Sunday, November 13, 2016

Sentiment Trumps All (Pun Intended)

Last week produced the post-election rally as expected, but started a little sooner than expected with the FBI reneging on the Hillary email investigation followup Sunday afternoon.  So I missed the Friday target posted earlier on Twitter (@mrktsignals)  I admit that since April when the SPX first hit 2080, I have been a cautious bear using extra caution approaching long positions.  So now that the election is over and the Tin Man won, but none of the markets crashed outside of bonds and gold, what is next?  As expected those looking for a Trump led crash in stocks have now switched sides looking for SPX 2300-2500, but I am seeing similarities to the Nov 2015 top as well as early 2000 where GB's proposed tax cuts produced a strong rally in the DJIA even as the NDX faltered.

Over the next few weeks I hope to update my long term view ( last updated in March 2015.  The Republican victory has given much clarity to my overall bearish view as I have for several years viewed the global economy like a 6-cylinder auto engine where the US and Europe are two cylinders each, China one and the ROW the other.  Now only 4-cylinders are working with Europe sputtering and Trump is proposing switching from mid-grade to high octane fuel for two cylinders but ignoring the rest.  My bullish LT forecast previously was dependent on a resurgent Europe resulting from a much higher US dollar (and lower Euro), but Yellen prevented that from happening by also adopting a US-centric position and keeping short term rates too low.

Since this is supposed to be a stock market sentiment site I want to take a look at several long term sentiment indicators using 25, 50 and 100 day EMAs to see if LT sentiment is bullish or bearish.  First looking at the VIX term structure (VXV/VIX) since mid 2012, you can see that the SPX rallied strongly while the VTS stayed above the mean, but began to lose momentum as the VTS spent more time below the mean thru mid 2015.  Since March of 2016, the VTS has spent most of the time below the mean, pretty much the opposite to 2013 and not much support for the bulls.

The second long term measure is the volatility ETF ratio VXX/XIV.  Here we see less cyclicality chart wise, but the same overall results.  Interestingly, the pre-election dip barely moved sentiment.

Finally, in case you feel that this is just an anomaly related to volatility, take a look at the SPX 2x ETF ratio SDS/SSO.  This looks almost like an average of the previous two charts.  As a result of long term sentiment, I am going to go out on a limb and predict the same "born again bulls" that are calling for SPX 2300 and beyond similar to Nov 2015 will get an even ruder awakening over the next 9 to 12 months with the SPX falling 15 to 20 percent (and more is possible longer term depending on what happens in Europe and China).  Part of the problem is likely to be sentiment as most will look at declines of 10 to 12% as similar buying opportunities to the 2015 and 2016 declines providing less bearish sentiment.

Return to Regular Programming (from Outer Limits)

After giving a Buy signal last week, it will probably take two to four weeks of distribution for a Sell signal to form using the overall Indicator Scoreboard which has just started to turn down.  Compared to the July and December 2015 tops, this would probably mean a reading of about -8.0.

The Short Term Indicator is in much the same position and is likely to drop close to the Sell line before a significant market decline starts.

Looking at some of the other indices, the gold bugs seem completely oblivious to what is happening in the HUI and despite Avi Gilbert's call for a doubling of the GDX in 12 months a couple of weeks ago, new lows look more likely.

Finally, I've been waiting for the bond market to wake up for at least six months.  While I expected a more gradual rise in the TNX to 2.5 to 3.0% with the Dems in control, the Reps policy to cut taxes and spend baby spend like GB2 is likely to drive rates to the 3.5 to 4.0% level.  If you read the FEDs dot-plot projections for rates, you know they were planning to gradually raise ST rates to 2% with a 4% TNX, but they may end up playing catch up with the TNX.  The long period of low bearish sentiment means MEGA distribution.

Conclusion, a top of significance is near.  Some of you may have seen Tom DeMark's comments last week calling for a top next week in the DJIA at 19,400 and the SPX at 2200+ before an 11% pullback.  I don't disagree, since this matches the 2015 top in Nov where a six week consolidation was followed by the January collapse.  This time I expect a more gradual decline with timing similar to 2008, with a first quarter pullback, a spring-summer rally then a fall decline.  Here, the outcome becomes more uncertain due to several key elections in Europe that may result in increased turmoil in the EU.

Weekly Trade Alert.  None at present.  Updates possible only at @mkrtsignals.

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