Timing Models – Noise or A Reversal in the Making?

The S&P 500 SPDR shows a reversal in the making when we focus on the candlesticks the last four weeks, but the overall trend remains up and the Trend Breadth Models have yet to flip.

The chart below shows SPY with a long white candlestick four weeks ago, two indecisive candlesticks and a long black candlestick this week. Despite the extra candlestick, these four clearly capture the essence of an evening star reversal. The long white candlestick shows an extension higher, while the spinning top and hanging man show indecision. The gap down and long black candlestick forged the reversal and argue for further weakness, perhaps towards the rising 40-week SMA.

SPY also formed a lower high because it did not take out the early September high. Should SPY firm after this week’s candlestick and bounce, I would then draw a lower trendline and a triangle pattern would form. Should SPY continue lower, I would watch the 310-320 area for possible support. This area also marks a 33% retracement of the entire March-September advance.

So is this just pre-election noise or something else? At this point, I would have to err with the bulls for the broad market environment. A reversal is not a reversal until we actually get a signal, and I do not want to front-run a signal. SPY is above its rising 40-week SMA, the S&P 500 breadth models are bullish and we have yet to see a significant widening in yield spreads. As noted below, some warning signs are starting to appear in large-caps and large-cap techs, but the bulk of the evidence is still bullish. Moreover, we have yet to see a breakout in the 20+ Yr Treasury Bond ETF, which represents the ultimate safe-haven.

Gold and TLT Stay Positively Correlated

The Gold SPDR (GLD) and the 20+ Yr Treasury Bond ETF (TLT) are the natural alternatives to stocks, or at least two assets that represent clear alternatives. BitCoin fits in this category, but volatility is in the stratosphere. TLT and GLD show a strong positive correlation since early August as both fell with falling wedge patterns. GLD is stronger because it is above its rising 200-day and above its late September low. TLT dipped below its rising 200-day and formed a lower low. Both established resistance levels with their October highs and breakouts here would be bullish for these stock alternatives.

Note that the breadth models will be updated tomorrow.

Cracks in the Thrust Models

Some cracks are starting to appear with large-caps leading the way lower. The table below shows the Thrust Breadth Model signals with three new bearish signals on Wednesday. The %Above 20-day SMA plunged below -10% for the Nasdaq 100 and S&P 100. A bearish breadth thrust also triggered as the S&P 100 10-day EMA of AD% exceeded -30% on Thursday. These “thrust” signals show broad participation during the decline of the last two weeks, at least within the large-cap universe.

The chart below shows the two new signals in the S&P 100 Thrust Model (red ovals). With two of the three signals bearish, the model reversed its late May bullish signal and flipped to net bearish.

The next chart shows the new signal in the Nasdaq 100 Thrust Model. Two of the three signals are still net bullish (%Above 50-day SMA and 10-day EMA of AD%). Overall, the model remains net bullish since April 29th.

Three 90% Down Days in $SPX

Even though the thrust indicators for the S&P 500 did not trigger bearish this week, S&P 500 AD% reached -80% or lower three times without an intervening move above +80%. AD% equals advances less declines divided by total issues. If there are 50 advances and 450 declines, then AD% equals -80% (50 – 450 = -400). This means 90% of S&P 500 components (450) declined and this shows broad downside participation.

This is the third time in 12 months that we have seen three successive dips below -80% (red shading). The other two were in late February and from mid April to mid May. A single breadth thrust does not mean much these days, but two or three in a row reflect broad participation that can foreshadow the beginning of a trend. The bottom window shows the 10-day EMA of AD%, which I use to filter out the noise of daily signals. It dipped to -27.6% on Thursday and stopped just short of a bearish signal. The green shading in late April shows the currently active signal.

Trend Models Remain Net Bullish

There is one new bearish signal in the Trend Breadth Models because the 10-day EMA of AD% is used in both models. All five indicators are still bullish for the S&P 500 and Nasdaq 100, while four of the five are bullish for the S&P 100, S&P MidCap 400 and S&P SmallCap 600. We have yet to see enough selling pressure to make a bearish dent in these models. Note that these are “trend” models and there will be some lag.  

SPX %Above 100-day Hits Moment of Truth

The next chart shows the five indicators for the S&P 500 Trend Breadth Model. All indicators have active bullish signals (green ovals). Currently, 58.4% of stocks are above their 200-day SMAs, 63.5% are above their 150-day SMAs and 47.2% are above their 100-day SMAs. The blue zone shows where %Above 100-day stabilized and bounced in June and September. This is a make or break area. Also notice that High-Low Percent hit -.8% on Friday and -2.4% on Thursday, which was the lowest level since early April. Internals are deteriorating, but we have yet to see bearish signals.

Sector Breadth Model Takes a Hit

Unsurprisingly, there were new bearish signals in the Sector Breadth Model: two in Finance and one in Industrials. The Finance sector whipsawed again and flipped back to net bearish. The 10-day EMA of AD% plunged below -30% to trigger a bearish signal in the Industrials SPDR. Overall, three sectors are net bearish now (XLF, XLRE, XLE). Five of the six big sectors are net bullish and the weighted sum of the signals remains firmly positive (+69.46%).

The charts used in the Sector Breadth Model can be found on the Art’s Charts ChartList. They are on page 8 if viewing 10 per page.

Finance and Industrials Weaken

The chart below shows the Finance sector doing what it does best: whipsaw. The sector turned net bullish in early June and whipsawed bearish a week later. Again, the indicators turned net bullish in early October and whipsawed bearish a few weeks later. This is one confused sector in breadth terms, but the chart shows relative and absolute weakness. XLF fell back below its falling 200-day and is testing the low end of the long triangle to nowhere.

The next chart shows the Industrials SPDR (XLI) testing the September low this week and holding just above the 200-day SMA, which is falling slightly. XLI did not record a new high in September-October and remains a laggard year-to-date.

Yield Spreads and Fed Balance Sheet

The AAA and BBB bond spreads widened a little over the last few days, but remain at low levels, and below their pre-crisis highs. The red lines mark these highs and I would not consider these spreads bearish unless they widen back above these highs.

Junk and CCC bond spreads widened over the last week or so and this widening was more pronounced (red shading). I placed my red line in the sand at the September high and further widening above these levels would be considered negative for stocks, especially banks and small-caps. The widening since October 22nd coincides with weakness in stocks, which makes since because the High-Yield Bond ETF (HYG) is positively correlated with the S&P 500 EW ETF (RSP).  

The Fed balance sheet contracted by $31 billion this past week, but continues to expand at a slow pace since mid July.

Thanks for tuning in and have a great day!

-Arthur Hill, CMT
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