Cartoonish Reason

 

Humans have evolved a characteristic need to assign ‘cause’ to events in the environment, so it is not surprising that every time the stock market makes a move, a cacophony of ‘reasons’ for the move surfaces in the financial media.

Last Friday at 7:00 a.m., during pre-market trading, the talking heads were already telling us that the market was down because the Fed statement from two days prior, while not raising interest rates, had reaffirmed the intent to normalize rates. What makes this assertion almost cartoonish in nature is the fact that the Fed has been telegraphing the intention to raise rates for the past two years, while the market has rallied 40%. The financial commentators expect us to believe that after two years of having this knowledge, the market suddenly decides on Friday morning that rising rates will kill the market. And they get paid to verbalize this clueless-nonsense.

The market reacts inconsistently to news, both fundamental and Geopolitical, and is, therefore, totally useless when trying to analyze the market. Only historically-repetitive patterns are of value when analyzing the market.

 

Equities

Sentiment

The AAII sentiment survey showed an increase in bull sentiment and decrease in bear sentiment again this week, but the levels continue to be outside of the thresholds of 50% and 30% bullish and bearish, respectively.  The odds of a bear market developing with these levels of fear are very low.

 

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The put-to-call ratio has a strong negative-correlation with the SPX; down-spikes in the 8-week MA indicate local market tops, while up-spikes indicate local bottoms.

After making an up-spike that marked the October low, the put-to-call ratio has again increased this past week.  This could mean that the SPX has formed a local maximum (down-spike) and is headed lower soon.

 

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The bear-to-bull asset allocation of the Rydex family of funds, has a strong inverse correlation with the SPX; a declining 36-week MA in the Rydex ratio is bullish for the SPX. Down-spikes in the ratio, correspond with tops in the market. In other Weekly Summaries, we have pointed out the similarity in trading patterns of the current bull market, with those of the tech bull market of 2000. During the later-stages of the tech rally, the Rydex ratio (nominal) made a down-spike early in 2000, but the 36-week MA continued to move lower while the SPX moved higher for another six-months before hitting its second (and final) high, and the Rydex ratio made its second (and final) down spike, after which, the 36-week MA started to rise as the S&P 500 corrected itself into a bear market.

What we wrote a couple of weeks ago still holds:

Despite the fact that we have many reasons to think that this is not the start of a bear market, the behavior of the Rydex bear:bull asset allocation ratio is starting to worry us. Each time that the nominal ratio value made a double down-spike and the 36-week MA started rising, the SPX corrected into either a bear market (2000), or into a significant local correction (2011 and 2015). That is the situation we are in now; the nominal ratio has formed a double down-spike, and the 36-month MA is starting to rise.

In 2011, the market corrected -19%, in 2015 it went down -14%, and as of this past Friday, the market is down almost -10%. The market could end up correcting down to meet the long-term trend-line in the 2400-2450 area which would result in a -17% correction. The bull market would not necessarily be over at that point (just like it wasn't over in 2011 or 2015), but it would be a painful correction.

The possibility that the market pulls back toward the long-term trend-line is still very much alive.  We continue to monitor this.

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The VIX continued to back off the recent high.  Even if it goes temporarily higher, the trend pattern (green dash-arrows) is one of lower VIX readings over the medium term.  The 38% Fibonacci retrace of the February to October rally at 2800 is the next resistance which is what makes us think there could be some more upside before turning around.

 

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Technical

 

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The long-term (monthly) situation has improved from what it was two weeks ago; the important 8-month and 12-month MAs are no longer converging and the the SPX has risen above both of them.

The behavior of the market is very similar to 1998 (pink rectangular areas below).  Take note that from the low on the S&P 500 in 1998 (957) to the high two-years later (1517) represents a 59% increase.  The fractal nature of the trading patterns from 2000 that we are following, allow for a significant rise over the next year or two.

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Fundamental

Industrial production is still increasing.

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The velocity of M2 is finally increasing from a historically low level.  Bear markets have not started while the velocity was increasing.

The 10y-2y rate differential and the unemployment rate are both still positive. No recession is likely to materialize in the next 6 to 12-months.

 

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Gold

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Gold still has further to fall in order to match silver's correction.

The USD/JPY pair is in an overall uptrend and after having come off a technically over-bought position has started moving higher again. This should put pressure on gold.

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The correlation between the dollar and gold has returned to negative, as have the gold/rates correlations.  The upward bias of rates is expected to continue putting upward pressure on the dollar and downward pressure on gold.

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Last week we wrote:

The short-term technical situation is neutral, to slightly negative. The MACD has made a bear cross-over, and the stochastic has dropped out of over-bought territory, but the RSI and the ADX are both neutral. Gold is trapped between $1220 support and $1240 resistance. We think a breakout to the downside is more probable.

Gold did breakout to close below both the $1210-$1220 support and the 50-day MA.  Technically, there is still more downside possible for gold as the MACD, RSI, and stochastic all head lower.  The next line of support is at $1200 followed by $1170.

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We wish our subscribers a profitable week ahead.