Health of the Market

Health of the Market (10/20/2018)

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It has been a scary market the last two weeks, and this is what the traders looked like. On Wednesday 10/3, the Dow Jones Industrials hit an all-time high and S&P 500 came close. Since then its been down dramatically. The market corrected last week, but then ended with little change. The small cap stocks led the market down ending the week down 0.34%. With the high number of new lows, a further drop to test the recent low is likely.

The indicators for the longer term equity market show a down market within a bull cycle. A switch to a bear cycle is likely next week. The S&P 500 is up 2.66% year-to-date; -5.56% since the record high; and +0.02% last week. 47.2% of S&P 500 stocks were above their 200-day exponential moving averages, up from 45.4% the week before. Only 25.8% of these stocks were above their 50-day EMAs, up from 15.0% the week before. This is a broad drop and thus may last a while.

[NC] Real gross domestic product (GDP) increased at an annual rate of 4.2 percent in the second quarter of 2018, according to the "third" estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 2.2 percent. In September Fed officials collectively estimated GDP to rise 3.1 percent in 2018, an upward revision from the 2.8 projection in June. The forecast for 2019 also moved higher by 0.1 percentage points to 2.5 percent.

[NC] As a result of the tax cut on corporations, $465 billion has been repatriated from overseas at the 15.5% tax rate. That is a lot, but there is still over $3 trillion in profits that are still parked overseas. Net investment by businesses is only 2.8% of GDP, about half what it was during the best times for U.S. productivity. The billions are going for other things like buying back shares, paying large dividends, and making huge merger-and-acquisition deals.

[NC] Lance Roberts stated on 7/20 "While I am trying to give the market as much room as possible, I am very concerned about the numerous warnings signs flashing in a variety of places from market breadth, to the yield curve, monetary policy, and earnings risk. Remember, replacing a missed opportunity to make money is easy, replacing lost capital is much more difficult."

[NC] A Health Sell Alert occurred on Wednesday 9/26 (see chart below). This is based on small-cap action. A VIX Sell Alert, based on large-cap action, occurred on Friday 10/5.

[NC] A measure to determine if the price is too high relative to the underlying earnings is the Shiller price to earning ratio. This is the current price divided by the 10-year average of "real" (inflation-adjusted) earnings. This ratio corresponds quite well to the peaks of price as shown by charts on this site.

[NC] The market in the typical October is good, after the first week or so -- not that this year's market is typical. The charts for the second year of the presidential cycle compared to all years show the second presidential year is great in October. The Power Zone, the favorable time of the year, typically starts sometime in October. Access more on the best six months in this 2017 article here. The Bull Cycle continues. The long-term BullHeal System went to a buy on 9/27/2017; it is now on a sell as of 6/29/2018.

[NC] From late March 2018 to mid August, the dollar ($USD) increased in value with respect to a basket of other currencies as long-term interest rates were hovering near recent highs. Since then the dollar has fallen. The 10-year Treasury bond rose to 3.48% on Friday 10/5, closing at 3.25%. The speed of the increase, 0.3% in a month, has spooked the stock market. The 10-year Treasury rate ($TNX /10) and $USD are shown in a 5-year chart with weekly closing prices.

[NC] The driving force between currencies is the relationship between global interest rates. The 10-Year Treasury yield remains higher than other developed-country yields. The falling dollar has a positive influence on the U.S. market, especially large cap multinationals that derive nearly half of their revenues from foreign markets.

[NC] Also shown is the CRB Commodities Index, which is a measure of inflation. This index is an unweighted geometric average of prices across 17 commodities including energy, grains, industrials, livestock, precious metals, and agriculturals. A rising dollar will hurt commodity prices.

[NC] Barry Habib on 2/27/2018 stated that the most important reason we will see higher yields is simple supply and demand. The US will need to borrow $400B more in 2018 then it did in 2017 through the sale of more Treasuries. At the same time, the Fed will curtail its reinvestment in Treasuries and Mortgage Bonds by an increasing and significant amount this year. They will buy $252B less this year in Treasuries, at the same time that $400B more supply will be issued. That's about $650B that will need to be absorbed by the open market.

[NC] The international bond market is provided by the WSJ. See the Income tab for a chart of U.S. Treasury yields.

[NC] The stock markets in other countries are quite well correlated to the U.S. market. To participate in these markets, the U.S. dollar can be hedged out. Click to check out the country hedged ETFs and the un-hedged ETFs. Note that BSE SENSEX is an India index, CAC 40 is France, FTSE 100 is a UK index, Nikkei 225 is Japan, Hang Seng is Hong Kong, DAXK is Germany, and Shanghai is, of course, Shanghai.

[NC] Sector investing via exchange traded funds (ETFs) is popular. The traders rotate between sectors. To see how some popular sector ETFs are doing, click here for the Candle Glance. Correlations of the sectors to the market (S&P 500) have been dropping. Sector fundamentals matter more now than what the overall market is doing. This is probably due to the concerns about tariffs. Correlations to the S&P 500 ETF (SPY) are now on the Candle Glance charts as is the relative strength of the sector to the SPY.

[NC] The theory is that if the small-cap stocks do better than the large-caps, it indicates that the traders are willing to take on more risk and the market will go up. The chart shows the relative strength of the Russell 2000 IWM with respect to the S&P 500 SPY. The 10/30-day EMA crossovers are marked by a pole. The U.S. Dollar is also shown. Note that when the dollar goes up, small cap stocks do better than large cap stocks -- and the relative strength chart goes up to indicate this.

