"The good news … is that if the pattern of August-November continues to play out, we could see a sharp move higher during the next few days up to the $210 level. The bad news for bulls is that if the pattern continues to assert itself after a move to $210, a top would be in place, followed by a month of choppiness that precedes another huge double-digit decline (think 'sell in May and go away')."
-- Monday Morning Outlook, April 4, 2016
The excerpt above, written when the SPDR S&P 500 ETF Trust (SPY – 206.33) was trading at $206.92 near the beginning of the month, has played out as we projected: a rally up to the $210 level, which has proven to be resistance. And, as suggested by my tweet late last week, not only are bulls at risk of a continuation of the price pattern like the second half of 2015, it has been increasingly apparent that, like 2015, Federal Open Market Committee (FOMC) meetings concurrent with SPY trading in the $210 area have not exactly been a bullish recipe.
In fact, you might find it of interest that the FOMC held a meeting on both April 27, 2015, and April 27 of this year. On the day the FOMC announced its policy action on April 27, 2015, the SPY closed at $210.77, but found itself trading as low as $206.76 only one week later. This price action preceded a move back above the late-April FOMC daily high and a period of sideways action into the June FOMC meeting, after which $210 was again sold, followed by a recovery to the recent highs.
Similarly, like late April of last year, the SPY has sold off in the immediate days following last week's FOMC meeting. Moving forward, a period of choppiness might be acceptable to bulls, as it is a better alternative to the 10%-plus correction that followed in the days after the June 2015 FOMC meeting when the SPY rallied up to the $210 area in the immediate days after the meeting, only to ultimately correct in the August lows.
And yes, we are entering that period when you will hear talking heads refer to the Wall Street saying, "Sell in May and Go Away." The point being, seasonality, weakness following Fed meetings when SPY is in the $210 area, and a pattern of double-digit percentage declines following double-digit percentage gains during the past several months is a direct risk to bulls.
The good news is that if the SPY behaves like it did last year at this time, the April highs will be retested and taken out in May, as last year's rally into late May began when the "Sell in May and go away" talk was at its height. There was a CNBC segment dedicated to the "Sell in May and go away" theme this past Friday afternoon, in fact.
Note as we enter next week's trading, the SPY is trading just above support from its 2015 close of $203.87. Friday's low was $205.06. Another major equity exchange-traded fund (ETF), the iShares Russell 2000 Index (IWM – 112.48) is trading around its 2015 close of $112.62, as well.
Clearly, as you can infer from the tweets immediately above, and the short interest chart on S&P 500 Index (SPX – 2,065.30) components, a closing out of bets against individual stocks and the broader market may have driven the April rally into resistance. If sideline players are set on awaiting a breakout in equities and many of the bets that were recently placed against individual stocks and the broader market earlier this year are closed out, one has to ask where the next source of support comes from. Sure, short interest on SPX component stocks has a lot further room to decline if the 2014 short interest lows are revisited, but for now, the short interest trend is higher since early 2014, and shorts may grow bold if they see resistance levels hold. Stay tuned.
Moreover, note how the CBOE Market Volatility Index (VIX - 15.89) has advanced comfortably above the 14.07 area, half its 2016 closing high of 28.14. This increases the risk of a volatility rally, which would likely be coincident with a market decline. Thursday and Friday of last week saw a pretty aggressive advance in this index, and VIX futures contracts have moved higher as well.
The VIX's pop from its "half-high" area comes at an interesting time when analyzing Commitment of Traders (CoT) weekly data, which we have referenced in the past. With large speculators on VIX futures near their largest short position since the summer of 2015, this adds to the risk of a volatility pop sometime in the near future.
As we have mentioned in the past, large speculators have historically been positioned wrongly at major turning points with respect to volatility movement. For example, they moved into a rare net long position in January, near the 2016 VIX futures contract highs, and increased this long position into February, when VIX futures finally peaked barely above the January highs. This group remained net-long into mid-March, even as VIX futures had declined 35%-40% from their February high.
With the VIX finding support around half its closing high in 2016, and VIX futures players aggressively moving into a hefty net short position in recent weeks, the risk of a market pullback sometime during the next few months has increased. In other words, volatility appears to be heading higher, but volatility traders are not positioned for such, which heightens the risk of a volatility surge and a stock decline.
There is a slight glimmer of hope for bulls with respect to the VIX potentially topping last week. The VIX's intraday 2016 high is 32.09. So, bulls can take some comfort that after the VIX advanced well above 16.05 (the half intraday 2016 high) in Friday's trading, it closed below this level. In fact, there were two prior failures to close above 16.05 earlier in April.
"… [L]ong-time readers know that we emphasize monthly closes. GLD popped over its 36-month moving average intra-month, but after last week's sell-off, it enters the last week of March below this important trendline that marked a key low in 2008. The declining 36-month moving average is now at $118.48, so we still advise a monthly close above this trendline to confirm that a change in the longer-term trend is probable."
-- Monday Morning Outlook, March 28, 2016
"One thing to keep an eye on in relation to energy, materials, and industrials is the U.S. dollar. Most of the products related to businesses are denominated in the U.S. dollar, so when it gets weak, these products get cheaper for customers. Lower prices usually mean higher demand, and it's not a coincidence that the U.S. dollar has been getting hit during this rally. Take a look at the chart below of the PowerShares U.S. Dollar Index (UUP - 24.65). It's currently bouncing off its lower channel, which coincides with price level support -- and it's showing strength to end the week. For the strength in these sectors to continue, most will want to see a break down below this support area."
-- Monday Morning Outlook, April 25, 2016
"The yen surged more than 3% against the U.S. dollar Thursday, its biggest one-day gain since May 2010, after the Bank of Japan stuck to its current package of policies aimed at stoking economic growth and inflation. … The BOJ's inaction at its April meeting defied market expectations"
-- The Wall Street Journal, April 28, 2016
As loyal readers know, we've been following the action in gold closely. When gold popped in late January/early February, we advised against chasing the move, as we viewed a monthly close on the SPDR Gold Trust (GLD – 125.65) with respect to its three-year moving average as an important clue as to whether or not a sustained trend higher could be in place. After two months of intra-month moves above the trendline, but end-of-month failures to close above this trendline, the GLD finally closed April above its three-year moving average. From a technical perspective, this makes GLD's prospects shinier.
In fact, per the second chart below, note how the GLD closed above the round 20% year-to-date gain for the first time this year. This round percentage level marked resistance in March. Additionally, the close above $120.60 pushed GLD more than 20% above its December 2015 closing low.
With the potential for sideways action in the equities market the next several weeks, and large speculator volatility futures players positioned in such a way that heightens the risk of a volatility surge, now might be a time to use short-term equity advances to lighten exposure and increase exposure in gold.
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