relatively new, so will be important to monitor.  For now, momentum and trends remain sloping higher for yields with no discernible weekly trend exhaustion that should cause meaningful strength in Treasuries.  While sentiment remains quite bearish and yields have pressed up to near Bollinger Band resistance on daily charts, weekly charts show no real resistance and last week having rallied to extend the recent breakout.   Overall, US 10yr Yields should make further headway higher in the weeks ahead, with no meaningful resistance before 3.50%.  If the equity selloff starts to cause a flight to quality that makes yields drop under 3.12, there could be a brief pullback to 3-3.05%, but should prove short-lived and a likely good opportunity to sell Treasuries.  Yields would require a move back down under 3.00% to reverse this breakout, which looks unlikely in the short run. 

short run.gif

Dollar has gotten a bit more bullish in recent weeks-  The US Dollar index has failed to rollover as thought possible in recent weeks, rallying 3 out of the last 4 weeks and increasingly resilient.  Last week's weekly close in the Bloomberg Dollar index (<38% vs Euro, vs 63% in DXY)  finished at the highest levels since mid-August.  As weekly charts show, the last 2 of 3 weeks trading right near highs of the range has the potential to breakout higher, not lower, which would put a serious crimp in the commodities trade yet again.   Most had banked on Gold and the precious metals trade in general to continue the recent bounce, and a breakout in the Dollar would at least postpone any further rally by a bit.  Overall, keeping a close eye here on the Dollar makes sense for those involved in commodities and/or Emerging markets as this chart has taken on a bit more of a Bullish bent in the last two weeks.  Sentiment has begun to lift noticeably in the US Dollar, so its thought that any rally into November/December likely would be a chance to fade this move, not dissimilar from late 2016.  For now, movement above 1200 in the BBDXY should result in further upward continuation for the US Dollar.


Commodities trending higher near-term, but require a breakout above Summer highs to help the intermediate-term trend shift to bullish.  Commodities trending higher near-term, but a sustained move requires a breakout above 450 in the CCI index.   Overall, the commodity rise which was thought to occur this year really took a serious blow given the lift in the US Dollar this past Summer.  The rally above 450 in CCI index into the late Spring had all the makings of a potential breakout and commodities as a group looked to outperform stocks as an asset class.  This faded into late Summer before reasserting some momentum just in the last few weeks, regardless of the shift higher in both Treasury yields and US Dollar.  Technically speaking, it does look likely that the next 1-2 weeks of October could see further rallies in commodities.  However, if the Dollar begins to breakout, it's likely that this bounce proves short-lived and might undergo even more consolidation before turning back higher .   Overall, the commodity liftoff very well could be postponed by a few months into 2019, but should be on the verge of turning back higher on an intermediate-term basis.  Going forward, it's important to monitor this long-term base in CCI index, as its thought that the series of highs near similar levels while lows are occurring at higher and higher levels should eventually result in big move higher for this space.  Technically, one simply needs to keep a watchful eye on the 450 level. 


 Transports breaking two-year uptrend- DJ Transportation Average looks to have officially broken the uptrend from early 2016 as of the last two weeks given the extent of the selling off mid-September highs.  This likely could bring about a quick move down to 10000 before hitting lows that were made back this past Summer ahead of any bounce.  The shape of this pattern has turned more bearish when examining the technical trend for this year in Transports.  As weekly charts show this began a pattern of churning this year with repeated failed rally attempts that resulted in deep retracements lower.  The breakout in this pattern into the Fall then failed again, turning back sharply to move back to new multi-month lows.  Unfortunately for the bulls, this has had a very detrimental effect on momentum, with MACD turning down to likely break its Signal line on monthly charts for the first time in two years.  Going forward, given the symmetry of the pattern since early this year, the ideal scenario would take the form of another few weeks of decline followed by a rally into end of year.  However, unless September highs are exceeded, this could take on the shape of a giant Head and Shoulders pattern for the first time in years.  At present, this is very much premature, but the key point on weekly charts concerns the break of this uptrend, which should give way to further October selling in this group.


