Nikkei setting up to resume its rise

The Nikkei is setting up to resume its rise. The weekly chart below says it all:

Source: Stockcharts.com

After completing a double-bottom spanning four years, the Index broke out late last year, shooting up by 60+% in six months, and has since been carving out a classic pennant formation. Flags and pennants are continuation patterns, meaning they typically occur within a trend and resolve with the trend continuing -- in this case, the trend being up. Also, flags and pennants have high hit or success rates, i.e. odds greatly favor a continuation of the preexisting trend versus a reversal. That said I would expect the Nikkei to eventually break out and resume its ascent.

Some may question the rise in the Nikkei earlier this year wondering if it appeared to be parabolic and therefore climatic, with the pennant formation instead setting up for a fall. Leaving aside the aforementioned point that flags/pennants tend to be continuation patterns with high success rates, parabolic "blowoff" or climatic peaks typically occur after extended moves, occurring over many months or years. Think of late 1999, early 2000 for the U.S. stock market. To me this move in the Nikkei is still early.

Finally, the chart of the Yen is quite revealing:



Not surprisingly, a near-opposite picture of the Nikkei, with a pennant formation recently occurring within a downtrend -- next move should be down. Note the Yen is up against its 200-day moving average (red line), now resistance. Also, from 2010-2012, the Yen completed a massive bearish head-and-shoulders formation, breaching the neckline late last year.

With respect to these charts, clearly Japanese QE appears to be working.

Sunny skies, but some grey clouds are moving in....

The recent stock market advance has been a healthy one, meaning it has generally been confirmed by market internals and other such indicators.

Source: Stockcharts.com

The chart above shows that the S&P 500 Index has successfully broken through the rising trend channel as key moving averages remain upward sloping.

The NYSE A/D line, perhaps the most popular market internal measure, recently hit a new high, confirming the S&P 500's new high:

Source: Stockcharts.com

I remain bullish on the market, however I am a bit concerned about some potentially bearish signs that either have appeared or are developing. The chart below shows the weekly S&P 1500 New Highs-New Lows Percent (lower inset) with the S&P 500 (upper inset): 

When this percentage (new highs minus new lows divided by total issues) has surpassed 20 on a weekly basis, it has generally indicated that the market advance has become overbought and is due for a reprieve.

I've discussed in the past the relationship between the stock market and UST yields, namely that they tend to be positively correlated. A falling UST note is generally coupled with the stock market rising.

That said the chart above highlights an inverse head-and-shoulders pattern for the 10-year UST note. In isolation, this bullish formation does not bode well for equities. However, although this may be true in the near-term, I've also discussed in the past how the 10-year UST looks to be in the midst of a longer-term, complex head-and-shoulders breakdown.

The chart above highlights the bearish complex H&S formation with the neckline breakdown at 127-128. Also note the rolling 100-day correlation between the S&P 500 and the 10-year UST price -- over time they tend to have an inverse correlation. 

As I wrote in a prior post, "I do expect the neckline to hold and for the UST to roll over, however if the 10-year climbs through $127 meaningfully (beyond $128), it would require prompt reassessment with equities likely feeling the brunt of it." I stand by that statement.

Energy stocks, crude oil and the USD: they're out of synch

Yesterday I wrote about what appeared to be a shift in sector leadership, with energy stocks in particular showing strong signs of relative price emergence.

Just to elaborate on what I pointed out yesterday, the chart above shows the Guggenheim equal-weight energy ETF (RYE) vs. the equal-weight S&P 500 ETF (RSP). The relative performance for RYE exhibits a double-bottom pattern for April and July followed by a recent breakout of a triangle formation -- all bullish attributes.

However, crude oil (WTI) has been behaving quite differently of late.

Rather than heading north like energy stocks, the associated commodity has been heading south since the start of September. I have been bullish on crude oil for months and I remain so for a few reasons. For one, as shown in the chart above, crude oil (WTI) broke out of an ascending triangle in July, shot up beyond $105, peaking at $110, and has since given back all those gains. Note $110 appears to be resistance and $97 looks to be support. Currently WTI is about $98, recently falling below round-number $100, but still above support at $97. The bottom line is crude has not broken down and still qualifies as a pullback off an earlier bullish breakout.

