US Stock Market Showing More Near-term Weakness

• More stock market indicators showing weakness
• Bonds close to a breakout
• Commodity rally over?
• Dollar bottoming or about to break down?

More stock market indicators showing weakness

Last week I made the case for a correction in the market based on some specific indicators that has started to flash some sell signals. Since then prices have sold off a bit. Sometimes when that happens other shorter-term indicators move to an oversold condition, thereby offering the all-clear for a resumption of the prevailing uptrend. Alternatively, price weakness can result in more damage suggesting that the correction has more downside implications than originally thought. In my view, this week’s action offers some evidence in favor of the latter.

Chart 1 reflects my thoughts of last week in that the S&P Bullish Percentage ($BPSPX), which had tentatively violated some key support in the form of the 2016-17 up trendline, has now experienced a decisive break. This penetration does not guarantee that the S&P will decline. However, it strongly suggests that more and more stocks will joining the “bearish” percent category. That usually means the S& P will drop as well.  In this instance the violation is especially egregious because it confirms the false upside break that developed in July. Whipsaw moves such as this are typically followed by above average moves in the opposite direction to the original breakout.

Chart 1

Chart 2 also reinforces this weakness since the $NYA has now violated its 2016-17 up trendline and has now been confirmed by the Common Stock A/D Line. A valid violation of a line like this means either the upside momentum has been ruptured and a trading range environment follows. Alternatively, it can also signal that a reversal in trend has begun.

Chart 2

Weakness in market breadth is also being confirmed by the Value Line Arithmetic Index ($VLE), which experienced a false upside break in July, later confirmed with a penetration of the red up trendline and blue 50-day MA. The bearish short-term KST adds further weight to the negative near-term outlook.

Chart 3

Chart 4 compares the $NYA to a PPO with 8 and 16 parameters. The dashed red arrows indicate that the oscillator has been diverging negatively with the NYA since the start of the year. That bearish activity has now been confirmed with a trendline break by both the Index and the PPO. This action is exactly the opposite to that of March and November 2016, where we saw two upside breakouts followed by nice rallies.

Chart 4

Finally, the ratio between high yield and government bonds (HYG/TLT), cited last week as a possible indication of a loss of confidence, has really begun to break down. Once again, we see a red trendline confirmation of a false upside breakout, as well as a short-term KST sell signal. Generally speaking, when confidence leaves the bond market as traders seek the relative safety of governments, it spills over into equities.

Chart 5

Bonds close to a breakout

The Barclays 20-year Trust, the TLT, is right at a major down trendline and looks set to go through it. I say that, because the intermediate KST is in a firm uptrend, and has just been joined by its short-term counterpart. It’s true that the long-term series, in the bottom window, remains in a bearish mode. However, if the price does break to the upside that would suggest that this finely balanced and flattening long-term series could easily reverse to the upside.

Chart 6

Chart 7 compares the TLT to the inverse of the confidence ratio cited in Chart 4. This time it’s expressed as the TLT/HYG relationship. A rising ratio this time means rising fear. Note how it tends to move with the price of the TLT itself, especially when two trendlines are more or less simultaneously violated. The ratio has already broken, can the TLT be far behind?

Chart 7

A big influence on this outcome will probably come from the commodity markets, because bonds like falling commodity prices and detest rising ones. So, with that in mind, let’s take a closer look at commodities.

Commodity rally over?

Markets have generally been responding to North Korea saber rattling in the expected way with a retreat to safety, as government bonds and gold have rallied. Normally commodities react favorably to military uncertainty by rallying as well. Chart 7 shows that that’s not the case in the current environment as the DB Commodity ETF, the DBC, experienced a giant bearish outside day on August 10. When a market should rise on a “favorable” news background and does not, that’s often a sign of vulnerability. If “good” news cannot move it higher, what will?  The outside day is only expected to have an influence for between 5-10 sessions, but if it is followed by the usual sideways or downside action, that would be sufficient to result in a KST sell signal.

Chart 8

Chart 9 shows the same ETF - DBC, but this time from a longer-term perspective. It’s likely that the price action since early 2016 will either turn out to be  a base that will support higher prices. Alternatively, it could be a consolidation in an on-going bear market, time will tell. For the near-term though, it seems likely that the red 2016-17 trendline is going to be tested, as the 10-day net new commodity high series has just peaked from an overstretched reading.

Chart 9

Dollar bottoming or about to break down?

There is no long-term established relationship between the dollar and bonds, but there is with commodities. Normally the two series move in opposite directions. Recently a softer dollar has been bullish for commodities, but now the dollar is oversold and commodities overbought.

Chart 10 tells us that the Dollar Index ($USD) is just above support in the form of the 2015-17 red trendline. At the same time, my dollar diffusion indicator has tentatively started to reverse to the upside. This series monitors a basket of cross dollar relationships that are in a positive trend, and is a broad measure of dollar strength or weakness. The green arrows show that previous recent instances of oversold reversals have either been followed by a rally or multi-month consolidation. The August 2011 signal, was an obvious exception.

Quite often the dollar is a currency that investors rush to in times of uncertainty, fear being the obvious motivator. Current uncertainty regarding North Korea has not yet tempted traders to move into the currency, in a similar vein to commodities not responding in the expected way. I think we are soon about to find out about the dollar. That just leaves Gold, which will probably be the subject of another article later this week. Stay tuned!

Chart 10

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 of Walnut Creek or its affiliates.