Homebuilders may be on the Verge of a Major Breakdown

• General correction in US equities not  over despite a higher S&P.
• Dollar Index breaks to the upside.
• Gold likely to experience more base building before moving higher.
• CRB meets downside objective, now we will see how it can handle a rally.

US Equities

Last week I pointed out numerous negative divergences being experienced by the US equity market and suggested that if 16,900 on the Dow was taken out on a daily close basis that these divergences would be confirmed and a more widespread correction would likely follow. That confirmation was never given, but the internal equity market correction is continuing, under the context of rising prices. That statement may sound contradictory but really depends on what the definition of the word “correction” is. Clintonian technical analysis you may say?..., but not really.

I regard a correction in an uptrend as a digestion of gains. That process can take the form of the market averages experiencing a decline or a trading range. Alternatively, a correction can develop where the averages work their way higher but quite a few individual sectors decline. This is known as an “internal” correction and seems to be what is taking place at present.

Chart 1 shows that the NYSE Composite experienced a false breakdown from a small head and shoulders pattern  last fall. The event that signaled the failure was a break above the declining green down trendline joining the head with the right shoulder. In the last few weeks the Index completed another head and shoulders top which again turned into a false downside break. That was confirmed this week with the violation of another head-to-right shoulder down trendline. This action suggests that higher near-term prices are likely.

Chart 1

However, the corrective process being experienced elsewhere is still continuing. Chart 2, for instance shows that the NYSE A/D Line has violated its 2014 up trendline. It is likely to find resistance at the extended line. Note also that both it and the upside/downside volume line in the bottom panel have so far failed to confirm this week’s new S&P high. Since these discrepancies are not that great the passage of time may see these divergences cleared up. At this point though, they remain a negative factor.

Chart 2

I cited problems at the NASDAQ last week and feature them in Chart 3, where you can see that the number of issues above their 200-day MA’s  was lower at the early July peak than the April top. At the end of July, with an even higher NASDAQ Composite the number was even fewer, less than 50% in reality.  The implication is that the NASDAQ is being powered by fewer and fewer stocks, the stuff of bull market peaks not that of healthy advances.

Chart 3

Chart 4 adds further evidence of greater and greater selectivity as we see fewer and fewer issues making new highs.

Chart 4

A sector that consistently leads the S&P is homebuilders.  Chart 5 shows that the Spider Homebuilder ETF, the XHB, is right at the neckline of a potential head and shoulders top. I think it’s likely to crack that line because all three momentum curves are pointing south.

Chart 5

Relative strength wise this sector is a disaster, as we can see from Chart 6, which features the iShares equivalent of the XHB, the ITB. Note the negative divergence flagged with the red dashed arrows in Chart 6.  This is a classic bearish setup. More importantly for the future, see how the RS line recently violated support and fell to a new bear market  low. Generally speaking relative action is a leading indicator, and where it goes the price eventually follows. That again suggests that the tops in both the ITB and the XHB will eventually be completed. Not a reason to sell the S&P but an early bird warning that the clock is closer to striking midnight.

Chart 6

US Credit Markets

Chart 7 shows the Barclays 7-10-year Trust, the IEF. The current trend is a bullish one as we can see from the rising short- and intermediate KSTs.  Even so, things are pretty precariously balanced as the intermediate series could easily go either way and its long-term counterpart looks as if it is about to go bullish. My inclination is to go with the trend unless support, in the form of the converging trendlines in the $102.5-103 area is taken out on the downside.

Chart 7

The fine technical balance is also apparent at the short end, where Chart 8 shows that the 3-year yield is struggling to maintain an upside breakout. A decisive move above 1% would confirm rising trend, whereas a drop below the red up trendline at .825% would  suggest the recent rally was a false move. Remember, the IEF in Chart 7 is a price series whereas the series in Chart 8 is a yield. A break to the upside in Chart 8 would therefore be the equivalent of a drop below the red up trendline in Chart 7.

Chart 8

US Dollar Index

Last week we looked at the potential for the US Dollar Index to break to the upside and for its largest component, the Euro, to complete a small top. As you can see from Chart 9, both series obliged, which confirms near-term strength in the dollar.

Chart 9

Chart 10  supports this view because the KST is in the early phase of a rally and has some way to go before it becomes overstretched. The dashed (AB) arrow points up the indicated upside objective from the pattern. I haven’t drawn it in because it is literally off the charts at 83.

Chart 10

That’s important because 82.5 (basis month-end close) happens to be the breakout point for the completion of the 10-year potential base in Chart 11. If  83 is bettered on a month-end basis then this will signal a major bull market for the Index.

Chart 11

Precious Metals

The short-term correction in the Gold Trust, the GLD, continues as its KST remains in a declining mode. It has reached a critical short-term pivot point in the area of the red support trendline, which has been slightly penetrated. However, all is not lost because the price is still above its 200-day MA. Since the US Dollar usually moves inversely with the price of gold its recent upside breakout certainly provides a head wind for the yellow metal.

Chart 12

Gold bulls may be biting their nails in the immediate future, but positive long-term momentum, as shown in Chart 13, combined with the recent upside breakout in this monthly chart suggests that the eventual direction of prices will be a northerly one.

Chart 13

Commodities

The CRB Composite just about met its downside target indicated by the two red dashed arrows in Chart 14. Now the KST has started to stabilize, probably as a prelude to an upside reversal. In this respect note that the 20,10,10 stochastic has a pretty good record of anticipating KST moves. There has only been  one recent exception, as flagged by the dashed arrow. That suggests that the Index is now headed higher, possibly after some more base building.

Chart 14

Long-term, Chart 15 shows that the technical condition is sound with a rising long-term KST and a price that is above its 12-month MA. I’d like to see a break above the green trendline to confirm the bull market. However, I would get extremely concerned about the bullish case in the event of a decisive drop below the red trendline at 275.

Chart 15

Hope to see you at ChartCon 2014 next month. I am definitely looking forward to hearing some of the great speakers Chip has lined up.

Good luck and good charting

Martin Pring