Another reason I remain bullish on crude is the US dollar (USD). Earlier this month, I discussed my bearish take on the USD, including what appeared to be a complex head-and-shoulders formation with an already-breached neckline (important).

The chart above shows the head-and-shoulders pattern for the USD with the breakdown through the neckline at the 81 level. There appears to be support at 79, which could serve to stall the USD's descent, but to me this chart continues to look bearish.

As I've reminded here before, historically there has typically been an inverse correlation between the USD and commodities in general -- which includes crude oil.

The chart above shows crude oil (WTI) in the upper inset, the USD, followed by the rolling three-month correlation between the two. The inverse relationship is clear when observing crude oil's chart versus the USD, an approximate mirror reflection. Note the rolling three-month correlation has tended to be less than zero (negative) over time. What's interesting is when the correlation spikes into positive territory, especially when reaching 0.50 or higher. Such instances are rare and do not last long. Currently the rolling three-month correlation is 0.77, the highest reading since 2005. Both crude oil and the USD have been in-synch, declining together, but as displayed such a positive relationship is out of the norm and very likely to change imminently. The question is: which will rise and which will fall? I've already weighed in with my opinion, believing crude oil holds and eventually resumes its ascent as the USD continues to erode.

Finally, an additional reason I remain bullish on crude oil is due to another relationship I've discussed in the past.

Between energy equities and their associated commodity, crude oil, it's my experience that the equities tend to lead the commodity. That said, and viewing the exhibit above, I have to think crude oil will soon regain its footing and revert upwards. The chart of RYE has broken out of a massive ascending triangle and is hitting new highs. And yet crude oil has been weak and in decline, despite the strength in energy equities.

I would also point out that the rolling three-month correlation for energy equities and crude oil tends to be positive (not surprising), but as shown above, this correlation is currently at -0.59, registering a 10-year low. It's very unlikely energy stocks and crude oil will continue to move in opposite directions. But as with the USD and crude, the question is which will head higher or lower? Will energy stocks revert down with crude oil, or will the commodity hold and resume its upward trend (note in chart above, the rising trend (red line) for crude oil)?

As I've stated, experience and weight of the evidence suggests crude oil will hold and eventually rise, closing the divergence with energy stocks. Stay tuned.

(Source for all charts above: Stockcharts.com)

Is Sector Leadership Changing?

With the S&P 500 recently hitting a new high, I thought it was interesting that none of the nine major sector SPDRs had yet to register a new relative high.

The charts below show the S&P 500 in the upper-most left corner with the relative performance of the nine sectors to follow.

The tech sector (XLK) has come close to hitting a new relative high but is not quite there yet. And the healthcare sector (XLV) did hit a new relative high last week but has since pulled back. 

I don't wish to make too much of this because it's likely a temporal occurrence with one or more of these sector ETFs likely to make new highs vs. the S&P 500 in the near future. Also, these SPDRs are cap-weighted meaning just a few stocks could be overly-influencing the return for the entire sector. However, I did find it a bit odd that at least one of the ETFs is not currently at a new relative high. 

There's a good chance this lack of clear sector leadership over the last few days could indicate that dynamics are changing and that perhaps new sectors and industry groups will soon emerge as market leaders. To get a better sense of what may be forthcoming in this regard, below are charts of twelve-month relative performance for the Guggenheim major sector ETFs. Unlike the SPDRs, these ETFs have equal-weighted constituents, not cap-weighted. As I've written in the past, I believe equal-weight ETFs offer a more accurate representation of sector performance.

Observations:

• Consumer Discretionary and Energy look to be approximate mirror-opposites. Discretionary stocks hit a ceiling over the last several weeks as returns generally just matched that of the equal-weighted S&P 500 (RSP), only to then have relative performance fall off a cliff this month, breaking the uptrend. In contrast, the relative performance for the Energy sector (RYE) appears to have put in a double-bottom this year and successfully broke through a downtrend in August. In fact, energy stocks have been stellar outperformers this month.
• Materials appear to have established a relative bottom during the summer and if anything an inverse head-and-shoulders formation is developing (bullish).
• Technology has pulled back within an uptrend, still looks good.
• Industrials double-bottomed this year and made a nice relative-price run in August-September, only to abruptly and somewhat severely retrench from mid-September through this month. 
• Relative performance for Financials broke down in July-August, slid further in September, and are enjoying a reprieve bounce this month.
• Healthcare remains in a healthy uptrend.
• Utilities and Consumer Staples (the risk-off contingent) remain in well-defined downtrends.

