The Equity Rally is Getting Overstretched on a Short-term Basis.

• More signs of an intermediate peak in the bond market.
• Dollar Index is now overbought.
• Gold and gold shares are down, but not yet out.
• Commodities continue to struggle at key short-term support.

US Equities

The short-term uptrend remains intact but is becoming overextended. You can see this from the elevated position of the KST in Chart 1. The arrows show what happened in the recent past when this indicator initially reached the red overbought line. It's often, but certainly not always, been followed by a correction.

In other words, unless this turns out to be a particularly robust rally, the odds of some kind of a 2-3 week correction developing are better than 50/50. A correction, of course, does not have to be down. It can also take the form of a trading range. The key level of short-term support lies at the converging two red trendlines at $192 for the SPY. If that level gives way, then a more widespread correction would likely follow.

Chart 1

That’s important to bear in mind because at this point, the long-term momentum indicators are very overstretched. Take the Special K (SPK), whichyou can read about here. It’s right at the bull market trendline and its MA. A break below this key support would most likely result in a correction of at least intermediate proportion; i.e., 6-weeks to 9-months. Note how this indicator turned simultaneously with the NYSE Composite in 2009 and 2011. If the trendline is violated and the Special K breaks below its April low, this would strongly suggest that it had peaked for the cycle and that something greater than a short-term correction had begun.

Chart 2

When a market is healthy the number of NYSE stocks that can maintain a position above their 200-day SMA’s typically exceeds the 80 level.  However, that level has not been attained in a while. Equally as important is that the peaks in the number of positive stocks measured in this way have been trending lower since late 2009.

Chart 3

I have always enjoyed comparing the performance of brokers to the overall market as they have a strong tendency to move ahead of it. The reason lies in the fact that the market discounts the economy and brokers discount the market. Brokers do well from commissions and underwritings in a bull market and profits suffer accordingly during bear trends when such activity is far lower. I use the Dow Jones Broker ETF, the IAI, as my benchmark for this savvy group. Throughout 2012 and 2013, the IAI consistently confirmed new S&P highs. Then, in early 2014, as you can see from Chart 4, they started to decline in the face of a rising market. Relative action was even worse. We can’t yet use this disappointing action to conclude that the market has peaked because we do not know if the S&P will go on to register even higher levels unaccompanied by the brokers. For instance, on a month-end basis, the Amex brokers Index peaked in June of 1999 compared to August 2000 for the S&P (the IAI was not available then.) All we can say, at this point, is that the poor performance of the brokers is giving us advance notice that a top in this market may be closer than most people think.

Chart 4

US Credit Markets

Chart 5 shows that my Bond Net New High indicator has now  peaked from an extended level. Based on recent experience this should mean weaker prices in the period ahead. Note that the TLT recently experienced a false break above the green trendline, and that sort of thing is usually followed by an above average decline. I had expected to see a small bounce take place once the price reached the red trendline, and that may still happen. However, the important thing to bear in mind from a short-term point of view is that the 2014 rally is probably over.

Chart 5

Price at any one time is determined by the interaction of many time cycles. When several of them are operating in the same direction this usually results in a strong move. Chart 6 shows three cycles as represented by the three ROC’s. The idea is that a joint trendline break by all three, when confirmed by a break in the price itself, triggers a signal. In this instance, only two marginal breaks have taken place. However, the price of the 30-year bond is right at its trendline, and if it slips through, it would be quite bearish. The next barrier would then be at $133.50; i.e., in the area of the green trendline.

Chart 6

US Dollar Index

Last week’s European Central Bank’s announcement concerning negative interest rates caused the Dollar Index to experience a bearish outside bar. That’s where the trading range encompasses at least one of its predecessors. Normally, these patterns only have an effect for between 5-10 bars. In this case, days.  However, if a short-term momentum indicator is overextended, that is often sufficient to reverse its trajectory. That’s exactly what we see with the 20,14,10 stochastic in the lower window. The indicator is still bullish, but also overbought. If it's in a primary bull market it could well shrug off a problem of this nature, but as I pointed out last week, it’s really in a trading range. That means that if the Index can take out the intraday high of the outside day at say 81.25 that would be a definite statement of strength. On the other hand, a drop below the extended green trendline at 80.20 would take the price below the outside day low and the red 200-day MA. Given the overbought stochastic, this would not be a good sign.

Chart 7

Precious Metals

In recent weeks the GLD broke below the red trendline in Chart 8. That extended line and the two MA’s around $124 are crucial resistance that any advance is going to find challenging. The hesitant action of the KST and low sentiment numbers in some polls offer hope of a challenge of $124, but until it is bettered, a cautious stance is appropriate.

Chart 8

Gold

Gold shares often lead the price of the metal, so it’s always good to have them on your side. Chart 9 features the GDX together with its KST and the bullish percentage of gold mining stocks. It’s KST has actually started to turn up,suggesting a change of the dashed green trendline at $23.50 is in order. What I would like to see though, would be a break above the solid line at $27, which would complete a good base and signal a primary bull market. Another thing to watch for is the bullish percentage of gold miners ($BPGDM), for if this series can rally above the bear trendline at 40, it would represent a confirming sign of improving breadth.

Chart 9

Commodities

The two ratios in the lower windows of Chart 10 are constructed from stock market groups. The first is a simple RS line between the Goldman Sachs Natural Resource ETF (IGE) (inflation) and the Spider Consumer Staples (XLP) (deflation). The second relationship compares my inflation to my deflation group index (!PRII:!PRDI). Both relationships usually move in tandem with the Powershares Commodity ETF, the DBC. Right now, they are offering a confusing picture because the IGE/XLP series is just below resistance, while its Inflation/deflation counterpart is just above support. To complicate matters even more, the DBC is above its 200-day MA but at support in the form of the extended trendline and the MA. Clearly, the commodity markets have reached a crucial point.

Chart 10

Chart 11, tells us that my net new commodity high indicators are oversold and starting to turn, which is bullish. However, that green down trendline that I have been featuring for the last couple of weeks is still intact. It now requires a break above $39.40 in order to confirm the potentially bullish action of the new high series. It really needs to do so because the price is hanging above support at the red trendline. The test of commodity bull market manhood we talked about last week continues!

Chart 11

Good Luck and  Good Charting!
Martin Pring