Will The End-Of-The-Month Bullish Seasonal for Equities Be Enough To Avoid A Downside Domino Effect?

• NYSE Composite is forming a head and shoulders top or is it a bottom?
• IWM experiences false upside breakout
• SPY/EFA ratio is signaling a dollar correction. Will the Index take the bait?
• Wisdom Tree Yuan fund right on a key up trend line

I last wrote about the US equity market about two weeks ago and came to the conclusion that we were likely to see some short-term weakness that could well be the domino that tipped the market over into  a much larger correction. The near-term weakness proved to be correct but the dominos have not yet fallen, leaving us with the possibility that prices could work their way higher.

Chart 1 shows that the S&P 500 ($SPX) may be in the process of completing a head and shoulders pattern. “May” and actually doing so are two different things, so we should not jump the gun. One encouraging factor for the bulls is that the daily KST in the lower panel of the chart, has started to reverse to the upside. The green arrows show that if this momentum indicator can cross above its MA there is a good chance of a rally.

Chart 1

Chart 2 offers a different take from the $SPX head and shoulders top in the form of a smaller inverse $SPX head and shoulders. That would be completed with a daily close above the 2070 level and would have an upside objective that could push the Index up towards the 2140 level.

Chart 2

Looking at the more broadly based NYSE Composite ($NYA) we can raise the stakes in both directions by observing two larger formations. The NYSE Composite had been under-performing the S&P for some while but now appears to be doing a bit better. This is also in line with the deterioration of the S&P in a relative way with Europe and the Emerging Markets ETF (EEM) that I cited in last week’s issue. Be that as it may, Chart 3 shows that the NYSE Composite may, there’s that “may” word again, be in the process of tracing out a much larger bullish consolidation head and shoulders, larger in this instance than that cited for the S&P in Chart 2. Arguing in favor of a near-term attempt at this overhead resistance is the bullish price oscillator in the bottom panel. The arrows demonstrate that below zero reversals, as we recently saw, have been consistently followed by a nice short-term rally in the Index. Another positive aspect lies in the fact that, starting Thursday the market begins its positive end-of-the-month seasonal and that lasts until next Wednesday.

Chart 3

Of course a failure to respond to this positive momentum and bullish seasonal would be quite negative thereby enhancing the odds of the $NYA bearish scenario painted by Chart 4 materializing. In this instance an even larger potential head and shoulders top appears to be forming.

Chart 4

One big problem that needs to be overcome is the recent deterioration in the bullish percent indicator for the S&P 500 ($BPSPX) itself. You can see this in Chart 5, where the brown arrows point up a narrowing of the advance as the S&P moves higher but is being supported by fewer and fewer stocks in bullish trends. Indeed since December we see the S&P tracing out higher bottoms whereas the bottoms in the  bullish percent have been progressively lower. This discrepancy has been flagged with the dashed red arrows. The broader list, as reflected in the NYSE, has been even worse as only 55% of stocks were in positive trends at Tuesday’s close as compared to 64% for the S&P 500.

Chart 5

Small caps, represented by the Russell 2000 ETF the IWM, is one area that was starting to look positive. Small caps, so the argument goes, are less reliant on profits earned abroad than larger companies. The IWM should out-perform the S&P 500 ($SPX) in a rising dollar environment. The second panel in Chart 6 shows that the RS line had been improving and actually broke out from a base on Tuesday. However, that breakout looked to be in danger of holding on Wednesday and the KST for relative action is still bearishly below its MA. That suggests that more base building (or worse) is in order before a strong trend of superior performance is achieved. In addition the price itself definitely experienced a false upside breakout in mid-December. It has since been consolidating below the green breakout trend line. Usually false breakouts are followed by above average moves in the opposite direction to the breakout. In theory that should mean that  the IWM will soon break down from its recent trading range. Wednesday’s action represented the second candle in an engulfing pattern, so it will be interesting to see whether the short-term correction being signaled by this formation will be able to be outbid by the bullish end-of-the-month seasonal.

Chart 6

Bond Confidence versus Equity Prices

Chart 7 compares confidence in the bond market to equity prices. When the ratio between the iBoxx High Yield Bond ETF, the HYG to the Barclays 20-year Trust (TLT) is rising it means that investors are confident as they reach for yield over safety and vice versa. The ratio moves in tandem with equity prices most of the time. It is when the two series diverge that trouble or opportunity is signaled. For example the ratio failed to confirm the new low in the S&P 500 ($SPX) in early 2009 and that was followed by a strong rally. We have to take some care because on rare occasions, the ratio offers false negatives, as it did in 2012. In the last few months equities have been moving higher but the confidence indicator has been falling like a stone, not a good sign. Some rationalize (correctly) that the drop in the ratio is due to the fact that the HYG includes energy companies as part of its portfolio and that this has pressured the price of the ETF. However, the very fact that such a large segment of the market may be under a credit watch may itself be a warning of impending trouble.

Chart 7

FYI at Greg’s Thursday webinar I will largely be covering the longer-term picture including one indicator that is currently at a record extreme. In the 100-year history that is available this series has triggered four sell signals. All were followed by major bear markets. You might be interested to see where it stands today.

The Dollar

Last time I reported that my Dollar Diffusion indicator (!PRDIFCUR) had started to roll over. Now you can see that this series has finally crossed below its MA thereby placing it in a bearish mode. The arrows show that reversals in the past have usually been reliable indications of trend changes in the dollar’s fortune in both directions. One thing to bear in mind is the fact that all these signals developed when the Index was in a trading range. However, I believe that the Index is currently in the early phase of a primary bull market where the behavior of oscillators can be very different. Under such an environment corrections tend to be sharp but brief. Either that or digestion of profits takes the form of ranging action. In either case it is usually better to focus on the main trend as trading such counter-cyclical moves can be hazardous to your financial health.

Chart 8

Another hint that some form of consolidation in the US Dollar ($USD) is close at hand comes from the fact that the ratio between US equities and the rest of the world (SPY/EFA) has started to peak out (Chart 9). The arrows show that if anything the ratio turns ahead of the Dollar Index. It’s by no means a perfect relationship but recent SPY/EFA weakness does point up a possible chink in the dollar’s armor.

Chart 9

Finally, the Wisdom Tree Yuan fund (CYB) is resting on key support in the form of a 4-year up trendline. Since both KSTs are in a bearish mode and the short-term series (not shown) has started to roll over, it seems likely that a major trend break will take place and that the yuan will extend its descent against the dollar.

Chart 10

Good luck and good charting,
Martin Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.