In summary, there are signs of rotation out of Consumer Discretionary and Industrials and into Energy and even Materials. To some extent, this is evidence of investors exiting early-cycle sectors and gravitating to mid- to late-cycle sectors. Nothing to necessarily worry about and if anything indicates normal maturation and progression of a bull market. I'm not convinced that the spike in relative performance for Financials will have legs given the preceding plunge did damage and the sector now faces overhead relative resistance. And as with Consumer Discretionary and Industrials, Financials tend to be an early-cycle sector, offering further hints that money is being reallocated out of these sectors. 

At this point, I would prefer to focus on Energy stocks in particular, but also Tech, Healthcare and even Materials (selectively). Consumer Discretionary and Industrials are not "broken" sectors and I will keep an eye on them for resumption of uptrends, however at the moment they've become relative laggards and thus potential sources of funds. Needless to say, Utilities and Consumer Staples remain sectors to avoid or underweight.

Eurozone: Rising Like A Phoenix, Part 2

About two months ago, I wrote about how Eurozone equities were taking off despite perceptions that the region was still mired in a painful recession. As is often the case, stock prices were discounting the end of the recession and looking ahead to brighter days of resumed economic growth.

I felt it would be worthwhile to update the August blog post and add a few more comments. The following chart shows respective equity returns since the end of June:

Although U.S. stocks have enjoyed a nice run with the S&P 500 up over 7% in the period, the Eurozone equivalent equity index has more than doubled that return at nearly +16%. It was not long ago when Greece, Spain and Italy were in dire straits and yet they have performed spectacularly over the last several months, far surpassing the STOXX50 return as the ETFs for all three countries have appreciated by more than 30%. Greece was on the verge of financial collapse, teetering on the abyss, but leads the pack with a striking 37% return. 

I thought the following chart was interesting.

It shows YTD equity returns for five Eurozone countries. See a pattern? A fairly well-defined double-bottom, as each country established the W-shaped formation at about the same time (April and July), including a bullish breakout in September.

Readers know I'm always looking for evidence of price leading news or reported data. The chart below shows the Conference Board Leading Economic Index (LEI) and Coincident Economic Index (CEI) for the Eurozone.

The CEI (red dashes) has remained repressed, which is not especially surprising given it's a coincident index and the recession only recently ended. The LEI (blue line) didn't begin to trend higher until the start of this year (intersection of orange lines) -- not bad for a leading index, but I would argue that equity prices did an even better job of discounting the recession.

The chart above of the STOXX50 shows the index putting in a double-bottom by the summer of last year and then breaking out in September, successfully getting through the declining trend line. The Index then underwent a pullback -- very common to follow a breakout -- before resuming its ascent in the latter half of November through December. 

The STOXX50 has recently ripped to new highs; the fact is the days of the Eurozone appearing moribund and left for dead are seemingly long past. And once again equity prices reacted well ahead of any news suggesting that such a confounding change in fate was in the cards. It frequently pays to consult the charts!

Stock market outlook remains bullish near-term, but bearish divergence developing longer-term

The stock market (S&P 500) continues to look bullish in the near- to intermediate-term.

Source: Stockcharts.com

The daily chart above shows the S&P 500 successfully held at the lower threshold of an ascending channel and currently resides at about the midpoint within the channel. It's good to see the Index has now spent three days above the round number 1700, the approximate previous high at the start of August. The stochastic is currently overbought at a reading of 90, but a newly-extended stochastic is common at the start of a move higher within an uptrend. Note also the MACD recently registered a buy signal, which have been timely in the recent past.

To give a better sense of which way the risk-on/risk-off pendulum has been swinging of late, I submit the following three charts.



