Market Timing Models – History does not Repeat itself, but it Often Rhymes.

Today’s report will focus on the S&P 500, the current advance and a future scenario. I am focused on the S&P 500, and SPY by extension, because this index is the driving force in the stock market. It accounts for some 80% of the US equity market and is the most widely followed benchmark for US stocks. Small-caps and mid-caps are more likely to follow the S&P 500, not the other way around.

The broad market environment sets the stage and the S&P 500 is the main driver here. Most stocks and equity-related ETFs will be affected by the long-term and short-term trends for the S&P 500. Get the S&P 500 correct and your chances of getting the ETF or stock pick correct increase. Not many stocks and equity-related ETFs will move counter to the S&P 500.

There is nothing to add as far as the bigger trend is concerned. It is up and strong. The S&P 500 is up 8.58% since early October and up ten of the last eleven weeks. It is an extraordinary run, but the index has yet to go parabolic and signal a blow-off top. I am not predicting a parabolic move, but it is certainly possible and it happen just two years ago.

Holiday Scheduling

The NYSE and Nasdaq will close at 1PM ET on December 24th (Tuesday) and close completely on December 25 (Wednesday). Volume levels will be light next week and I do not expect much change in the overall patterns at work. This is a good time for all of us to spend some time with friends, family and loved ones. Next week TrendInvestorPro will only publish on Friday (December 27th). I will publish a condensed version of the ETF Grouping and Ranking Report, update the ChartBook and provide a video that day. Merry Christmas!!

Learning from the Last Parabolic Move

Before looking at the current S&P 500 charts, let’s review the situation in January 2018. The red zone on the chart below shows the index going parabolic with a four week surge that began on January 2nd 2018. By early January, the index was already up around 10% after a strong advance from mid August to late December. Notice how the index stalled into year end with a flag and then broke out on the first trading day of 2018. The index then added another 7.5% with a parabolic move the next four weeks.  

Chartists can measure the parabolic nature of a move using the Percentage Price Oscillator, which measures the distance between two EMAs. The PPO(1,200,0) measures the distance between the 1-day EMA (close) and the 200-day EMA. Notice that the close was over 10% above the 200-day EMA from mid to late January. This is extreme. For reference. Also notice that the 50-day ROC exceeded 10% in late January. This is also extreme.

Weekly Gains Still Contained

The next chart shows weekly candles for the S&P 500 SPDR. The Ascending Triangle still dominates the chart and the breakout extended from the 302 area to the 321 area. This advance, while strong and getting extended, does not seem to be parabolic at this stage. Price is around 8% above the 40-week EMA and we have yet to see outsized gains on a weekly basis. In January 2018, the weekly Rate-of-Change exceeded 2% twice and the advance ended with a 2.2% surge. Thus, watch out if this advance accelerates in January.

I am not going to start marking support levels to watch going forward because there are no signs that a pullback is starting or a reversal is in the making. I could mark broken resistance as the first support level in the 302 area or use the rising 40-week SMA to mark, but these levels are still quite far away so it does not make sense right now.

Going back again, notice how it took the index some 15 weeks to stabilize after the parabolic move. In addition, the rising 40-week SMA held in early 2018 when SPY corrected. Yes, the index pierced this SMA at least seven times and even closed below it twice (on a weekly basis). This SMA and support levels are not exact and should be treated more as zones to watch on pullbacks, should we get one in the coming weeks or months.

History does not repeat itself, but it often rhymes
-usually attributed to Mark Twain

Identifying the Reversal

Now let’s see how this parabolic advance reversed in 2018. The chart below shows the S&P 500 with three familiar indicators: the 1-day Rate-of-Change, the 2-day Average True Range (ATR) and S&P 500 %Above 20-day EMA (!GT20SPX). I use the 1-day Rate-of-Change to look for an outsized decline (< -1%). ATR(2) is used to measure volatility and a move above 30 signals an uptick in volatility, which is potentially negative. %Above 20-day EMA is used to measure short-term participation.

The parabolic advance reversed on January 30th with a gap down and 1-day decline that was more than 1%. This was a breakaway gap punctuated by the largest 1-day decline since August. Also notice that the largest 1-day Rate-of-Change in several months marked the exact high. This is why we must be careful when SPX is already extended and the advance accelerates even more. It is called a blow-off top.

