Confidence Is Breaking Out All Over

• Last week’s bearish dark cloud cover fails
• These confidence ratios are breaking to the upside and that’s bullish for stocks

Last week’s bearish dark cloud cover fails

Last week I pointed out that many of the principal indexes had traced out bearish dark cloud cover candlestick patterns. My conclusion, was that we should expect a correction of between five to ten sessions to follow.  Since several oscillators were also short-term overbought it seemed that something larger than the normal five to ten period correction would be more likely. Clearly, that did not happen. Now the NYSE Composite ($NYA), as shown in Chart 1, has moved well above the dark cloud high. Even though those oscillators are still overstretched I am expecting the market to continue to rally for the following reasons. First, when a pattern that normally works well, does not, that’s usually a sign of a strong technical market. Second, the market had every excuse to decline, given the government shutdown, but once again chose not to. A market that fails to respond to bad news and uncertainly is usually one not to be messed with.

These confidence ratios are breaking to the upside and that’s bullish for stocks

My final point relates to the performance of several confidence indicators that I follow. In almost every situation when these relationships are pointing north, so does the market. Currently, they are all breaking out to the upside above multi-year resistance or look as if they are going to do so. That’s important, because each these relationships is attacking the same problem, but from a different aspect. This widespread breakout in confidence argues for these ratios to move higher. If that proves to be the case, we should expect to see an extension to the recent rally, however hard that may be to believe given its already incredible run up.

Chart 1

Chart 2 features a ratio calculated from my Risk-On and Risk- Off indexes.   Risk-Off contains defensive vehicles such as utilities, gold, the Japanese yen etc. The kind of thing investors and traders buy when they are in a cautious mood. On the other hand, Risk-On is an index comprising more aggressive entities such as resource based equities, small cap stocks and so forth. A rising relationship indicates that risk appetite is growing amongst investors and is a bullish factor, a falling one the opposite. Using the benefit of hindsight, the green shaded areas flag rallies in the ratio. Note, that pretty well all of the S&P advances develop during the shaded periods, whereas the important declines develop during the unshaded ones. This relationship has just broken above a 10-year down trend line. That’s a very significant breakout and suggests that the ratio has now established a trend of rising peaks and troughs, a process that began in early 2016. The one major negative on the chart comes from the fact that, between 2009 and 2016, the ratio traced out a series of declining peaks compared to rising ones for the S&P. That’s something to worry about later, but for now both series are in gear on the upside.

Chart 2

Chart 3 shows a similar relationship, but this time between the Fidelity Capital Growth and Income (FAGIX) versus the Vanguard Treasury Fund (VUSTX). The former invests in high yielding stocks and bonds and the latter, only high quality government paper. A rising relationship again reflects growing confidence and vice versa. Green shading reflects periods when the ratio is advancing. This relationship is resting below a major resistance trend line, this time one of close to 20-years duration. If it moves above it that will represent a major vote of confidence.

Chart 3

Chart 4 compares the ratio to its three KSTs, monitoring the short, intermediate and long-term trend. Both the short and intermediate series are positive and neither is overstretched. That suggests that the breakout in Chart 3 will take place. Also supporting this view is the upside objective from the breakout of the 2017/18 consolidation formation, which is literally off the charts! If achieved, that objective would project into a breakout above that 20-year resistance trend line.

Chart 4

Chart 5 features a credit spread, where bond traders get to vote on their level of confidence. This time we are comparing high yield bonds, in the form of the iBoxx High Yield ETF, with high quality treasuries, as represented by the Barclays 7-10-year Trust, (HYG/IEF). A rising ratio means that traders are bidding up the price of junk bonds over treasuries and reflects a growing confidence. Once again, the green shaded areas use the benefit of hindsight to flag bull trends in the ratio. Typically, they are associated with rising stock prices. That ratio recently violated a 10-year down trend line, which strongly suggests that it will move higher, powering the S&P as well.

Chart 5

Chart 6 features more recent action of (_HYG:_IEF) along with three KSTs. All these momentum series are in a rising trend, which validates the upside breakout by the ratio itself.

Chart 6

Our final relationship is not so well established because of its limited history. It compares the S&P High Beta with the S&P High Quality ETF (_SPHB/_SPHQ). Once again, a rising ratio means growing confidence, as high beta stocks out perform their high quality S&P counterparts. This series has also tentatively broken above its long-term resistance trend line.

Chart 7

Chart 8 more clearly identifies the break above the 2017-18 resistance line. Since all three KSTs are in a rising mode, a more decisive breakout in the ratio (_SPHB:_SPHQ) above the 2014-17 down trend line in Chart 7 looks to be a likely bet.

Chart 8

Thus, we have positive action on the confidence front from four different aspects, a multi-asset relationship from the Risk On/Risk Off relationship, a stock/bond ratio from the Fidelity/Vanguard ratio, bond market votes from the HYG/IEF ratio and a purely stock market measure between high beta and high quality. All look positive to me.

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.