[NC] The U.S. Dollar dropped from its August 14th high to the lowest level in two months on Thursday 9/20. Most of those losses are coming against European currencies like the British pound, the euro, and the Swiss franc. One side effect of a weaker dollar is a rebound in commodity prices. But the falling dollar may also be contributing to some stock rotations in the states. A strong dollar earlier in the year helped domestically-oriented small caps outperform multinationals that are more closely tied to the global economy. A weaker dollar has the opposite effect. [John Murphy 9/20/18]

The S&P 500 large-cap index hit an all-time high on Friday 9/21 with very high volume and almost went there again on Wednesday 10/3. Since then a 7.8% drop occurred before a correction and consolidation -- a very volatile one. Note the drops have been on higher volume than the corrections. It is likely that the index will fall to the support level indicated.

The Russell 2000 small-cap index hit an all-time high on Friday 8/31. Since then there has been an 11.6% drop that is significantly below its 200-day moving average. The index got a bounce and a retracement to the area of the lows. It is likely to go lower.

The technology-heavy Nasdaq composite index came close to a new high and then dropped 9.5% on high volume and went below its 200-day MA. It corrected and then is moving down again. Only 18.9% of Nasdaq stocks are above their 50-day moving averages (up from 17.0% last Friday).

[NC] The S&P 500 exchange-traded fund closing price is shown with its Bollinger Bands below. The bands are two standard deviations above & below a 20-day simple moving average. When the price goes above or near the upper Bollinger Band a downswing in price is likely as the market is overbought. Similarly, when the price goes below the lower band, an upswing is likely.

[NC] Also shown is the 21-day Money Flow Index. This is an oscillator that uses both price and volume to measure buying and selling pressure. A green pole is marked when the MFI moves above 50 indicating a good time to buy. If the MFI hits the oversold level at 20 (green dashed pole not on chart), it might be a better time to buy. A red dashed pole when the MFI comes down from around 80 might be good time to lock in some profit. A solid red pole when MFI goes below 50 indicates selling might protect from a downswing.

Health Alert

[NC] Below is the Russell 2000 small-cap index that tends to lead the overall market both up and down -- as the small-cap stocks are generally more risky than large cap stocks. This index is shown with high-low-close bars. It's 50 and 200-day simple moving averages are included. The 200-day moving average often acts as support or resistance to price movement as many traders watch it.

[NC] The Health Alert is based on the momentum of the small-cap Russell 2000 index, the Nasdaq breadth data, and the Nasdaq 52-week new highs and new lows. The thresholds are described below. The green buy and red sell 'alert' poles on the chart show when these alerts have occurred.

[NC] A Health Sell Alert occurred on Wednesday 9/26. Then the 21-day RSI dropped below 49. The small cap stock index is used here as small-caps have tended to lead the market both down and up.

[NC] The second pane is the Relative Strength Indicator (RSI) for the Russell index, a measure of momentum of the market. This is the relative strength of the Russell 2000 itself -- it's not relative to any other index. Above 50 shows positive momentum over the last 21 days. The latest plot can be seen by clicking here. The green arrows indicate a positive change in momentum as the RSI crosses above 50; red arrows indicate downward momentum when the RSI crosses 49. The threshold of 49 is used to give a more definite indication of the start of a down-swing.

[NC] The third pane is the Nasdaq McClellan Summation Index, $NASI, (red) and it's 5-day exponential MA (blue). This is a running sum of the difference of two moving averages of the number of advancing issues minus the number of declining issues. A 19-day and a 39-day exponential moving average (EMA) are used. This shows whether a market move is broad based. As the trend changes, the red index will cross the blue EMA and an arrow will be drawn. This indicator must be consistent with the RSI before an alert pole is drawn on the price chart. When this index is below the 5-day EMA, and a 'sell alert' has not occurred, this is a warning not to purchase new positions, but to HOLD those that were bought earlier on the 'buy alert'.

[NC] Dr. Alexander Elder in his book Trading for a Living says that the 52-week New Highs minus New Lows Index is "probably the best leading indicator of the stock market". This display for the Nasdaq market shows the this index in pink. The 3-day MA of the NH-NL index is shown in blue. A green arrow is placed if the 3-day MA of the NH-NL index goes positive for three consecutive days, or a red arrow is placed if the MA goes negative for three consecutive days. To see a summation of the NH-NL numbers, click here. When a green buy arrow is put on the price chart, it indicates a Health 'buy alert', if the other indicators concur. The red sell arrows here are not used in the determination to place a sell pole on the price chart, due to the lag.

[NC] The Health Alert acts as a confirmation and does not do well as a stand-alone signal for buying and selling. After a long trend, it works well to signal the end of the trend.

Long-Term Overview

[NC] This chart gives an overview of the situation. The market had done well since the termination of the QE3 Fed bond buying, until the last half of 2015. The 10-year Treasury rates moved down even when the Fed raised the over-night Federal Funds Rate in December 2015. There have been eight 1/4 point rate increases, the last two in June and September of 2018. Now there is an expectation of one more in 2018 and three in 2019. The Fed has been continuously reducing their inventory of bonds. See more here. A chart of various Treasury yields since 1962 are shown on the Income tab.

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The source of the charts is located on the upper right of the chart. This page is for amusement only, and should not be taken as advice to buy or sell anything.