Saturday, March 31, 2018

Is Another Melt Up Possible?

I am starting to get a deja vu feeling to Aug 2017 when the overwhelming consensus was that as result of Kim Jong and Trump's hurling Tweets of nuclear threats, the world was headed for nuclear war and markets would crash.  Again in mid-Jan after several months of calling for a melt up not melt down, the consensus came to my point of view and instead we had the Feb crash.  Now, the consensus is agreeing with my opinion of the last two months that the the SPX would head for the 2400s not the 3000+ target that many were looking for after the Feb correction.  So now I have to consider that the majority will again be wrong now that everyone is looking for SPX 2400 as a result of trade wars, so what happens next?

There are indications using the Dumb/Smart Money Indicators that a final flush to retest the Feb lows may occur as soon as next week.  Overwhelming bearishness in other sentiment indicators show that we are likely to start a multi-month advance soon.  Comparisons to the Aug 2017 period may be appropriate where the markets started out slow from Sep-Oct, but then accelerated to the upside in Dec-Jan.  There are indications that a positive surprise on the interest rate front may provide the catalyst for upside acceleration for Jun-July.

A new addition to the Investment Diary has been made for the Dumb Money/Smart Money Indicators.  I have added back tests for 2015 for the ETF Long Term/Short Term Indicators as well as a long term view from 2014-2018.  The LT view of the NDX Indicator gives an explanation of the cyclicality factor since the index went from a strong BUY at 3,500 in early 2014 to a strong SELL at 7,000 in late 2017.  For the NDX, the strong SELL is more indicative of the end of a bull cycle (up twice SPX %), rather than the start of a bear market since overall bearish sentiment of each ETF indicator is high.

I. Sentiment Indicators

The overall Indicator Scoreboard, considering that it started at much lower levels, has now risen as much as it did in both the flash crash and retest of 2015 and the Jan-Feb decline of 2016.  A multi-month rally should begin soon as a result.

The Short Term Indicator (VXX $ volume and Smart Beta P/C) has risen to the BUY levels, indicating that a prolonged rally could start at any time, but the lower levels indicate that the rally will not be as strong as off the Feb lows.

Bearish bond sentiment (TNX) remains very high, indicating that rates should continue to fall/consolidate for the next several weeks, a positive for stocks and gold miners.

The gold miners (HUI) bearish sentiment remains positive, but seems to be moving inversely with prices.  The HUI looks like it is setting up an inverse H&S pattern that would first target the 185-190 area.

II. Dumb Money/Smart Money Indicators

The normal Dumb Money/Smart Money Indicator continued its pattern of short term oscillations with a weak BUY at the close Tues and a weak SELL possible by Mon.  I may have to start posting updates on Twitter, time allowing.

The cyclicality component, however, is strongly positive so I am assuming that any decline will be quickly reversed.

Since the NDX seems to be the tail wagging the dog in today's market volatility, I want to look at the NDX Long Term/Short Term ETF Indicator which is pretty much in agreement with the DM/SM Indicator.  A continuation into Mon should set up a weak SELL.

The SPX Long Term/Short Term ETF Indicator seems to be stair stepping higher much as we saw in the Aug-Sep 2017 period which eventually resolved into a bullish outcome, but the end of week pullback in sentiment looks a lot like that preceding the SPX 2789 and 2801 tops.  A short term pullback seems likely next week.

III. Technical Indicators

First, just a note on the various 200 day SMAs to keep a watch on.  Ideally if there is a drop, I would like to see both the DJIA and NDX bottom close to their 200 SMAs.  Since the SPX move is usually between the DJIA and NDX, the SPX may drop 3-4%.

Current 200 SMA Difference
SPX 2,641 2,589 52 / 2%
DJIA 24,103 23,412 691 / 2.9%
NDX (fixed typos)6,581 6,268 313 / 4.8%

Second, on Tue I posted on Twitter a fractal of the Feb crash based on the two DM/SM sells of Jan 31 and Mar 15 using the highs of SPX 2830 compared to 2750, the next high was projected at 2679 (act 2675) and the next low at 2544.  Close to the same result.

Next of short term importance, there was a 9 pt drop in the SKEW Thur to 119.  Over the last year most drops to that level saw 2-4% declines.  Notably in Jan there were two occurrences, mid-month there was an SPX drop of 30 pts the next day and the second time on Jan 26 and 29 it dropped to 118+ and the SPX fell 300 pts the next few days.

Finally on the interest rate front, both the two year rate (red) and the TNX (black) have been falling recently and the implied probability of a fed funds rates hike to 2.0% in June has fallen from 36% to 8% the last two weeks.  Hence a possible positive surprise.

II. Options Open Interest

Most seem to be expecting a big selloff Mon, but strong put support at SPX 2610 and 2625 should keep the market above those levels.  a move over 2640 could go as high as 2660, and the most likely (expected) close is 2630-35.

For Wed, a Mon close below SPX 2640 is likely cause some negative delta hedging with little price support until 2570.  If prices do fall that low or lower, the expected close is 2585-90, but if 2640 holds, the expected close is 2650.

For Fri, if prices can push above 2630, there is little call resistance until 2675 with an expected close of 2660-70.

For Fri 13th, there is little call resistance until SPX 2700 with an expected close of 2700-20.

Conclusions.  It's possible we see a final plunge next week to complete the retest of the Feb lows.  Several indicators including the DM/SM, SKEW, and options OI indicate a sharp drop to SPX 2550-70 or lower may occur Tue/Wed, if so a sharp rebound to 2650 or higher is likely by Fri.  Longer term we may see a weak recovery/consolidation for a couple of months similar to the post Aug 2017 lows that may be followed by an acceleration to the upside if the Fed delays additional rate hikes in June.

Weekly Trade Alert.  A short Mon for a decline to SPX 2550-70 (or lower based on 200 SMAs of DJIA and NDX) is possible but is considered as high-risk and counter trend.  Will look for long on possible drop to SPX 2550-70 with an upside target 2650-70 by Fri.  Updates @mrktsignals.

Investment DiaryIndicator Primer,  update 2018.03.28  Dumb Money/Smart Money Indicators
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  1. Arthur, your work is excellent, thank you! Are these proprietary sentiment charts or can I make these on my own? Or are they available on a website/s?

    1. All charts that start with "Bearish Sentiment" are homemade using custom software and data compiled from and brokerage acct. SPX options and VIX Calls as well using Excel.

  2. Some of the charts are at:

    I second that comment to say that your work is very helpful Arthur