The chart above shows what has been working since the market low of late August. Clearly, risk-on has been outperforming as 1) smaller-cap stocks have outperformed larger-caps, 2) high-yield "junk" bonds have outperformed T-bonds, and 3) cyclical stocks have outperformed staples.

But what does this exhibit look like since the market peak in September?



Interestingly, despite the S&P 500 decline, which typically translates into risk-off assets doing better than their risk-on counterparts, the chart above shows the opposite. The S&P 400 and 600 have actually appreciated in that time with junk bonds outperforming T-bonds and cyclical stocks holding up better than the more conservative staples.

Finally, the following chart shows results for this most recent rally.



Once again, and not surprisingly, risk-on has outperformed risk-off. In sum, the three charts collectively depict a bullish backdrop for the market.

I would mention that longer-term there is a negative divergence developing that is concerning.

The weekly chart above shows the S&P 500 and its MACD. Note that as the Index has climbed this year, the MACD has been trending down -- a bearish divergence. In the past, such a negative divergence has often resulted in equities suffering a correction, in some cases quite a drastic one at that (2008!). It's still too early to make any sort of definitive call on this looming development, and late last year a similar bearish divergence appeared only to result in a fairly mild correction before the Index resumed its ascent. Price has yet to confirm this divergence, but it's definitely something worth keeping in mind.

10-Year UST Note Has Dandruff

In a blog post last week, I discussed the relationship between interest rates and the stock market, namely that over the last several years the relationship has tended to be positive. As yields on UST bonds have risen, so too have equity prices, and vice versa. 

With the following weekly chart of the 10-year UST note, I wanted to further explore this topic.

It appears as if the 10-year UST is experiencing a case of dandruff as a bearish head-and-shoulders formation is plainly evident (blue circles). The neckline looks to be a bit upward sloping (orange line), which is not a more classic horizontally-drawn line but also not a nullifier of the pattern. Nonetheless, a case can be made for a horizontal neckline at about $127 (red line) -- in either case, both necklines have been breached to the downside. More recently, the multi-year ascending trend line (red) has likewise been broken to the downside as the UST fell below $125. The 10-year has since undergone an anemic, reflex-rally back to the horizontal neckline and looks to be rolling over as the $127 neckline level now serves as overhead resistance. This snap-back price retracement after a neckline breach is a fairly common occurrence and more often than not sets up for a follow-through move to the downside in response to the neckline holding firmly as resistance.

Assuming the UST does indeed suffer another leg down, it would be bullish for equities, at least based on past history. In the chart above, I show respective S&P 500 levels (purple numbers) at key turning points for the 10-year UST note. Since late 2008, a downward-trending UST -- and therefore upward-trending yield -- has generally seen the S&P 500 appreciate in that time (and vice versa).

Needless to say, $127 has become a key level for the 10-year note, something to monitor closely. I do expect the neckline to hold and for the UST to roll over, however if the 10-year climbs through $127 meaningfully (beyond $128), it would require prompt reassessment with equities likely feeling the brunt of it.

Yesterday's action was a great start, but we need follow through....

As I wrote on Tuesday, I continue to reside in the camp believing it won't be different this time, that Congress won't let the country default on its debt. Yesterday offered an encouraging sign in this direction as the stock market shot up over 2% with word that key Republicans were meeting with the president. Advancers outnumbered decliners by more than a 5-1 ratio, up/down volume was even more impressive at greater than 10-1 and the TRIN finished at 0.45, one of its lowest numbers YTD -- all very bullish readings. What we need to see from here is follow through to the upside, and so far today we are seeing it.

An updated S&P 500 chart:

Source: Stockcharts.com

As it did in June and August, the S&P 500 held at about the 100-day moving average before spiking higher yesterday. Note also it held at the ascending trend line (orange line), insuring that the rising channel remains intact with the upper limit beyond 1720 (red line). On Tuesday, I pointed out the Index was oversold with the stochastic below 20, but that it was "prudent to wait for the stochastic to hook-up and rise beyond 20 to better confirm a buy signal." With yesterday's move, the stochastic has indeed reverted up through 20.

