From the desk of Thomas Bruni @BruniCharting
The weight of the evidence has been building in favor of the bears over the last week or two, making the US equity weakness this week anything but surprising. Throughout the duration of this post I’ll outline the evidence that I’ve been noticing over the last two weeks and what it means for us as market participants moving forward.
Yen Strength – The Yen broke out structurally late last year and hasn’t looked back since. Tactically my upside targets were hit this week, but structurally this market has a lot more room to run. Given the high negative correlation between the Yen and US equities, this should continue to be a headwind for equity markets going forward.
Dollar Index Strength – I’m bullish on the dollar index over the short-term because of the bullish divergence and bottoming tails that have been occurring at the bottom of its roughly 16 month range. Also a flat 200 day moving average tends to cause whipsaws and prevent range breakouts / breakdowns, so I’m expecting prices to rally toward 97 in the coming weeks.
If I’m right, that’d suggest the currencies and equity markets of countries with commodity exposure will likely experience some weakness relative to the US Dollar in the short-term. This could exacerbate the global equity selloff and drag the US down with it.
Global Equity Weakness – Many global equity markets began pulling back last week with selling accelerating this week. US equities are now starting to play catch-up to the downside. For example, the Nikkei 225 Futures have been down 6 of the last 7 days and are already back near the February lows. Global equity markets tend to move together, so if this selling pressure continues I’d expect further weakness in US stocks.
Bond Market Strength – As long as the Ten Year Yield remains below 1.85 on a daily closing basis, the bias in bond yields remains to the downside. We’re also seeing the 10 year yields of many countries around the world, like Germany and the UK, heading back toward or making new YTD lows as well. If the bond market continues to show strength, it’s unlikely that equities will be able to continue higher at the same time.
Breadth and Momentum Divergences – One of the key factors in the February bottom in US stocks was breadth and momentum divergences, but those divergences work at tops and bottoms. Last week as the S&P 500 made new marginal highs in price, the NYSE new high new low index made a lower high. This signals that new highs contracted and new lows expanded (albeit marginally) as the index made a new high. Additionally, of the 41 US indices and sectors I follow, 30 (73%) of them have bearish momentum divergences as measured by a 14 period RSI.
Failed Breakouts – Of the 41 US indices and sectors that I follow, 28 (68%) of them have either confirmed a failed breakout this week or are dangerously close to doing so. A failed breakout confirms when a market closes back below a previous high or resistance level. This provides a great entry on the short side because fast moves in the opposite direction are generally the result of failed breakouts. It’s also an ideal setup because the risk is very well-defined. A good example of this can be seen in the daily chart of the Dow Jones Industrial Average.
Downward Sloping 200 Day Moving Averages – Of the 41 US Indices and sectors I follow, 27 (66%) of them have downward sloping 200 day moving averages. This signals that the long-term downtrends in these markets are intact and that trading the short side of those markets in downtrends provides a higher probability trade than shorting those markets in uptrends or trendless markets.
VIX Bullish Divergence – In addition to the VIX moving back toward the bottom of its long-term range, it put in a bullish divergence as it made new lows last week. This divergence was clearly confirmed by the upside follow through over the last several days.
Weakness In Financials: Sector rotation and breadth expansion have been fueling the grind higher in the S&P 500 over the last two months, yet the financial sector has not been able to participate. Financials, Regional Banks, and Broker Dealers are now all resolving their multi-week consolidation patterns to the downside while momentum remains in a bearish range and their 200 day moving averages are downward sloping.
We’ve seen participation from almost every sector out there with the most recent beneficiaries being Healthcare and Biotech, but if a large sector like Financials is leading to the downside I find it hard expect the broader market to continue higher.
The theme of lower stock prices here in the US and globally is great, but how do we actually translate that into a trade?
The way I’m approaching this particular thesis is by looking for short setups in those markets where the long-term trend remains lower, momentum is diverging, and price is at a level where the risk is well-defined. I’m seeing quite a few of these setups across asset classes around the world, but I’ll provide just a few examples below to get your research and idea generation started.
Retail (XRT): The retail sector put in a nasty failed breakout above the 3/21 highs of 46.15 and the 61.8% retracement of the July-Feb rally. This suggests approaching this market from the short side as long as prices are below 46.15 on a daily closing basis with price targets at prior support near 42 and the YTD lows of 37.8.
Semiconductors (SOX): Semiconductors failed a fourth test of resistance near 680 and confirmed a failed breakout and bearish momentum divergence by closing back below the 3/21 highs. It also closed below the uptrend line from the 3/10 lows and the 200 day moving average is downward sloping, both of which add to the weight of evidence that this market is headed lower. Shorts want to sell any strength in this as long as prices remain below 682 on a daily closing basis and want to take profits near support at 620 and the YTD lows of 560.
Chile (ECH): Chile put in two nasty failed breakouts this week, one above the 3/21 highs, and another above a larger support/resistance near 36. It also managed to close below the uptrend line from the 2/11 lows, but in either case, the bearish momentum divergence has clearly been confirmed. This weak price action, combined with the fact that the long-term trend remains lower, suggests fading any strength in this market as long as prices remain below 36.20 on a daily closing basis. Profits can be taken near support at 32 and at the YTD lows near 29.50.
The Bottom Line: The weight of evidence currently suggests that it’s appropriate to tactically approach US equities, and many global equity markets for that matter, from the short side. Looking for short setups like the ones above where the weight of evidence is largely pointing toward further downside is a strategy that allows you to participate in high probability trades where the risk is well-defined and the risk/reward is elevated.
Regardless of whether you trade these particular setups or not, the information gathered from taking a top-down approach to analyzing all liquid global asset classes is invaluable. If you’re going to capitalize on a particular theme occurring in the market, it makes sense to invest the time in finding a trade that expresses your thesis in a capital efficient way.
As always, if you have any questions feel free to reach out and I’ll get back to you as soon as I can. @BruniCharting
JC Here – This is the exact opposite of what we were seeing at the end of January. We had every reason in the world to get aggressively long stocks at or near January 26th. The weight of the evidence then made it impossible for us to stay bearish, as we had been since November. Everything Bruni has mentioned, along with other factors, has us back in the bear camp. The risk vs reward is very much in favor of the bears here. The only thing that could change my mind, other than a severe price correction in stocks is some time, consolidation, and improvement in the aforementioned problems. I think that is the lower probability outcome, however, and we are likely to see much lower stock prices in the near future.
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Tags: $6J_F, $USDJPY, $DX_F, $NK_F, $TNX, $NYHL, $DJIA, $VIX, $XLF, $KRE, $IAI, $XRT, $SOX, $ECH
The author does not have a position in the mentioned securities at the time of publication.
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