Closer Than You Think

The Fed seems to have finally noticed the rise in interest rates (TNX) by not only increasing the Federal Funds rate to .50%, but also increasing the expected hikes next year to three.  As I mentioned a couple of weeks ago the Fed's dot plot forecasts future rates with the FF rate about 2% below the TNX rate.  If I am right and the TNX rises to 3.5% or higher by the Fall, this means four rate hikes are likely for 2017  Gold stocks and bonds reacted as expected with the TNX breaking over 2.5% and the HUI and GDX dropping over 10% or about 25% of the entire decline I expect for next year.  The surprise was the big yawn shown by sentiment, indicating more downside ahead.

Looking at the overall Sentiment Scoreboard for the SPX, the 20 day EMA has now broken the SELL line, reaching the lowest level seen the last two years.  This supports my view of a more serious decline than seen recently which may be less intense in volatility, but stretching over a much longer period in time. 

The Short Term Indicator  (VXX $ volume and Smart Beta P/C) has finally started to show signs of capitulation with a flat to down week even with the volatility induced by the Fed.  I remember a few (or longer) years ago when the market held up into the end of the year and began the new year with a pop and drop that lasted most of the year; we may see a repeat.

Bonds (TNX) have continued to follow my sentiment calls closely with the breakout in rates over 2.5%  last week following the sharp decline in  bearish sentiment the week prior.  The surprising aspect is that bearish sentiment only recovered half of the drop from the previous week, while rates increased by more than twice the previous drop in rates - a very bearish sign.

Gold stocks (HUI) were even more surprising than bonds.  This is the third sharp drop in gold stocks over the past several months, having retraced two-thirds of its early 2016 run-up, but bearish sentiment can not rise over the mean.  I can understand the somewhat faulty logic, "if gold is worth $1,500 with no inflation then it will be worth more when inflation rises."  There is even now a "contrarian" argument being made for bonds and gold in a recent article by Tom Mcclellan.  With the recent trend in sentiment, we may see GDX in single digits and a new low for the HUI (80s) by mid or late 2017.

Conclusion.  Bonds and gold continue to follow my sentiment guide lines for lower prices, while the SPX is lagging but is likely to start playing catch up in the next two to three weeks.

Weekly Trade Alert.  None. Updates @mrktsignals if necessary.

If you want to know why I think rising rates are bearish for stocks and gold, read my long term forecast What Happens When Growth Returns?