Also on Tuesday I highlighted the developing head-and-shoulders pattern in the weekly DJ Industrials chart, but wrote:

[A]s I always remind, it's important not to jump the gun and overly anticipate what may happen with a formation-in-progress. For a head-and-shoulders pattern to actually become bearish, the neckline must be penetrated to the downside -- something that has yet to occur (neckline at about 14750 level) and, importantly, may not occur at all.

An updated weekly chart of the DJ Industrials:



The neckline was never breached in a meaningful way, i.e. beyond just slightly below 14750. In fact, instead a candlestick hammer has formed (orange circle), which is typically a bottoming pattern. Also, note in the upper inset that the RSI has retreated but held at the 50 level, thus far remaining in the upper portion of the RSI range (bullish).

Yesterday was a great start to what could evolve into a sustained move off oversold levels. But obviously we'll need to see continued follow-through to build on yesterday's gains, and that will presumably require sensible follow-through by the folks in Washington -- something that has been in short supply of late. However, yesterday's crack in the political standoff was an overdue and gratifying indication to investors that sanity will likely win out (it won't be different this time).

Making a difference: market cap size and interest rate direction

Amidst much talk and reporting of a possible U.S. debt default, the stock market continues to take it all in relative stride. That's not surprising since the market did quite well during the last government shutdown, with investors presumably assuming this time around that once again Congress will eventually hammer out an agreement. I'd like to assume the same, that we'll avert default and thus disaster, and I never want to say it's different this time because usually it's not, but considering the extreme degree of dysfunction in Washington perhaps this time it really is different.

It's interesting to view the stock market by market cap as different pictures are taking shape.

The weekly charts above show the DJ Industrials, S&P 500 and Russell 2000 Index, respectively. In general, the lower the market cap, the more bullish the chart. In fact, the DJ Industrials is in the midst of carving out a bearish head-and-shoulders pattern. The S&P 500 remains in a solid uptrend, recently pulling back to its 50-day moving average, and the Russell 2000 looks terrific as it just hit a new high and remains well above its 50-day MA. All in all, a bullish backdrop for the market as the flatter small-cap index with nearly 2000 stocks is more indicative of healthy breadth and internals than the more top-heavy S&P 500, not to mention the mega-cap and sparsely populated DJ Industrials.

I would also emphasize that even though the DJ Industrials appears to be taking on dandruff, as I always remind, it's important not to jump the gun and overly anticipate what may happen with a formation-in-progress. For a head-and-shoulders pattern to actually become bearish, the neckline must be penetrated to the downside -- something that has yet to occur (neckline at about 14750 level) and, importantly, may not occur at all.

Taking a closer look at the S&P 500, the daily chart remains fairly bullish.

As already mentioned, the Index remains in an uptrend, well within the ascending channel that has been in place since the start of summer. 1675-1680 looks to be an approximate level of support from the prior high in May and also with the 50-day MA currently residing at 1679. The stochastic is just below 20 indicating the Index is oversold within the uptrend; note in the past such conditions have been opportunistic entry points (green circles). It's prudent to wait for the stochastic to hook-up and rise beyond 20 to better confirm a buy signal. I would also point out that the MACD is trending lower as the S&P 500 has headed higher, a negative divergence that certainly warrants close monitoring.

Finally, with regards to interest rates, I thought the following chart of the S&P 500 and 10-year UST yield was revealing.

Over the last several years, interest rates have generally trended down, primarily due to the Fed and QE activity, and in that time the stock market has generally risen, primarily due to the added liquidity in the system. However, notice in the chart above that within these longer-term opposing trends (interest rates down, stock market up), the S&P 500 (market) and 10-year UST yield have tended to have a positive relationship. The lower inset shows the rolling 200-day correlation for the S&P 500 and UST 10-year yield and clearly the two have been positively correlated. What this means is that while the longer-term trends have generally been diverging, in the more intermediate- to short-term time frame stocks and interest rates have tended to move in tandem. In other words, the near-term directional move of interest rates has tended to correlate with the near-term directional move of stocks -- with the longer-term trends of each gradually deviating over time.

