Saturday, August 15, 2015

Weekly Market Summary

Summary: Price action in US equities is weak. Two potential opportunities to kick off a rally failed this week. Despite this, short term sentiment and seasonality support a move to the upper end of the range. Ultimately, lower lows are still ahead over the coming weeks.

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US equities had two opportunities to kick off a rally this week. Neither had much follow through.

On Monday, positive breadth was 89%; days like these typically indicate strong buying interest among big investors and thus the initiation of a rally. The most recent ones were in October and December 2014 and January and February 2015, and equities rose higher each time. This one failed the next day, giving back all the gains. The last time this happened, at a low, was in the turbulent summer of 2011.

Then on Wednesday, US equites sank early but then reversed hard, rising 2% from the low. A downside rejection, to shake out weak hands, can often initiate a rally higher as investors reposition. But the next day closed lower. There was no follow through.

Since the start of the year, equities have been unable to move higher or lower. That continues to be the pattern. Until something changes, assume that the sideways pattern will dominate. The best trading odds are at the high and low edges. Right now, we are in the middle.

There's an obvious falling channel in $SPY, but there have been many of these in recent months. A break higher has marked the end of the up move. Note weekly R1 as a likely target on strength. Connect the June and July peaks and weekly R2 becomes the target on exuberance.

Our view has been that $SPY will ultimately move lower in the next few weeks or months. There is an open gap under $205 from July 10 that is only partially filled; that is unusual and suggests lower is still ahead. There is also an annual pattern where $SPY has lost more than 7% from its intraday high of the year every year since 1996, and every year except 3 since 1980. We don't want to get stubbornly stuck on the idea that either of these has to happen, but the odds are skewed in that direction. So a move to the high end of the trading range is an opportunity to lighten up or fade.

An ultimate move lower is supported by longer term measures of sentiment. BAML fund managers still hold a 42% overweight position in equities; a washout low would bring this to at least 20%. There are still 2.2 times as many Investment Intelligence bulls as there are bears; a washout low would be nearer parity. Neither of these has occurred since 2012.

But short term, we think the likelihood is in favor of equities moving to the upper end of the trading range, for two primary reasons.

First, shorter-term measures of sentiment are bearish. The 10-day ISE equity-only call/put ratio is at a decade low. Even during the 2008 meltdown, it never reached current levels. This has corresponded with a good upside risk/reward in equities (data from Sentimentrader).

Similarly, the 21-day equity-only CBOE put/call ratio is back at the highs from July 27 and at one of the highest levels in 3 years. Yes, it could go even higher, but the recent pattern has been for equities to move up, not down.

Sentimentrader also tracks a half dozen sentiment reports. Averaging these shows that investors have reached a bearish extreme from which equities have moved higher within the next month more than 80% of the time in the past 30 years. The main exceptions have been in bear markets.

That equites have struggled to move higher, with these sentiment indicators showing upside is a clear watch out. When equities can't move higher despite bearish sentiment, equites usually fall very hard, very quickly. This was last seen in August 2011.

The second reason to be biased to the upside is seasonality. August starts weak, as it did this year. But that period has passed and the middle of the month is stronger (next week starts with Day 11; data from Almanac Trader).

Moreover, the coming week is options expiration. As Northman shows, equities have had a strong propensity to rally into a short term top during options expiration.

So, the bias is for a test of the upper edge of the trading range. We don't believe the rally will be sustained for long. In the event prices move higher, the $VIX term structure will likely signal poor risk/reward.

Among the other indices, the leader, $NDX, has made a pattern of lower highs and lows since its "breakout" in July. It's now overlapping the trading range from 6 months ago. Note RSI diverging at this week's low. This is a very weak uptrend.

Small caps are in a falling channel. Its February "breakout" from the 2014 trading range has failed. The one positive is that MACD is near recent bottoms. Watch for a crossover. Also note, there is more than 2% upside within the falling channel.

The weakest is the Dow. Its in a falling channel, like RUT, and it has entirely given up the higher trading range from February through June. The positives are that it is nearing prior support from 6-8 months ago and, like RUT, the MACD is near prior lows in price. Watch for a cross, on strength.

Ironically, the meme in late-2014 was that lower oil prices would boost equities: "it's like a tax cut." History suggested this was exactly wrong, that lower oil was not a positive, and that has turned out to be the case this time as well. Has oil bottomed yet? It might be getting close, but a good risk/reward pattern hasn't set up yet. We looked at this in detail this week (here). A move up in oil would be a nice positive for equities.

We have recently looked in detail at how to trade gold (here). Price is moving higher, very slowly. The set-up is working. There's a cup with handle forming, but the overhead gap, when filled (yellow), plus the bottom of the prior trading range, will likely be solid resistance (green).

Our weekly summary table follows:

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