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?

Blow Off

I will be the first to admit that my call last week for further consolidation was wrong as the SPX followed European markets higher last week after the "No" vote on the Italian referendum.  The breakout over the previous high last month at SPX 2014 produced what can only be described as panic buying or a blow off.  I mentioned a couple of weeks ago a Tom DeMark prediction of the same type of market action, but it was still somewhat unexpected.  Given that the Indicator Scoreboard has reached the SELL point, but that the Short Term Indicator remains in the murky middle ground, I can only say that more gains are possible, but it is likely a terminal rally.

Before discussing this week's sentiment outlook, I want to mention that the update for my long term forecast is out, What Happens When Growth Returns?

The overall Indicator Scoreboard has reached an extremely low bearish level seen only twice the last two years, where the November 2015 high was followed by a volatile six weeks before the sharp January decline and the July 2016 high produced a rounded top with a moderate decline. 

The short term SPX ETF ratio of SPXU/UPRO continues to look more like the six months preceding the August 2015 crash where only a few brief instances were seen of more funds flowing into shorts than longs.

The Short Term Indicator  (VXX $ volume and Smart Beta P/C) shows that bears are still fighting this rally as hedging by VXX and ETF put buyers still lends a modest support for stock prices.  Compared to the August and November 2015 highs, a decline to about -.5 for the 5Dy EMA and -.4 for the 10Dy EMA is expected.

Disbelief in the stock market rally is being matched by renewed safe haven demand for bonds as fund flows into the long TLT ETF continue to exceed those into the short TBT ETF.  The argument that money is flowing out of bonds and into stocks doesn't seem to hold water.  The last drop in bearish sentiment this steep was in August 2015 as rates fell from 2.4% to 2.0%, and the fact the rates have consolidated at the highs looks very bearish for bonds.  Other measures for NDX, RUT and HUI have shown little change in sentiment.

Conclusion.  The last two years I was expecting a December rally that would last into the first of January, so maybe this is the year.  Although sentiment points to much higher interest rates over the next year, until a break and hold over 2.5% on the TNX is seen, the outcome is unclear.  The only time I can remember when stocks rallied with rates rising strongly was 1987.  In 1987, the DJIA rallied 20% the first six months until the dividend yield approached 50% of the TNX yield, then the second half of the year stocks fell 40%.

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

Watching the Grass Grow

... is how I feel at this stage of every rally.  The bulls call it a pause to refresh when sideline cash is building up for the next rally phase, while the bears look at it as a period when smart money that loaded up on shares during the panic before the rally sell to the dumb money that buys after the rally based some mythical belief in Goldilocks and the fairies, this time the ethereal Santa Clause rally.  Yes, the rally was impressive up over 5% in one month, but we have seen this many times over the last two years, and in fact the November 2014 high was at SPX 2080, the same as the start of this rally, so the SPX is up a little over 5% in two years.  Does this really mean the market will rally 15-20% in the next twelve months?.
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This is why I find sentiment so refreshing compared to straight line predictions or straight line with wiggles predictions, when everyone is in, you get a top and when everyone is out, you get a bottom.  The only question is how to measure investor commitment, and the weakness of course is that areas in the middle are not clearly defined. 

So enough philosophy, but since there is little change in sentiment outside of bonds, I needed something to fill up the space.  The overall sentiment Indicator Scoreboard has now reached a level close to an official SELL over the last two years, so it's doubtful that we see much of Santa this year.

The Short Term Indicator  (VXX $ volume and Smart Beta P/C) is still moving down at a leisurely pace and may see further decline before risk is high of a significant stock market downturn.  One other factor still missing is a swelling in the VIX call buying as smart money prepares for an increase in volatility.  December 2015 saw several days at twice normal volume starting mid-month.

The SPX ETF measure SPXU/UPRO remains at levels consistent with a SELL, while the NDX measure SQQQ/TQQQ shows only a minimal bounce with the recent sharp decline.  The gold bugs HUI measure DUST/NUGT is showing a slight drop in bearishness.

The bond/interest rate sentiment measure for the TNX using TBT/TLT is probably the most interesting change for the week.  After increasing 1.0% over the last four months and 0.7% after the election, a modest decline from 2.49% to 2.39% was met by a flood money into TLT as volume more than doubled while TBT volume was only up 50%.  This resulted in bearish sentiment dropping to almost neutral and is likely to see the eager BTFD buyers being neutered.  I stand by my S/T target (1-2 months) of 2.8% as a break of 2.5% seems more likely to create enough bearish sentiment for a S/T top in rates.

Conclusion.   If Trump was wearing a red suit and had a beard, I would say we just finished the Santa Clause rally early this year, just like the last two years.  More consolidation likely. 

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

Up,Up and Away

... at least that's you are led to believe by nearly all of the market pundits.  While I was one of the few calling for a post-election rally early November based on extreme bearish sentiment, intermediate indicators are now warning that an end is near.

Today, I will be looking at a variety of indicators, including a last look at the the IBB (biotech) which I plan to replace with the banking sector BKX (FAS and FAZ ETFs) due to the resurgence in interest rates.  The overall Indicator Scoreboard has almost completed a 180 degree turn from before the election, having surpassed the low bearish sentiment before the August 2015 and January 2016 declines, but still above an official SELL signal.

The Short Term Indicator (VXX $ volume and Smart Beta P/C) has been falling even more slowly, mostly due to the Smart Beta P/C (ETF Puts/Equity Calls), leaving me to expect more time is required before a significant decline is seen.

The SPX 2x ETF ratio, SPXU/UPRO, is probably the closest indicator to giving a SELL since the short term EMA has reached the lowest level in two years, while the longer term EMAs may have further to decline.