Why would rising interest rates be "good" for stocks, and vice versa? Three related reasons come to mind: 1) rising yields = falling bonds, inferring capital is being reallocated from bonds into stocks, 2) rising interest rates infer a stronger economy and less need for Fed assistance via QE, with a healthy economy being bullish for stocks, and 3) capital very often flows into US T-bonds for safety reasons, driving down rates or yields, and because such capital flow indicates risk-off, it's bearish for equities.

The chart above shows what looks to be an inverse head-and-shoulders formation for the UST 10-year yield, with the yield piercing through the neckline at about 2%. During this time, the S&P 500 has more or less appreciated with the rise in rates, and has likewise stalled out more recently with yields as the 10-year rate has pulled back from near 3% to about 2.6%. I believe UST yields have been falling of late due to reason #3 discussed above, as investors have been flocking to the safety of US bonds given the looming threat of debt default (I know, doesn't quite make sense, but I get it). The growing fear that perhaps it truly is different this time has kept both equities and UST yields under pressure.

In sum, and assuming this time is not different, for now the market outlook remains relatively good.

(Source for all charts: Stockcharts.com)

Metals & the US Dollar

It continues to appear as if the major metals are in a bottoming process.

When I last wrote about gold, it had successfully broken through both a declining trend line and its 50-day moving average only to then pullback.

Source: Stockcharts.com

Regarding the price retreat from the recent break in the downtrend, I wrote, "it wouldn't be surprising to see price retrace a bit more to $1330-$1350," which occurred and then some as gold has dipped just below $1300 before recovering. The daily chart above shows what looks to be a bullish inverse head-and-shoulders formation developing. I always strongly caution against jumping the gun and overly anticipating a price formation before its fully established, but better to at least be aware that this bullish pattern could be unfolding. Note also that $1300 looks to be a decent support level (orange line) and that the MACD had finally risen above zero, a bullish sign. Finally, I would also mention a key point: since the $1200 low this past summer, many of the wide candles are white, inferring range expansion on up days; compare to pre-1200 level months where most of the time the wide candles were red, i.e. more-severe down days dominated -- a gradual change in control of buyers over sellers.

Not surprisingly, the chart of silver very much resembles that of gold (over time, the correlation of gold and silver has tended to be 0.70, very high).

Source: Stockcharts.com

As with gold, silver also looks to be potentially carving out a bullish inverse head-and-shoulders formation. In addition, the MACD successfully rose above zero and note also the many wide-range white (up day) candles since the "head" or post-$19 level versus the many wide-range red (down day) candles pre-$19 level.

When I last wrote about copper, I discussed how smart(er) money appeared to be making a very bullish bet on the metal.

The price of copper then was at the $3.15-3.20 level and currently it resides at about $3.30. Again, as with gold and silver, copper also looks to have a bullish inverse head-and-shoulders formation in the works, with $3.35 serving as the possible neckline. Price is now on the right side of the 50-day moving average (bullish) and the orange line depicts a maturing uptrend. That said the 200-day moving average at $3.37 and the preliminary neckline of $3.35 serve as overhead resistance in the near-term.

Closely related to the price behavior of these metals is the US dollar (USD) as commodities in general tend to move opposite the USD.

The chart above shows the USD versus the Reuters-CRB commodities index (CCI) with the rolling 1-year correlation in the lower inset. Clearly the relationship is historically negative or inverse.

That said the picture for the USD appears bearish.

The USD recently broke down through support at $81, mustering a brief snap-back move only to then roll over to the current level of $80. In the chart above, I drew what appears to be a bearish complex head-and-shoulders formation, complete with the breach of what could be considered a neckline at $81. Granted, not a classically-drawn formation, but perfect is frequently the enemy of the good. Support does exist around $79, but to me this chart looks broken.

The weekly chart of the USD also looks vulnerable.

Source: Stockcharts.com

A multi-month rising trend line has been broken and if $79 doesn't hold, the next fairly well-defined level of support is at the $74-$75 level. Also note that a Death Cross -- when the 50-day MA declines through the 200-day MA -- recently occurred. 

In isolation, this bearish outlook for the USD is a bullish tailwind for commodities.