How Concerning is an “Overbought” Reading on Weekly RSI?

By Chris Ciovacco

Stocks Are “Overbought” In 2017

On February 17th the S&P 500’s weekly RSI reading closed above 70, which may appear to be a red flag for the stock market based on common terms associated with RSI. From stockcharts.com:

“Developed J. Welles Wilder, the Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. RSI oscillates between zero and 100. Traditionally, and according to Wilder, RSI is considered overbought when above 70 and oversold when below 30.”

Stocks Were “Overbought” In 2014

We can find numerous examples in history when the S&P 500 struggled after weekly RSI approaches 69-to-70 (overbought), including the 2014-2016 example below.

In this post, we will address one question and one question only:

“Is it in the realm of historical possibility for overbought markets to remain overbought for long periods of time while posting impressive gains and avoiding significant pullbacks?”

Is An “Overbought” Reading A Showstopper?

There are numerous examples from history when positive trends in stocks were not derailed after weekly RSI approached 69-to-70. The early 1980s were marked by strong bullish trends. When trends are strong, the S&P 500 can continue to rise for some time after weekly RSI nears “overbought” status. As shown in the chart below, after high weekly RSI readings in 1982, the S&P 500 gained an additional 27% before experiencing a significant pullback.

Continue reading How Concerning is an “Overbought” Reading on Weekly RSI?

Stocks and Gold; the Next Opportunity

By NFTRH

Unless you visit the Notes From the Rabbit Hole website regularly, you might think the title of this article implies it is written by a market analyst pretending to know what will happen; like a top in the stock market or a resumed bull cycle in gold.  You might also think it is written by one of the writers who’ve either a) been fighting the stock bull since the bearish market terminated a year ago or b) been a perma gold bug bull.

So once again, we have our disclaimers because in a milieu of quickly forgotten soundbites, integrity is important.  So I point you to a couple of posts (among many others) that indicated, when the time was right for people to get bullish the stock market in favor of gold.

AMAT Chirps, B2B Ramps, Yellen Hawks and Gold’s Fundamentals Erode (May 30, 2016)

Detailed Multi-Market Update (an NFTRH premium update, now public, from July 22, 2016)

From the July 22 NFTRH update, in the event you don’t wish to follow the link to read the whole thing…

Yesterday in a public post a target was established for the S&P 500.  I’d love to see a drop toward 2100 to clear over bullishness but regardless, SPX targets 2410 as long as it’s at or above the noted support zone.

Here is the price panel of the chart from that update…

spx

Indeed, SPX went on to make a hard test of 2100 on election jitters, as you can see by today’s version of the very same chart.  That folks, was the last opportunity for those who had remained bearish after Brexit, to stop being so.

Continue reading Stocks and Gold; the Next Opportunity

VIX Futures Traders Finally Getting Complacent

By Tom McClellan

Highest priced VIX futures contract
February 17, 2017

The recent story about low readings for the spot VIX Index is well-reported.  What has escaped the attention of many is that prices are now finally coming down for VIX futures at the long end of the maturity spectrum.

The spot VIX has been below 15 for most of the time since July 2016, except for a brief spike up to 22.51 on the Friday before the November 8, 2016 federal elections.  Despite the spot VIX remaining low, the highest priced VIX futures contracts have been fairly steadily above 20. Usually the highest priced contracts are the farthest out expiration month contracts. Just recently, they started creeping lower, down into the 19s, then the 18s.

Something different is happening now.  The current far-month contract is Oct. 2017, which closed on Feb. 15 at 17.675. That is the lowest number for the highest VIX futures contract since August 2015, just before the China-fueled mini-crash.

This week’s chart shows a plot depicting the value of the highest priced VIX futures contract over time. The prices are inverted to better align with the price action.  Instances with the highest priced VIX futures contract being below 18 are pretty rare, and usually associated with meaningful tops.  That “rule” did not work during QE3, but it is fair to say that a lot of things did not work then.  The rule started working again after QE3 was ended.

You have probably heard of the several VIX related ETNs that are available now. Some folks do not know that those products are not actually tied to the spot VIX, but rather they own VIX futures, either long or short depending on the type of ETN.  A big winner this year is XIV, the short VIX futures ETN, which has more than doubled since the November elections.  XIV goes short the two VIX futures contracts nearest to expiration.  It has a nice upward bias because of the natural time-decay of VIX futures pricing.

Here is what that term structure looks like as of Feb. 16, 2017:

VIX futures curve

Continue reading VIX Futures Traders Finally Getting Complacent

Is Market Breadth Waving Bearish Flags?

