Equity Markets Start To Broaden Their Appeal

• Whipsaw leads to sharp rally
• Global equity markets starting to heat up
• Broad sector participation
• What’s going on with the yield curve?

Whipsaw leads to sharp rally

Chart 1 compares the Dow ETF (DIA) with my Dow Diffusion Indicator, an oscillator that monitors a basket of Dow Stocks above their 40-day MA. The red trend lines point out that when the Dow experiences a temporary break below support, this is often followed by a pretty sharp rally. The chart displays three recent instances whereby the price experiences a quick whipsaw below a line. Each example demonstrates that the false break shook out the weak holders, thereby leaving the price to move significantly higher. The fourth instance occurred in June. The advance, so far, has been pretty sharp and certainly in keeping with its predecessors. History suggests there is more to come. First, prices have just broken out from a 1 ½-year consolidation and second the Diffusion Indicator is still some way from an overbought condition.

Chart 1

Global equity markets starting to heat up

Earlier in the week we looked at the strong breadth underlying the US equity market, but something else is striking about the current rally and that relates to the global technicals. In this respect, Chart 2 shows my Global A/D Line, constructed from the daily plurality of a basket of country ETF’s. This Global A/D line (!PRGLAD) has just started to break out from an important base. Throughout most of 2014 and 2015, this series was in a clear-cut down trend. The fact that it has started to perk up at a time when the MSCI World ETF (ACWI) is also breaking out is a very encouraging factor that suggests that the current rally is a broad-based, worldwide phenomenon. Note that both series are above their 200-day MA’s for the first time since late 2014.

Chart 2

Other global breadth indicators are also acting well. For example, the Global Net New High (!PRNNHGL) in Chart 3 has just given a buy signal. The green arrows show that previous instances have usually been followed by nice advances.

Chart 3

Finally, the Global Diffusion oscillator (!PRDIFGLO) has also gone bullish by crossing above its MA. Again, previous oversold MA crossovers have been flagged with the green arrows. Two additional points are worthy of note. First the ACWI, like the S&P before it, has completed a large consolidation reverse head and shoulders. Second, the right shoulder, highlighted by the two diverging blue trendlines, in itself is a broadening formation with a flat top. These formations, as outlined in my previous article, are usually followed by advances far in excess of the actual size of the patterns. Given the whipsaw activity of post-Brexit trading, I see no reason why the current advance cannot rise to the occasion. Reward does not come without risk, and it’s important to note that these patterns are often subject to sharp shakeout moves. For those willing and able to look through such turbulence the rewards are usually well worthwhile.

Chart 4

Broad sector participation

Earlier in the week we looked at the long-term momentum of the principal sectors and found that most were in a bullish, rising mode. As long as that continues it definitely offers a strong underpinning. Charts 5, 6 and 7 display short-term momentum. In this instance, we see that without exception, these sectors, market averages, and key industry group ETF’s are in a rising mode. Originally, the advance was driven by lower interest rates, so not surprisingly, some interest-sensitive and defensive areas have started to become a bit overextended. Examples would be utilities, consumer staples, telecom and that other safe haven, gold shares. None have yet started to roll over to the downside, which is a good thing. However, if the rally begins to narrow, these would be the areas less likely to do well.

Chart 5

Chart 6

Chart 7

What’s going on with the yield curve?

Yield curves compare the yield of a short-term maturity to one of a longer-term one. They take many forms but one of the most popular is the 2-year/10-year treasury spread. When this ratio is rising it indicates that short-rates are gaining on longer-term ones. The implication is that the economy is growing. In most situations, this rising trend terminates with the 2-year moving above its 10-year counterpart, which is known as inversion. At some point this inversion process, which is caused by a stringent monetary policy, causes the economy to weaken to the extent that recessionary conditions prevail. As a result, the curve then starts to fall. Pretty well all recessions in the post-war period have experienced this process, though a few prior to 1940 were not preceded by an inversion. Last week I pointed to a major (red) trendline break that had taken place. This, combined with weak momentum, argued for a decline in this spread, implying a weaker economy. That may yet take place, but in the last few days, a relative tightening in the 2-year yield has resulted in a re-penetration of the trendline and a move above the 200-day MA. On the other hand, the trend breaks in the overextended Special K indicate that long-term momentum is rolling over.

With the benefit of hindsight, it is evident that this spread has been in a trading range since the fall of last year. The Special K argues that it will eventually break to the downside. However, the daily short-term KST, in Chart 9, suggests that that theory is about to be tested as it has just gone bullish. The green arrows showing recent buy signals tell us that a move to new highs is quite possible.

Chart 8

Chart 9

This discussion of the yield curve may be a bit dry….. no, it certainly is dry. However, I think it’s important, as the direction of the ultimate breakout will provide us with a clue as to whether we have an improving  economy (upside break) or a weaker one (downside break). From a stock market point of view, experience largely tells us  that an upward breakout would be a strong signal for higher prices. Alternatively, a falling curve would strongly suggest a topping out process followed by a bear market.

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.