The 3x NDX ETF ratio SQQQ/TQQQ is also approaching the lowest level of bearish sentiment for the last two years, leaving the potential for a H&S as a strong possibility for this sector.

The outsize reaction of the small cap index RUT to the rest of the market is understandable when you consider that the proposed 20-25% corporate tax rate would allow small businesses to pay the same tax rate the large corporations have been paying for 20 years or more thru the use of foreign subsidiaries.  Surprisingly, bearish sentiment (TZA/TNA) is still moderate, supporting further gains for this sector short term.

The gold bugs HUI index is in a precarious position as sentiment (DUST/NUGT) is less bearish than May of 2015 when from the same level as today at 180, a waterfall decline began taking the index down to 100 over a three month period.  A repeat performance may be in order the first quarter 2017 if talks begin of additional FED rate hikes.

Bonds, unlike gold stocks, have seen a sharp rise in bearish sentiment.  However, the current bearish level is equal to the April 2015 period after rates rose to 2.1% before rising to 2.5%.  This leads me to believe rates may rise to 2.8% short term.  But longer term, my belief that long periods of over bought (below mean) are matched by long periods of over sold (above mean) means the next 12 months will be rough for bonds (see gold stocks sentiment cycle).

Finally, without explanation the IBB, although this may just be an example of the long term sentiment cycle.

Conclusion.  Not much change from my Nov 6 post on the expectation of a fast and furious post-election rally lasting two to four weeks followed by a sharp decline of 15-20% in the SPX over the next 9-12 months starting by EOY.

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

The Lonely Bear

I'm starting to feel a lot like I did last Nov when everyone was predicting SPX 2300 by EOY and higher beyond and I was warning of an SPX 10% or more correction in Dec-Jan due to problems from China.  Even Pretzel Logic has seemingly thrown in the towel, although I don't completely disagree that higher highs may be seen longer term but only after the born again bulls are predicting SPX 1100-1200 like they were in Feb-Mar.  My position on gold, however, has radically changed from last Nov when I was predicting a 50% or more rally in gold stocks, but now see a continued decline as likely over the next 9-12 months.

I did not develop my two main composite indicators, the overall weighted Indicator Scoreboard and the Short Term Composite (VXX $ Volume and Smart Beta P/C) until May, but today I want to back test these indicators to compare the positions at the end of 2015 to today.

The Indicator Scoreboard from 2015 showed similar behavior in bearish sentiment before both the August 2015 plunge and the December 2015 selloff with an initial SELL (at -10) followed by a rise and short covering rally then a decline in bearish sentiment to a less bearish -8.0.

Now comparing this to the 2016 Indicator Scoreboard, we can see a similar pattern from July through November 2016.  In fact, the overall Indicator Scoreboard is in the same position as at the end of Dec 2015 immediately before the January plunge.

The Short Term Indicator shows a slightly different story, however.  Following short covering rallies in 2015 the STI dropped to the -.40 level before both the August plunge and the December top and even in Oct 2014 had dropped down to the -.20 level.

So far in Nov 2016, however, the STI has not even reached the .00 level and it is likely that a drop to -.30 to -.40 occur before a significant pullback.

One other indicator that I have been watching for confirmation of a top is the bipolar VIX P/C which can see upward spikes when smart money bets on volatility declines at market bottoms or when dumb money bets on volatility declines at market tops.  This time we saw both with a pre-election spike by smart money followed a week later by a dumb money spike betting on continued volatility declines.  The later confirms a top as in the May, August and December tops of 2015.

Conclusion. A significant top may be in (Indicator Scoreboard), but a significant decline is not imminent (Short Term Indicator).

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

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 (arthurk024.wordpress.com) 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.

Setup for a Bounce or More?

First, I want to thank the loyal readers since I first started this journey a year ago October.  Many thought my contrarian approach was too left field, but the last few weeks have seen over 3,000 page views a week, so I must be doing something right.  I was also able to provide some timely updates last week at twitter.com/mrktsignals

The past week saw a fairly strong rise in some of the bearish sentiment indicators, especially those related to options as the VIX has risen to the highest level since the BREXIT in June (22 now vs 26 then) and so have put/call ratios.  Oddly other measures, especially the money flow measures (SPXU/UPRO) have barely budged.  This leads me to believe that we are likely to see what John Hussman called several years ago, "a fast and furious short-covering rally that is prone to fail", rather than the 5th wave blowoff to SPX 2300 or 2500 that many EWers are looking for.

So let's start by looking at an update of two of the short term measures I mentioned last week. The Short Term Indicator (VXX $ volume and Smart Beta P/C) is not at levels seen during BREXIT but has reached the levels of early Feb and Oct.

The 3x SPX etf ratio SPXU/UPRO has struggled to reach the mean, showing that outside the options market, investors remain unconcerned about the current pullback.  This leads me to believe that a sharp post-election rally is likely but it is not likely to have much follow through and may not make it above the SPX 2160-2180 level.

The tech sector which I mentioned two weeks ago as having extremely low intermediate term bearish sentiment has almost gone into crash mode with even less concern by investors as measured by the short term SQQQ/TQQQ ratio.

Finally, switching to the intermediate term view, the overall Indicator Scoreboard has almost reached levels seen at the June 2015 lows before the final rally of mid-2015.

One other thing I should cover for those looking for a safe have in gold stocks is an update of the HUI etf ratio DUST/NUGT.  Other than for very short term plays, the sentiment picture here is not much better than for the NDX.

Conclusion.  Short term rally but not much more.  I want to enter a long position Mon-Tues around SPX 2080 with a target of 2160.  If the H&S pattern in the NDX holds, the SPX should top out in two to four weeks and be in full decline by late December.

Weekly Trade Alert.  Long SPX around 2080, stop 2065, target 2160.