By Chris Ciovacco

All things being equal, during a healthy rally, we prefer to see a high number of stocks participate in the move (strong market breadth). In recent weeks, you may have come across something similar to the MarketWatch headline below:

Market breadth can be tracked in numerous ways. One of the most logical is to compare the health of narrow indexes, such as the Dow which contains only 30 stocks, to broader indexes, such as the NYSE Composite, which contains over 1,900 stocks.

Breadth Before 10% Plunge In Stocks

As described in this week’s video in detail, the S&P 500 experienced a waterfall decline of over 10% following the close on August 18, 2015. Notice in the chart below how vulnerable the trends were in the broad NYSE Composite Stock Index before the S&P 500’s big drop.

How Does The Same Chart Look Today?

The answer to the question above is “much better”. Instead of the moving averages making a series of lower highs and lower lows, the 2017 version of the same chart looks much healthier (see below). Recent gains have been much more broad-based than what transpired in the spring and summer of 2015.

Continue reading Is Market Breadth Waving Bearish Flags?

Bubbles, Money and the VIX

By Doug Noland

Credit Bubble Bulletin: Bubbles, Money and the VIX

February 10 – Financial Times (John Authers): “The Importance of Bubbles That Did Not Burst:”

“Is there really such a thing as a market bubble? I feel almost heretical answering this question. I and most readers have lived through two decades that were dominated by two vast investment bubbles and the attempt to deal with their consequences when they burst. Getting into definitions is beside the point. As US Supreme Court Justice Potter Stewart once said to define pornography: ‘I know it when I see it.’ And there is no point in arguing that the dotcom bubble that came to a head in 2000, or the credit bubble that burst seven years later, were not bubbles. I know a bubble when I see one, and they were bubbles. For those of my generation, spotting bubbles before they get too big, and thwarting them, seems to be vital for regulators and investors alike.”

“But in a great new compendium on financial history, several writers make the same points. The number of bubbles in history is very small. That makes it hard to draw any valid inferences from them. Further, definition is a real problem, and not just one for linguistic nitpickers. History’s acknowledged bubbles all have one critical factor in common; they burst. But that gives us a one-sided view. We need to look at those bubbles that did not burst and the crises that did not happen.”

We’re at the stage where there’s impassioned pushback against the Bubble Thesis. To most, it’s long been totally discredited. Even those sympathetic to Bubble analysis now question why the current backdrop cannot be sustained. “The number of bubbles in history is very small.” Most booms did not burst. So why then must the current boom end in crisis – when most don’t? It has become fashionable for writers to try to convince us that such an extraordinary backdrop need not end extraordinarily.

There’s great confusion that I wish could be clarified. I define Bubbles generally as “a self-reinforcing but inevitably unsustainable inflation.” There are numerous types of Bubbles. Most definitions and research (as was the case with the analysis cited by the FT’s Authers) focus specifically on asset prices (“an extreme acceleration in share prices. In one version, [Yale’s Will Goetzmann] required them to double in a year — which excluded the dotcom bubble and the Great Crash of 1929. To keep them in, he also tried a softer version where stocks doubled in three years”).

Behind every consequential Bubble is an inflation in underlying Credit. My analysis focuses on the nature of the monetary expansion responsible for the asset inflation. I’m less concerned with P/E ratios and valuation than I am Credit expansions and the nature of risk intermediation. Earnings are important, but more critical to the analysis is the degree to which they (and “fundamentals” more generally) are being inflated by monetary factors – and whether such inflation is sustainable or susceptible.

Credit Dynamics are key. Mr. Authers refers to the “dot.com” and “Credit” Bubbles. Yet the nineties Bubble was fueled by extraordinary expansions in GSE Credit, securitizations and corporate debt. Internet stocks inflated spectacularly, but in the grand scheme of the Bubble were rather inconsequential. The Bubble faltered initially in 2000 with the sharp reversal in technology stocks. Less embedded in memory is the near breakdown in corporate Credit back in 2002. The resulting aggressive Fed-induced reflation then spurred a doubling of mortgage Credit in just over six years. The transformation of risky Credit into perceived safe money-like securities (“Wall Street Alchemy”) was integral to both “tech” and “mortgage finance” Bubble periods. The fact that dot.com price inflation and overvaluation greatly exceeded that of home prices is meaningless.