Tech breakdown might prohibit this group from bouncing back to lead the charge- Equal-weighted Technology has violated its two-year uptrend vs SPX in recent weeks.  Another disturbing development concerns the deterioration in Tech, as the SPXEWIT index (Bloomberg), an equal-weighted Technology index, has broken down to the lowest levels since January vs SPX in relative terms.  This violated the uptrend from winter 2016 and shows signs of falling further in the next 1-2 weeks before stabilization and a bounce attempt.  While many use XLK as a gauge for Technology, this tends to be too large-cap focused and it's more practical to look at Technology in equal-weighted terms to gain some insight as to the underlying rotation at work.  Technology peaked in June of this year, so the start of the recent pullback in Tech (given the 26% weighting in SPX) was directly responsible for causing markets to soften in recent weeks.  This rotation is important to pay attention to, as Tech has now underperformed on a 1 and 3 month basis.  This breakdown in relative performance means that Tech is unlikely to reassert itself as a leader again quickly and rebuilding will take time.  Other sectors like Healthcare look healthier to expect continued leadership, and while a bounce back in Tech likely can happen in November, its gains in all likelihood could prove to be selling opportunities for many stocks.  


Equity Put/call Ratio starting to lift meaningfully, which should be a welcome sign for the Bulls from a contrarian perspective as concern is finally starting to grow into the start of fear.   This daily Put/call chart of the Equity Put/call has risen over .80, the highest since early October and the highest level in Put/call since February.  This was noticeably lacking in recent weeks during the equity pullback, but given the October selling during a time when many expected equities to be quite strong for Q4 has noticeably taken a toll on sentiment.  Polls such as AAII and Investors Intelligence have contracted meaningfully and now Put/call spiking should bring about an end to this first pullback in stocks likely in the next 1-2 weeks.  Ideally, the Put/call should spike up to near 1 or higher, coinciding with a final drop in stocks down to test recent lows near 2710 in SPX.  On a minor undercut, it would be proper to use any uptick in fear into late October to consider buying stocks and selling volatility, given the better relative breadth and momentum being "less bad" of late.  The Total put/call had already made its move to the highest level in months and now the Equity put/call looks to be following suit which is at least one of the necessary ingredients to putting in a trading low.  Stay tuned. 


Financials look close to bottoming, but likely have one final pullback to new lows which should represent a buying opportunity from a technical counter-trend perspective.  Looking at daily charts of XLF, this group remains under pressure, but has started to show some stability near prior lows from this past Summer which is a welcome sign for Financials after recent damage.  The XLF managed to hold prior lows and bounce a bit,  helping Financials to outperform seven other groups in the last week, with positive returns in XLF of +0.76%.  The two negatives however concern the ongoing negative momentum of the last couple months, along with the wave structure from September only showing three waves down .  Most bottoms should occur with a completed five-wave decline, which opens up the possibility of a final pullback which would reach $26 in XLF, but likely not extend too much further.  This should present a buying opportunity for this group, as Financials as a whole are likely to start to trend up to join the recent spike in Treasury yields.  For now, technically, a bit more weakness looks likely, and one should be prepared to buy dips down to new lows.  Going forward, the act of regaining prior lows of this consolidation (shown above as a giant box in white) would make Financials start to strengthen more meaningfully.  Technically speaking this lies near 27.50 near the lows made into October 2.  Any move above 27.50 is bullish for XLF and should be followed. 


Financials showing some early signs of bottoming, but more work needs to be done-  Relative charts of Financials vs SPX shows this recent stabilization in the group, despite Regional banks having pulled back to new multi-month lows.   The pattern currently for XLF/SPX shows a completed counter-trend Buy signal based on Demark's TD Sequential indicator, which confirmed a buy on Financials late last week on the uptick in relative strength.  While it's premature to call a bottom in this group potentially given the ongoing downtrend at work, this is a healthy development for Financials and should point to an upcoming rally just as interest rates have begun to move sharply higher on the long end.  Movement back over this downtrend in relative terms to SPX (shown in white) would be a very welcome development technically for strength in Financials, which might very well start to take Technology's place, strength-wise.  So at present, an early potential buying opportunity for this group, but more work needs to be done for additional conviction