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.