The Balance of Technical Evidence At The Short-end Is Now Pointing Towards Higher Rates

• A tale of two possible market scenarios
• Are we there yet?
• Watch those techies
• The charts support a higher interest rate scenario

A tale of two possible market scenarios

I have been calling for a US equity market correction for the last few weeks because an overbought condition in several short-term oscillators argued for such a possibility. That was pretty easy, but now the difficult part comes in. That involves knowing whether this is a correction in a bull market, in a bear market, or nearly 2-year trading range. I don’t have any great answers on that one, so I am now focused on at least trying to identify where the correction ends and when the next rally begins. Charts 1, 2 and 3  flag two possibilities. The message from Chart 1 is that this is a right shoulder correction that will be resolved with a decisive upside breakout and much higher prices. In the case of the NYSE Composite ($NYA), that would require a move above the green “neckline” at 10,600. Such an advance would presumably also take the Special K in the lower panel above its MA and 2014-16 down trendline. It would also complete a downward sloping head and shoulders formation in the Special K, the neckline of which has been flagged by the dashed green trendline.

Chart 1

Chart 2 charts a similar course for the S&P Composite ($SPX), though in this case the Special K is closer to its down trendline and further from its MA.

Chart 2

Chart 3 doesn’t deny the possibility of an ultimate bullish breakout but it does suggest that more recent action in several market averages reflects a small head and shoulders. The decisive completion of this pattern would imply an extension of the correction. Price action in this regard has been conflicting since the $NYA and ACWI (in the lower windows) have held their recent breakdowns but the S&P 500 ($SPX) (in the top window) has not. If these patterns are completed in a more decisive way, the price objective calls for a move towards the blue lines near the mid-February highs, where some support is identified.  If that were to happen it would merely enlarge the right shoulder activity outlined in Chart 1, not invalidate it.

Chart 3

Chart 4 shows that the Dow Industrials ETF (DIA) has also completed a top and that its KST is still declining. It is just below its equilibrium level, which gives the impression that the correction is nearly over. That may or may not be the case, but please take note of the fact that this indicator was at a similar level at the turn of the year, so a lowish reading does not guarantee the avoidance of a decline. In the current situation, I would assume lower prices unless we get a break above the green down trendline, which is  currently around 17750. The green horizontal lines in Chart 3 represent similar benchmarks.

Chart 4

Are we there yet?

Chart 5 compares a 10-day to a 20-day EMA for the McClellan Volume Oscillator. Buy signals are triggered when the more sensitive (black) 10-day series crosses above its red 20-day counterpart. Examples have been flagged by the green arrows. Solid ones reflect worthwhile signals and dashed lines more problematic ones. Right now this technique is bearish, but the oversold nature of the black 10-day EMA suggests that a turnaround may not be far off.

Chart 5

Watch those techies

Finally, if we are going to get a rally, it’s often a good idea to look for a potential leader. In terms of daily sector KST action, the best-placed one right now appears to be technology. In this respect, Chart 6 shows that the Spider Technology ETF (XLK) has already triggered a KST buy signal and is very close to its green horizontal trendline. It’s the only major sector to have done so. Alternatively, a break below the red trend line would complete a top but the unfilled gap that was established in April argues against such a development.

Chart 6

The charts support a higher interest rate scenario

A couple of weeks ago, I pointed out that several different interest rate series had reached important support. I also drew the conclusion that, because a lot of the short-term momentum indicators were bearish, this would mean that the various rate series would violate that support. In effect rates would come down. As it turned out I was dead wrong as the support held and now those same momentum indicators have reversed to the upside.

Take Chart 7, for instance, the 2-year yield ($UST2Y), a very Fed sensitive one, fell back to support at .70% and bounced. The short-term KST, which had been declining, abruptly reversed to the upside where it is now. It’s true that the intermediate and long-term KSTs are still pointing south but with the rate having slightly violated its green (dashed) down trendline it seems like a challenge of the solid green line, just shy of the 1% level, is likely.

Chart 7

Chart 8 features the yield curve spread between the 2- and 10-year yields. It also offers evidence in favor of a higher yield curve, a process known as “flattening” because the spread between the short- and long-term yield narrows. The first thing to note is that this spread is in a primary bull market because it is above its bull market trendline and 200-day MA. In addition, the Special K indicator in the middle panel remains above its MA and bull market trendline. Finally, the short-term KST in the bottom window has started to rally again. If the two red lines are violated, that would be another matter, but since they are intact I am assuming that the uptrend is also.

Chart 8

Chart 9 shows the 30-year yield ($TYX). Here we see that since early 2015, it was threatening to complete a consolidation head and shoulders, which would have signaled substantially lower rates. However, April saw the yield bounce from the neckline at 2.5% and rally above the line joining the end of the head with the right shoulder. Currently, it’s caught in the middle of its 2016 trading range. If it breaks to the downside, that would complete the head and shoulders pattern of course. Conversely, if it moves above the dashed green trendline marking the top of the trading range that would be quite bullish for rates, thereby setting up the potential for a move above the 2014-2016 green down trendline. Since the intermediate and long-term KSTs have gone completely flat they could comfortably support a move in either direction. The benchmarks I am looking for are therefore 2.75% and 2.9% on the upside or 2.5% on the downside. Right now it’s too close to call!

Chart 9

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.