Market Timing Models – The Rock, a Hard Place and Choppy Seas

Overview and Bottom Line

A battle royale is brewing as the long-term downtrends battle the short-term uptrends. Hmm, think I will bet on the heaviest fighter. Today we will try to handicap the winner and mark support for the big three (SPY, QQQ and IWM). I will also examine retracements in the key equal-weight sectors and dissect the signals in the sector breadth model. And finally, I will review recent trend signals in the sector SPDRs using the 125-day Full Stochastic and cover the Fed.

The S&P 500 SPDR is caught between a rock and a hard place, which means there is not much to do right now. The rock is defined by the long-term downtrend and bearish breadth models. The hard place is defined by the short-term uptrend and 25% surge since March 23rd. Thus, we have a bear market environment competing with a short-term uptrend.

Assuming a bear market environment, the expectation is for this counter-trend bounce to ultimately fail because the bigger downtrend is the dominant force at work. It has not failed yet as stocks simply stalled the last two weeks. The chart below shows IWM, QQQ and SPY retracing different amounts with the recent advance. The green zones mark support and breaks here would reverse the short-term upswings.

There are pockets of strength within the stock market, but the pockets of weakness still outweigh the pockets of strength. Healthcare, biotechs, medical devices, consumer staples and technology groups show relative strength, while finance, industrials, consumer discretionary, regional banks, retail and housing show relative weakness.  

As the chart above shows, the EW Consumer Discretionary ETF (RCD), EW Finance ETF (RYF) and EW Industrials ETF (RGI) are well below their falling 200-day SMAs and their retracements were shallow. The EW Healthcare ETF (RYH) led with a move above the 200-day and 61.8% retracement line. The EW Technology ETF (RYT) retraced a garden-variety 50% and formed a rising wedge. A break below this week’s low would reverse the wedge.

As ominous as the rising wedges and key retracement zones look, don't forget that the bears are battling some pretty big forces. Congress is opening the fiscal purse, the Fed is buying everything in sight and the "powers that be" are working behind the scenes. Bear markets sure get a lot of attention. Bear market + Big Forces = Nobody Wins. This means we could see the S&P 500 extend to the 200-day SMA and a lot of chop in the coming weeks.


Note that I will post a video covering the broad market environment, the core ETF chartlist and more on Saturday. Next week I will publish an article on the pros, cons and realities of dividend adjustments. I will also post an article detailing a trend-momentum strategy using the 125-day Stochastic and a revamped list of 50 ETFs.

Index Breadth Model Remains Bearish

There were no new signals for the Index Breadth Model and it remains net bearish (since 27-Feb-2020). The 10-day EMAs for S&P MidCap 400 AD Percent and S&P SmallCap 600 AD Percent surged above +30% to signal bullish breadth thrusts on April 9th, but these were not confirmed by S&P 500 AD Percent, which fell short. $SPX is still the 800 pound gorilla in the market.

The 10-day EMA of Nasdaq AD Percent is not part of the table because the index is not broad enough. However, it too failed to trigger a bullish breadth thrust. This is a bit strange because the Nasdaq 100 is one of the leaders over the last five weeks. In any case, the breadth thrust indicators account for just a third of the Index Breadth Model and we have yet to see any of the longer-term indicators trigger bullish signals.

New lows dried up as stocks rallied the last five weeks, but the High-Low Percent indicators remain seriously subdued. Notice how the High-Low Percent numbers increase ever so slightly as we move up in market cap (small-caps .33%, mid-caps .75% and large-caps 1.2%). These numbers are not even close to a bullish signal (move above +10%).

Speaking of subdued, the percentage of stocks above the 200-day EMA remains at extremely low levels. All three triggered bearish on February 27th with moves below 40% and plunged below 10% to become seriously oversold. We got the oversold bounce, but all three remain at very low levels. In fact, just 12% of small-caps are above their 200-day EMAs right now. These are not the numbers one would see in a bull market.

The next chart shows the Index Breadth Model signals over the last five years.

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.

