Trend Of US Equities Slipping In A Southerly Direction

• Low momentum close to price highs is often followed by above-average declines
• Failed patterns are often followed by above average price moves
• Those credit spreads are widening again

Last week I wrote that there were some positive short-term signs that suggested the reaction to Brexit might be overdone. Monday’s initial action, taking out Friday’s low indicates that I was wrong and underestimated the seriousness of the current picture. Normally, when wall-to-wall media coverage adversely affects markets it’s time to get out those buy slips. However, those kinds of conditions are usually preceded by a sell-off as the market fully discounts the bad news. Consequently, when the news breaks, prices have already factored in the uncertainty and are free to move higher following one final media associated drop. This time, and I hate to use this phrase----“It’s different”. It is different because intermediate market measures of momentum are overbought and short-term measures are rolling over from dangerously low levels. In effect, the market is by no means oversold and that places it in a dangerous position as market participants quickly factor in the unexpected news. For an example of what I mean, look at the intermediate KST for the NYSE Composite in Chart 1. It’s bordering on an overstretched reading and is therefore nowhere close to a constructive oversold condition.

Chart 1

I prefer to rely on the charts for my interpretation rather than forming opinions based on fundamentals or events. However, we do know one thing, and that’s that markets abhor uncertainty. Over the weekend, uncertainty began a bull market as David Cameron’s resignation and those of half the labor shadow government created a leadership vacuum for the next couple of months at least. Moreover, Scotland’s first minister threatened a veto over the Brexit vote. It’s above my pay grade to know whether that’s legal or not but it seems as if the Brexit crowd, of which I would be one had I voted, have no follow through plans as to how Brexit will be executed. This creates a situation, not unlike the post-Iraq invasion or post-Gadhafi in Lybia. All these things may become clearer, but as it stands now, the short-term charts do not look that enticing.

Low momentum close to price highs is often followed by above-average declines

Chart 2 shows that the daily KST for the S&P Composite recently triggered a sell signal from a relatively low level. The situation is not dissimilar to that of last August’s signal. Note that the early 2016 drop was also associated with a downside reversal in the KST from a below zero position. The point I am trying to make is that low levels of momentum that develop at or close to previous price highs indicate an unusually weak underlying technical structure and that when confirmed by a trend break in the price, are often followed by above-average price declines.

Chart 2

Charts 3, 4 and 5 feature various market averages, together with some industry group and sector short-term KST’s.  Note that with very few exceptions, the KSTs are in a bearish mode and have recently reversed to the downside from a relatively low level. Even the high-flying utilities have now started to reverse to the downside.

Chart 3

Chart 4

Chart 5

Failed patterns are often followed by above-average price moves

Chart 6 shows another phenomenon that is often followed by an above-average price move. In this case, it’s a failed right angled triangle. That pattern forms part of an even larger potential inverse head and shoulder formation.  The rationale for the above-average decline lies in the fact that traders and investors become progressively more bullish during the development of the pattern as they anticipate an upside breakout. When that breakout fails to materialize and prices break down these folks are caught on the wrong side of the market and become strongly motivated sellers thereby acting as a sharp drag on prices.  This characteristic is already starting to play out as the sharp two-day drop off testifies.

One saving grace is the gap I pointed out in Friday’s trading. Gaps are usually filled but in this case that would appear to be later rather than sooner unless some of the uncertainty soon dissipates.

Chart 6

Those credit spreads are widening again

One thing I have been watching closely are the spreads between poor-quality and high-quality bonds, specifically the IBoxx/Barclays 20-year Trust (HYG/TLT) spread. Credit spreads are important because they reflect confidence or lack thereof in the bond market. These trends typically spill over into equities. Chart 7 shows this relationship broke down from a major top some time ago. Since then it rallied back and now appears to be resuming its downtrend. Note that the ratio was never able to surpass the 200-day MA. Chart 8 indicates that if prices close on Monday below the .605 level it will have completed a consolidation head and shoulders, which would suggest at least a test of the February low.

Chart 7

Chart 8

Chart 9 compares the UK market expressed in dollars to that expressed in pounds. Both are below their respective 12-month MA’s and have violated key trendlines. Please note that this is jumping the gun a bit because we have to await the final month-end close before the June part of the chart is correctly plotted. However, it does give an indication of where prices will be if they close the month at current levels.

Chart 9

Interest rates are breaking down

The 2-year yield recently fell to support at .70%. Now it has dropped below it as you can see from Chart 9. Note that all three KSTs are in a bearish mode, which suggests that rates have much further to drop in percentage terms before this decline is over.

Chart 10

The popular 2/10-year treasury spread or yield curve has just violated its 2013-2016 up trendline and 200-day MA.  Chart 11 also shows that the Special K has also experienced a double whammy sell signal as it has completed a small top and violated a key up trendline.  This strongly suggests that this section of the yield curve has begun a trend of steepening, whereby short-term rates under-perform longer-term ones. In a practical sense steepening is usually associated with a weakening economy.

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.