GLOBAL STOCKS START YEAR WITH A BANG WITH STOCKS AROUND THE WORLD HITTING NEW RECORDS -- BUT THE S&P 500 INDEX IS THE MOST OVERBOUGHT IN TWENTY YEARS -- AND IS WELL INTO A FIVE-WAVE ADVANCE -- THE CRB INDEX MAY BE NEARING AN UPSIDE BREAKOUT
S&P 500 IS MOST OVERBOUGHT SINCE LATE 1990S... Global stock markets started off the new year with a bang. U.S. stock indexes exploded to record highs for the best start in years. Foreign stock benchmarks did the same, including the FTSE All World Stock Index which also hit a new record. New records were set in North America, Europe, and Asia and in both developed and emerging markets. So what's there not to like? Well, there is one thing. Stocks are very stretched on a historical level. That may not be a problem at the moment. But could become one later in the year if some things start to go wrong. But first let's look at how much stocks are stretched. The black bars in Chart 1 compare monthly bars for the S&P 500 to a 14-month RSI line. Readings over 70 show a major overbought condition. The last two times that happened was in the 2006/2007 period and in 2014 (circles). The first condition led to a major downturn in 2008. The second one led to a downside correction in 2015 in excess of 10%. What really jumps out in Chart 1, however, is that the monthly RSI reading of 86 is higher than both of those two prior peaks. In fact, it's now at the highest level since the late 1990s. That puts the S&P 500 at the most overbought level in twenty years. That's not necessarily a bad thing over the short run. But it is a caution sign that things may have gotten a little too good. The 14-week RSI line has now risen to the highest level since 1958. That's sixty years ago. That makes me a little nervous that 2018 may not end as well as it started.
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Chart 1
S&P 500 IS IN IS FIFTH ELLIOTT WAVE ... During the market's last downside correction which lasted from spring 2015 to February 2016, I did an Elliott Wave analysis on the market's uptrend since 2009. I pointed out at the time that S&P 500 appeared to have completed three waves of a normal five wave advance. That meant that the 2015 correction was a normal fourth wave pullback and not a final top. That's the circled area on Chart 2. That meant that another upleg was likely. And that has certainly been the case. The numerals superimposed on Chart 2 bring that earlier chart up to date, and suggest to me at least that the market is well into its fifth wave since the 2009 bottom. [Elliott Wave Analysis is based on the idea that stock uptrends have five waves -- three upwaves (1,3,5) with two intervening corrective waves (2 and 4)]. Elliott Waves aren't infallible (nor are people who use them). But it is something that concerns me. So does the fact that the 14-week RSI line (top of chart) has now reached the most overbought level (85) since the bull market started in spring 2009. One final point. One of the oldest ways to determine how far an uptrend might go is to triple the size of the first upleg. That's the boxed area from the spring 2009 bottom to the spring 2011 peak. That first upleg measured 704 points (1370-666). By tripling that value to 2112 (704x3) and adding it to the 2009 bottom of 666, we get an eventual upside target to 2778 for the S&P 500. That's only 35 points above Friday's closing price of 2743. Markets often overshoot those targets. But it's worth paying attention when long term price objectives are reached. [The idea of tripling the first upleg comes from Dow Theory which holds that markets have three major uplegs. That supports Elliott Wave Theory which also has three upwaves].
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Chart 2
COMMODITY UPTURN MAY POSE THREAT ... So what could go wrong this year? How about a new uptrend in commodity markets. Stocks have been rallying in a low inflation environment which has helped keep interest rates down. Any serious uptick in inflation this year could upset that scenario, and could tempt global central bankers to become more aggressive raising short term rates later in the year. The weekly bars in Chart 3 show the Reuters/Jefferies CRB Index in an apparent bottoming formation that started at the beginning of 2016. A secondary bottom last summer was higher than the earlier bottom (up arrow) which is usually a bottoming sign. The CRB Index of 19 commodities is now challenging previous highs formed in the summer of 2016 and the start of 2017. I don't have to tell chartwatchers that an upside breakout through those peaks would be a bullish sign for commodity markets. That might even get the attention of economists at the Fed who don't usually watch such things. The CRB Index might actually be understating the inflation threat. Most commodity gains over the last year have been in industrials metals (+28%), precious metals (+14%), and energy (+13%). They're the markets most sensitive to economic trends. Agricultural markets (which make up 41% of the CRB) lost ground over the last year (-2%). They're more closely tied to weather. Imagine what would happen if they ever started rising. Rising commodity prices could also put upward pressure on bond yields at the same time that global central bankers are either reducing their bond holdings (like the Fed) or buying less (like the ECB).
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Chart 3
GOLD MAY BE BOTTOMING ... No commodity bottom is credible without a corresponding upturn in gold. And that may be happening. The weekly bars in Chart 4 show the price of gold forming a potential bottoming formation that started in the middle 2013 (four and half years ago). I've drawn a "neckline" over the last three rally peaks extending back to the start of 2014. The last two failed rally attempts took place in mid-2016 and late summer of last year (see arrows). Gold's latest upturn (helped by a weak dollar) may lead to another test of that major resistance line. A decisive close over that line would signal that the gold market has bottomed. That would certainly strengthen the inflation argument. And it might also be a sign that investors are starting to hedge their bets against an overbought stock market. They may be buying gold miners for the same reason.
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Chart 4
GOLD MINERS TURN UP... The daily bars in Chart 5 show the VanEck Vectors Gold Miners ETF (GDX) rising to the highest level in three months (and climbing above both moving average lines). It appears ready to clear its early October peak as well. Gold miners have started to show relative strength over the past month. The GDX has gained 10% since mid-December which is three times greater than the S&P 500 gain of 3%. The GDX also outpaced the price of gold over the last month by a 10% to 6% margin. That's important because gold miners usually rise faster than the commodity in an uptrend. Their longer range chart is also encouraging.
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Chart 5
GOLD MINERS ETF MIGHT BE BOTTOMING AS WELL ... The monthly bars in Chart 6 show the VanEck Vectors Gold Miners ETF (GDX) hitting bottom during 2015 before rallying during 2016 to the highest level in three years. After pulling back during the second half of that year, the GDX trended sideways during 2017 in a consolidation pattern. The overall look of the chart since 2015 suggests that a bottom is being formed. That would certainly support an upturn in gold which, in turn, would give a boost to commodity prices in general. It's also worth noting that investors usually turn to gold when they start getting nervous about the stock market. So far, the rise in gold assets is relatively small. But it's worth monitoring. That will be even more true if the GDX is able to rise above its 2016 peak (flat line). Or gold achieves a bullish breakout. I would take that as another warning sign for stocks.