SPX stalled for two days after the outsized decline and then continued lower with a very sharp move on February 2nd. ATR(2) then moved above 30 and %Above 20-day EMA fell below 50%. There was not much time to react because the index fell over 4% the very next day.  

Current Situation

The next chart shows these indicators for the current SPY chart. Note that these indicators are not that great for identifying bullish reversals, but I think they can help identify bearish reversals after an extended advance with low volatility, which is what we have now. There was a blip in early December when ATR(2) moved above 30 and %Above 20-day EMA moved below 50%, but the 1-day ROC did not dip below -1% to show an outsized decline. It is the outsized decline that shows a sudden increase in selling pressure.

Index Breadth Model Remains Bullish

Unsurprisingly, there is no change in the Index Breadth Model. 5 of the 9 indicators have been bullish since early September and 8 of the 9 are currently bullish. S&P SmallCap 600 High-Low% ($SMLHLP) continues to drag its feet as the only indicator that has yet to trigger bullish. A move above +10% is needed for a bullish signal.

The chart below shows the percentage of stocks above the 200-day EMA for the S&P 500, S&P MidCap 400 and S&P SmallCap 600. A move above 60% triggers the indicator bullish, while a move below triggers bearish. S&P 500 %Above 200-day EMA (!GT200SPX) has been bullish since early February, S&P 400 %Above 200-day EMA (!GT200MID) has been bullish since early September and S&P 600 %Above 200-day EMA (!GT200SML) joined the party in late October. All three are above 65% and strong.

Click here for an article and video explaining the indicators, signals and methodology used in the Index Breadth Model. This article also includes the signals of the last five years.

Sector Breadth Model Gets New Signal

The Sector Breadth Model added a small notch to its bullish configuration with another bullish signal. The 10-day EMA of XLE AD Percent ($XLEADP) moved above +30% for a bullish breadth thrust. More on Energy below. For now, note that five of the six largest sectors have been net bullish since early September (Technology, Healthcare, Finance, Consumer Discretionary and Industrials). Communication Services turned bullish on October 22nd and broke out to new high recently. Broad market trouble does not start until three of these big sectors turn net bearish.

Energy Still Lacking Follow Through Signal

The next chart shows the Energy SPDR and the three breadth indicators. First, note that these indicators have been net bearish since early May. Second, notice that the 10-day EMA of Advance-Decline Percent moved above +30% at least four times since June (bullish signal). This is the most sensitive of the three indicators. XLE High-Low% ($XLEHLP) has been on a bearish signal since October 2018 and Energy %Above 200-day EMA (!GT200XLE) has been bearish since early May. The latter two indicators take longer to trigger and represent the “follow through” signal needed to turn the sector net bullish.

Fed Assets Continue to Increase

Fed Assets continue to expand at a serious clip. The balance sheet went from $3.76 trillion to $4.14 trillion in 16 weeks (starting in early September). The balance sheet increased 15 of the last 16 weeks and the System Open Market Account (SOMA) increased 13 of the last 16 weeks. Forget what the Fed says and watch what the Fed does. The Fed is providing liquidity (punch bowl) and this is positive for stocks. Don’t fight the Fed.

Bottom Line: Bull Market Environment

The evidence remains stacked in favor of the bulls as we head into year-end. The tape is clearly bullish with the S&P 500 SPDR, S&P MidCap 400 SPDR and Russell 2000 ETF hitting new highs this week.  Seasonal patterns are bullish and the Fed has the punch bowl out.

Stock market strength is broad and broadening. Small-caps are coming alive with new highs in the Small-cap Tech ETF (PSCT), Small-cap Industrials ETF (PSCI), Small-cap Finance ETF (PSCF) and Small-cap Consumer Discretionary ETF (PSCD). Also note that seven of the ten equal-weight sector ETFs also hit new highs the last five days.

I have yet to see signs that the S&P 500 is punch drunk (parabolic). Moreover, the breakouts in MDY and IWM are still relatively fresh (4-5 weeks). Predicting a short-term bearish reversal seems unwise when the bigger forces at work are clearly bullish and the advance has yet to get seriously frothy. As noted on the chart two years ago, we could see a lull in the next week or so and then perhaps a resumption in early January.

Thanks for tuning in and Happy Friday!

-Arthur Hill, CMT
Choose a Strategy, Develop a Plan and Follow a Process

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