Uncomfortable, but Not Deadly

Oct. 21, 2018


Bull markets are driven by fear, and powered by fundamentals.  Bull markets end in euphoria, and weak fundamentals.  Despite the uncomfortable ride the market experienced this week, our first sentence continues to describe the present situation.

The AAII bull sentiment had its largest one week drop since November 2017.  30.6% is not a euphoric level; no bull market has ever ended with bull sentiment below 50%.

Only 6% of companies have posted results for the quarter so far, but 86% of them reported positive surprises in their EPS, and the average earnings growth is +19.1%; no bull market has ever ended with such strong growth.

Although we knew corrections were inevitable, we were surprised by the sharpness of this week's move.  Maybe we should not have been so surprised since the steepness of the move matches the corrective trading pattern of 2000 labelled C4 in the two charts below.

CHART 1

CHART 2

The next two charts show the similar steep drop (blue oval) that marked the start of the C4 correction in 2000 and which may be replicating today.

CHART 3



CHART 4



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Equities

Sentiment

(Please see Thursday's update on the AAII survey.)



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The National Association of Active Investment Managers (NAAIM) exposure index 50-week MA leads market down-turns and lags behind market up-turns. The average continues to bottom, which is not how bull markets end (chart below).

CHART 6

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. The average has made two short-term up-spikes and a third is in the process of forming. (chart below).

CHART 7

The chart below shows the put-to-call ratio at the daily-scale with the 8-day MA highlighted.





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The volatility index (VIX), by itself, has a strong inverse correlation with the S&P 500; down-spikes in the VIX correlate with market highs.

Just like the put:cal ratio, and the PE:VIX ratio, the VIX is replicating the pattern from last January's correction (and, again, the C4 correction of 2000).

It is likely that the VIX will drop back if the SPX bounces next week.

 

CHART 11




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Technical

At the monthly-scale, the technical picture has weakened somewhat, but as long as the 8-month MA stays above the 12-month MA, there is no technical damage to the bullish position.

This pattern is similar to what happened during the 1998-2000 trading period (shaded areas on the chart below). All the indicators are reacting similarly to 2000 when the SPX continued rallying after a good correction.

CHART 13

 





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Fundamental

The 10-year minus 2-year Treasury yield differential, despite spiking up and off its downward slope, remains on track to invert late this year or early next year, with the recession window opening in 2020-2021 when the Fed funds rate is scheduled to hit the maximum 3.00% mark.  This implies that the bull market is still healthy and we are only experiencing a correction.

 

CHART 15






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Gold

Just like last week, gold and copper continue to replicate their 2015 pattern. If this continues, after a near-term rally, the price of both metals will drop.

CHART 19

The Euro rallied as we had expect, gold followed along. At this point, the RSI and the stochastic continue pointing to a higher Euro, the MACD is converging to a bull cross-over, and the ADX is neutral. There is resistance overhead at the down-trend line that may stop the Euro (and gold) rally at that point.

CHART 20

 

The Yuan/gold pattern from 2017 which we are following is no longer replicating. The Yuan has dropped below support, and while the RSI and ADX are replicating the pattern, the MACD, stochastic, the gold price, and the correlation are not.

Last weekend the Chinese announced that they had cut the reserve requirement ratio for some banks in a bid to counter a deceleration in the economy. This widens the policy divergence between the Fed and the PBoC as the Fed tightens while the Chinese loosen. This caused further weakness in the Yuan, but the drop was short-lived and a quick recovery took the currency back up to meet the 50-day MA.  Gold shot higher in response, but we do not think that the Yuan will be allowed to strengthen much further, which means gold will not either.

CHART 21




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The commitments of gold futures traders showed another record net short for the money managers.  Since the data covers only Tuesday of the reporting week, it will be interesting to see what the managers did following Thursday's gold rally.  As we have been pointing out for months now, this indicator has not been working in a contrarian way.  That may change soon, but at the moment, we are not using this indicator.

CHART 24







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We wish our subscribers a profitable week ahead.

 

Regards,
ANG Traders