Small Caps Complete 12-year Top Relative To Large Caps

• Bullish exhaustion on Monday suggests that last week’s lows will hold during 2015
• Longer-term indicators continue to point to an overall topping out process
• Small caps break down against large caps
• 30-year yield at a critical juncture
• Euro and yen-denominated gold complete large bearish (deflationary) formations

Small year-end rally signaled, but the bigger picture is more cautious

At the last three short-term turning points, the market obliged with the formation of some one and two bar reversal patterns. One was an outside bar, one was a bullish two-bar reversal, and one was a bearish two-bar reversal. Chart 1 shows that a fourth pattern in this series, an exhaustion day, developed on Monday. Since it reflects downside exhaustion, the pattern is a bullish one that would be expected to have a positive, or at least not negative, effect on prices for 5-10 sessions. This action, therefore, supports the end-of-the-year bullish seasonal. Note that while not deeply oversold the Money Flow Indicator (MFI) in the bottom panel has reached the same level that supported a rally in mid-November.

Chart 1

Chart 2 features the S&P Composite ($SPX), where you can see that the gap created in early October has yet to be closed. The bad news is that most gaps are eventually filled. Note that the PPO using the 8/16 parameters has started to tick up.This is often an early warning of an upside reversal in the slower moving short-term KST. Consequently, a few days strength or even sideways trading as a result of the exhaustion bar could easily enable it to reverse to the upside.

Chart 2

Chart 3 shows the S&P 500 ETF (SPY) in candlestick mode where Monday’s price action displays a bullish hammer. That kind of action again suggests that prices will continue to rally or consolidate thereby permitting the MACD in the lower clip to reverse to the upside.

Chart 3

Several very short-term oscillators have become very oversold from which a rally ought to follow. Chart 4, for example, tells us that the 9-day MFI for the NYSE Composite ($NYA) has reached the red deeply oversold zone. Usually, when this level is touched or even exceeded, as it is now, some form of reflexive advance follows.

Chart 4

The same is true for the 10-day ratio of NYSE advances to declines (!NETADTOT) in Chart 5, which is currently recovering from a deeply oversold condition.

Chart 5

These signals are all signs of very near-term strength. Let’s call it a “year-end rally”. However, the market still has to deal with other longer-term indicators that are not performing so nicely.

For example, the lower panel from Chart 6 shows the flow of money (!ASETBULSE) between bullish (Index and sector linked) and bearish (money market and inverse) funds as managed by Guggenheim (formerly Rydex). A rising line indicates that there is a positive net flow into bullish funds and vice versa. Occasionally it is possible to construct trend lines for this indicator which, when violated, signal important price moves by the S&P Composite. The chart clearly shows that after an attempt at new highs it recently sank back below its main trading range for 2015. Rallying action by the S&P in the last couple of weeks has not enabled this indicator to recover lost ground. This suggests that the post-November bounce has not been supported by much in the way of positive volume.

Chart 6

The S&P Composite ($SPX) has been one of the strongest of the major averages in the last few months. However, Chart 7 shows that breadth indicators, constructed solely from S&P Composite have been lagging the average itself. This is especially true for the upside/downside volume line in the bottom window of the chart as it is a long way from its bull market high set several months ago.

Chart 7

Chart 8 features the MSCI World Stock ETF, the ACWI, together with its advance decline line constructed from the cumulative plurality of advancing and declining country ETF’s. This series usually moves in tandem with the price itself. However, it has not only been diverging negatively in the last few months but also touched a new low in early December. This underscores the technical weakness in the rest of the world and argues in favor of the potential top, and I emphasize the word potential, being completed with a daily close under $53. If that happens you can be sure of a bumpy ride as 2016 unfolds.

Chart 8

Small versus Large Cap

Chart 9 features the ratio between the Russell 2000 (small cap - $RUT) versus the S&P Composite (large cap- $SPX). In the last few weeks, this relationship has completed a top whose roots goes back to the beginning of the century. That’s a pretty big top and suggests that we are witnessing a major change in this relationship equivalent to or of even greater significance than that which developed in the late 1990’s. Note that the KST was unable to rally above the zero level during the formation of the right shoulder. This is particularly weak action, and since it is not even close to an oversold level does not bode well for small caps in their relative battle with their larger cap brethren.

Chart 9

Interest Rates

There seems to be little doubt that yields at the short-end of the spectrum have broken to the upside. This is shown in the lower panel of Chart 10 featuring the 2-year yield ($UST2Y). Twice it has tested its green breakout trendline and has now moved on to a marginal new high. As long as it can remain above that extended green line we should assume that the trend of higher short-term rates is intact. The 30-year series remains below the two converging trendlines. Recently it temporarily violated the red trendline, which hints of a false move. That would be confirmed with a move above the green line at 3.10%. If that proves to be the case we would then expect that whipsaw to be followed by seriously higher yields, just as the two previous whipsaws on the 2-year series were. On the other hand, a break below 2.85% or 0.8% respectively would signal a downside break.

Chart 10

Gold in euro and yen

Gold prices recently completed a major top when expressed in Euro (GLD:$XEU) or Yen (GLD:$XJY). These are shown in Chart 11 and 12 respectively. The KST for the Yen-denominated series has started to rise, so some form of corrective activity may be in the cards. However, the overall flavor from these two charts is a very deflationary one that signals substantially lower Euro and Yen gold prices during the course of 2016.

Chart 11

Chart 12

Good luck and good charting,
Martin J. 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.