Medium-term Breadth Thrust Signals

I also use the %Above 50-day EMA to measure medium-term breadth thrusts. The 50-day EMA is a medium-term moving average, in my book at least. The 200-day EMA is a long-term moving average, while the 20-day EMA is a short-term moving average. Medium and long term indicators are best used for trend following, while short-term indicators often work best for mean-reversion signal. Thus, %Above 200-day EMA and %Above 50-day EMA are best used to identify trend shifts, while %Above 20-day EMA is best used as a mean-reversion indicator.

The chart below shows the percentage of stocks above the 50-day EMA for the S&P 500, S&P MidCap 400 and S&P SmallCap 600. A move above 80% shows seriously broad upside participation for a bullish breadth thrust, while a move below 20% shows seriously broad downside participation for a bearish breadth thrust. These events signal a momentous change in market dynamics. As with all breadth indicators, the group turns bullish/bearish when two of the three have active bullish/bearish signals.

These signals do not exactly match with the Index Breadth Model because there was a bearish signal in February 2018 and a bullish signal in early February 2019. There were no signals in between as this group remained with a bearish configuration. Nevertheless, notice that all three plunged below 20% on 11-Oct-2018 and on 27-Feb-2020. The current signal is bearish and all three remain well below 40%. These indicators are not even close to a bullish signal.

Sector Breadth Model Remains Bearish

The stock market surged the last 22 days and the S&P 500 is up around 25% since March 23rd. This move was enough to trigger some bullish signals in the sector breadth indicators, but the majority remain with active bearish signals (23 of 33 or 70%). Half of the bullish signals are in the four smallest sectors (Utilities, REITs, Energy and Materials). Three of the other five are in Healthcare and Staples (defensive sectors). Thus, eight of the ten signals are in small or defensive sectors. There is one bullish signal in Finance and one in Communication Services.

I consider the Technology, Communication Services, Finance, Consumer Discretionary and Industrials sectors as the offensive sectors. Strength in these sectors shows a risk-on environment and this is bullish for the stock market. However, of the 15 possible signals, only 2 are bullish (green) and the other 13 are bearish (red). We need to see bullish signals in these offensive sectors before thinking bull market.

Vast Majority of Sectors in Downtrends

The next image shows CandleGlance charts for the 11 sector SPDRs and SPY. The red line is the 200-day SMA and the indicator is the Full Stochastics (125,5,1). The latter can be used to rank the sectors and generate trend following signals. A move above 60 is bullish and a move below 40 is bearish. Currently, only two of the eleven sectors are above their 200-day SMAs (XLV and XLK) and only two have bullish signals for the Full Stochastics (XLP and XLV).

The offensive sectors remain on bearish signals. The following bearish signals triggered in the Full Stoch (125,5,1) in late February and early March: XLY 28-Feb, XLC 3-Mar, XLI 12-Mar, XLF 28-Feb, XLK 11-Mar and SPY 2-Mar. Four of the five offensive sectors and SPY were on bearish signals as of March 3rd and all remain with bearish signals. A move above 60 is needed to reverse these signals. We need to see the majority of offensive sectors return to bullish signals to get the bull market back.

Monetary and Fiscal Policy Battle Market Dynamics

It is no secret at the corporate bond market would be in shambles were it not for a massive intervention from the Fed. In addition, there was a strong fiscal response from Congress and this softened the blow to the economy. We can expect more from both the Fed and Congress. Congress is working on another package and the Fed is meeting next week. The stock market environment may be bearish, but monetary and fiscal policy are trying to say otherwise. Note that the monetary-fiscal situation was similar in October 2008 and the S&P 500 did not bottom until March 2009.

The next chart shows the spread between AAA bonds and Treasuries, and BBB bonds and Treasuries. These spreads widened in early March as chaos hit the credit markets. They then contracted as the Fed stepped in and bought investment grade bonds. The BBB spread fell back to 3.14, but is still well above pre-crisis levels. The spread flattened the last week or so (blue oval). An upturn would signal renewed stress and could be negative for stocks. However, the Fed is likely to intervene again at the first sign of trouble.

Junk bond spreads also narrowed over the last four weeks, but remain well above pre-crisis levels. We also saw a little uptick in the Junk bond spread and the CCC bond spread over the last few days. It is just a blip at this stage, but an upturn would suggest stress at the low end of the credit market.  

Thanks for tuning in an enjoy your weekend!

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

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