A Funny Thing Happened On The Way To The Rally

• Some short-term equity market cracks are starting to appear
• Rates are starting to breakdown
• Keep watching those credit spreads

Some short-term equity market cracks are starting to appear

In my last article, I pointed out that most of the short-term oscillators were in a bullish configuration. Moreover, they were not in an overextended mode and that prices were likely set to rise some more. That condition is still basically in force as you can see from Charts 1 and 2, which feature the short-term KSTs for the NASDAQ and NYSE Composite. It’s true that the NASDAQ KST has begun to flatten, but at this point, it is still bullishly above its MA.

Chart 1

Chart 2

On the surface that looks to be fine. However, there are three factors that suggest that prices may undergo some corrective activity in the very near-term.

First, as Chart 3 demonstrates, it looks like the NYSE Composite ($NYA) breakout above the resistance trendline was a false one. That would be partially confirmed in the event that the red trendline is violated and certainly confirmed with a drop below that 'must-hold' support level of 10200. Second,  the PPO using the 8/16 parameters, has diverged negatively with the NYSE Composite ($NYA) and looks to now be in danger of crossing below its MA.

Chart 3

Third, both EMA’s of the McClellan Volume Oscillator (!VMCOSINYC) in Chart 4 have started to move lower. This is not yet serious as sell signals are best generated when the 10-day (black) EMA crosses below its 20-day (red) counterpart. However, the red arrows do show that a reversal to the downside by the 20-day EMA more often than not results in a decline of some kind. Remember, that this also comes following a couple of negative divergences, as flagged by the dashed red arrows. Finally, you may not think that a reversal from a low level is as serious as one from an overextended reading. However, the two sharpest declines on the Chart, in August and December 2015, came from around the same level as the current reading. That’s not a prediction of a repeat performance, merely a statement of fact. This same point can also be applied to the possible reversal in the KSTs featured in the first two charts as they are currently at a relatively subdued reading.

Chart 4

The inverted $VIX tracks the S&P quite closely and has just broken down from a small top. Further weakness in this indicator (i.e. an increase in volatility) would result in a more decisive break and likely lower prices. That looks to be a strong possibility as the MACD for the VIX has just gone bearish. As you can see, the S&P on a closing basis is very close to the red up trendline. Its decisive violation with say, a drop below 2075 would likely tip the balance of the short-term technical to the bearish side.

Chart 5

Keep watching those credit spreads

Finally, I have been monitoring credit spreads for quite a while. That’s because I have been looking for some signs that bond market confidence has been improving to a sufficient degree that would support an upside breakout in the stock market. There are many ways of measuring this relationship between poorer and better quality bonds. My favorite is the ratio between the iBoxx High Yield and Barclays 20-year Trust ETF’s, the HYG/TLT ratio. Chart 6 shows that it broke below major support in the form of the red trendline at the turn of the year and has been trying to move back above this resistance and its 200-day MA ever since, but to no avail. Also, at no time was the positive intermediate KST able to help in reversing it's longer term counterpart to the bullish side. It now looks as if a test of the early-2016-low is in the cards.

Chart 6

The near-term picture can be seen more clearly in Chart 7. The short-term KST for the ratio has just gone negative at a time when the ratio itself has completed a bearish head-and-shoulders pattern.

Chart 7

In conclusion, it appears that there are enough negative short-term technical indicators for equities to suggest that a re-grouping might be necessary prior to another test of the overhead resistance.

Rates starting to break down

In last week’s article, I pointed out that several yield series had fallen close to critical support. At the short-end  yields have subsequently fallen closer to that support, whereas longer-term maturities have actually violated it.

Chart 8 features the Fed sensitive 2-year yield ($UST2Y), together with its Special K. A downside break would take place with a decisive drop below the .70% level. Such action would not only violate the uptrend line but take the yield below its previous short-term lows. Such a move would also result in the rupturing of the two converging Special K red trendlines.  That’s a strong possibility because the three KSTs in Chart 9 are all bearish.

Chart 8

Chart 9

Chart 10 features the 30-year yield ($UST30Y). This one has broken down from a bearish head and shoulders pattern and has been accompanied by a bearish short- and long-term KST. The intermediate series has gone flat and is likely to go negative as well.

Chart 10

Finally, Chart 11 shows the spread between the two series. Strictly speaking, the trend is still a rising one, meaning that short rates are out-performing long ones. However, this version of the yield curve is very close to a downside breakout. Since all three KSTs are falling, a violation of that red uptrend line looks to be an odds-on possibility. If that happens, the implication would be for a weaker economy. That is a prediction that is also implied from the price action of the 30-year series itself.

Chart 11

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.