Friday's Trump tirade somewhat upstaged my "'unintended consequences" topic which is basically that Trump's trade war has lowered growth outlook for our trade partners, namely China, EU and Japan. The result has been weakness in our partners currencies due to growth concerns and strength in the dollar. Trump of course blames this on currency manipulation, but it is hard to believe that all three are colluding. The "'unintended consequence" is that dollar strength offsets the effects of the tariffs. Consider that initially one $US equals one EU. You buy something that costs 100 EU and pay with 100 $. Add a 10% tariff and the cost is 110 EU, but if the $US increases by 10% then 100 $ equals 110 EU and the price remains 100 $US. The Urban Carmel makes an argument that the $US is topping, but I am not so sure. A strong dollar will reduce the stagflationary effects of tariffs and also keep interest rates (TXN) low, while as we saw on Friday a weak dollar is likely to push int rates higher.
I. Sentiment Indicators
The overall Indicator Scoreboard (INT term, outlook two to four months) continued to fall, dropping below the May topping period which saw an SPX 70 pt drop.
After tweaking my software to make it easier graphing composites, I noticed that the ST view of the Indicator Scoreboard (ST, outlook two to four weeks) has done a good job of the monthly cycles in 2018.
The INT view of the Short Term Indicator (VXX $ volume and Smart Beta P/C, outlook two to four months) has also dropped to the level of the May top
It's hard to tell if Friday's jump in rates (TNX) was due to a falling dollar or low bearish bond sentiment. My feeling is that continued dollar strength makes US T-bonds more attractive to foreign buyers, and less attractive for dollar weakness.
For the INT outlook with LT still negative, the gold miners (HUI) bearish sentiment fell sharply with high vol in NUGT on down days last week. The last two times sentiment was this extreme was Jan and Jul of 2017. The Jul rally was caused by a sharp drop in the dollar as seen here. If the Urban Carmel is correct, the dollar may drop, but this not what I expect.
The Risk Aversion/Risk Preference Indicator (SPX 2x ETF sentiment/NDX ETF sentiment, outlook 2 to 4 days/hours) as a very ST indicator has now dropped down to close to the June SPX top on the longer EMAs and may be as low as it goes. Now on SELL.
The option-based Dumb Money/Smart Money Indicator as short/INT term (outlook 2 to 4 days/weeks) dropped sharply Thur reaching the SELL level of May before rebounding Fri.
The INT term SPX Long Term/Short Term ETFs (outlook two to four weeks) fell sharply last week due to strong buying by the dumb money (2x) ETFs with the ST EMAs nearing the SELL level. Considering the drop from recent highs close enough for a SELL.
Looking at the SPX smart money (3x) ETF sentiment back to 2015, seems to have bottomed half way between neutral and SELL. Comparing this to Dec 2015, a spike lower seems necessary for a top, implying that a new high is likely after the next pullback. Since the Nov 2015 high was within 1% of the May 2015 top, this could mean SPX 2850 for a larger top.
The INT term NDX Long Term/Short Term ETF Indicator (outlook two to four weeks) rose last week, but due to strong buying by smart money (3x) ETFs. This is not as bullish as it seems as shown in the next chart.
The NDX smart money (3x) ETFs have been the last to buy into this rally and sentiment has now reached the level of early Nov 2015. Other than the Aug 2015 flash crash, most significant pullbacks were preceded by SELLs. Once dumb and smart money buy, everyone is "all in", so no one is left to buy.
III. Options Open Interest
Using Thurs close, remember that further out time frames are more likely to change over time. This week I will look out thru the EOM, Jul 31.
For Mon the SPX setup is similar to last week (2770-80) which ran to 2794, this time the large put hedge at 2800 should support prices into the close. The calls at 2790 may cause a weak open, but the low call resistance below 2820 makes a run higher more likely. Best guess is a small range 2800-10.
For Wed, SPX 2800 put support becomes call resistance where a move below 2800 finds first support at 2785 then 2760.
For Fri, very large call resistance above SPX 2810 may dampen prices during the week and the first large put support is 2750, and a close between 2750-75 is likely.
For Jul 31 EOM, has similar large open int below SPX 2800, where call resistance is likely to keep prices below 2780, and the hedges (overlaps) at 2750 and 2725 may act as magnets to pull prices lower. Possible to see a washout as low as 2700 before recovery back toward 2750.
Conclusions. While last week was expected to go nowhere, the next week and a half is likely to surprise to the downside. SPX and NDX 3x ETFs indicate, however, that a final rally may be in the works before a larger correction. The US dollar may hold the key to both inflation, interest rates and precious metals, and although others are calling for a top in the US $, I am at least 60/40 leaning towards continued strength. SPX options open int show downward guidelines after Mon with Wed targeting the 2760-85 range, Fri the 2750-75 range and Jul 31 EOM a likely 2700-50 washout.
Weekly Trade Alert. Last week did not see the SELL setup expected, although a top was reached in the expected timeframe (Wed/Thu). Next week should give a final shorting oppty in the SPX 2800-10 area with 2750-60 expected by Fri and possibly 2725 the following week. Updates @mrktsignals.
Investment Diary, Indicator Primer, update 2018.03.28 Dumb Money/Smart Money Indicators
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