When I initially titled my weekly writings the “Credit Bubble Bulletin” back in 1999, I anticipated that “Bubble” would remain in the title only on a short-term basis. And indeed, I thought the Bubble had burst in 2000/2001 and then again in 2008. But in both instances Credit Dynamics and resurgent monetary inflation made it clear to me that a more powerful Bubble had reemerged. Whether one prefers to date the beginning of the Great Credit Bubble 1992, 1987 or even 1971, it’s been inflating now for quite a long time. Too be sure, the expansion of government Credit over the past eight years puts mortgage Credit and other excesses to shame. I would argue that price distortions and risk misperceptions similarly overshadow those from the mortgage finance Bubble period.

Of course, the vast majority have become convinced that the boom is sustainable. Indeed, analysis these days is eerily reminiscent of “permanent plateau” jubilation from 1929. The bullish perspective sees an improving global economy and a powerful pro-growth agenda unfolding in the U.S. Worries about debt, China and such matters have turned stale. A contrary argument focuses on Credit Dynamics and the unsustainability of today’s unique monetary and market backdrops.

Over the years, I’ve made the point that a Bubble financed by junk bonds would not create a systemic issue. There are, after all, limits to the demand for high-risk debt. Long before such a boom could go to prolonged and dangerous extremes (imparting deep structural maladjustment), investors would shy away from increasingly unattractive Credit issued in clear excess. The boom would lose its monetary fuel.

I define contemporary “money” as a financial claim perceived as a safe and liquid store of (nominal) value. Money these days is Credit, but a special type of Credit. Unlike junk bonds, “money” enjoys essentially insatiable demand. As such, a boom fueled by “money” is a quite different animal than our above junk bond example. I would posit that a prolonged inflation of perceived safe “money” by its nature ensures far-reaching risk distortions. For one, Bubbles fueled by “money” appear especially sustainable, while a prolonged inflation of “money” virtually ensures a destabilizing crisis of confidence. Governments throughout history have abused money. Contemporary central bankers took it to a whole new level.

Continue reading Bubbles, Money and the VIX

Low QQQ Volume A Sign of a Top

By Tom McClellan

QQQ Volume 10MA
February 10, 2017

When investors get complacent, they do certain things.  They show up as bullish in the various surveys.  They bid tiny premiums on options, driving down the VIX.  They put all of their cash to work, letting money market fund levels get down really low.  And they trade tiny volumes on QQQ.

This week’s chart looks at a 10-day simple moving average in the daily trading volume of QQQ, the largest of the ETFs which tracks the Nasdaq 100 Index.  Low readings like this are associated with investor complacency, and thus with important price tops.

Volume has been trending lower in recent months, so the static thresholds of “high” and “low” employed in the chart may not be ideal.  But there is no question that this is a low reading.

One problem with this analysis technique is that holidays like Thanksgiving and Christmas naturally produce low trading volume, which is not a function of how investors are feeling.  So one needs to employ at least a mental filter when examining QQQ volume around those days.

Holiday effects are not an issue at the moment.  Instead, low VIX, low worry, and high complacency are producing low QQQ volume.  The one-day reading on Feb. 6 was the lowest in the past year, if we except holidays.  Traders are clearly not very worried about volatility risk, correction risk, and strangely enough, political risk.  And if they cannot get any less worried, they can only get more worried.  When they do, they’ll likely react in a bad way, meaning prices going lower.

Moments of excitement in the stock market tend to produce high volume in QQQ, and also in other big ETFs like SPY.  So big high spikes in the QQQ Volume 10-day MA are good markers of important price bottoms for the stock market.  Someday in the future, we’ll get the chance to make such an interpretation as prices drop into an important bottom.  But the interpretation task for the moment is to observe that volume numbers are low, and thus top-worthy.  This confirms the expectations of an early February top, as explained in our Daily Edition and our twice-monthly McClellan Market Report.

Subscribe to Tom McClellan’s free weekly Chart In Focus email.

Related Charts

Jul 02, 2015

QQQ Volume Spikes on Selloff
May 22, 2014

ETF Volume is Different
Oct 20, 2016

The Post-Election Stock Market

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A Pro-Business Government Does NOT Lead to a Stronger Stock Market

By Steve Saville

The historical record isn’t consistent with the view that a more pro-business President results in a stronger stock market

Putting aside the fact that prior to the US Presidential election last November almost everyone believed that a Trump victory would result in a weak stock market, the popular view now is that the stock market has strengthened since the election due to the incoming Trump Administration being more pro-business. It is arguable whether the Trump Administration really will be “pro-business” (early signs are that it won’t be), but in any case the historical record indicates that the currently-popular view is total nonsense.

According to the historical record, the stock market’s performance during a Presidential term has nothing to do with the extent to which the Administration is pro-business. Let’s consider some examples to help make this point, using the Dow Industrials Index as our stock-market proxy and the November election dates as the starting and ending points of a presidential term. It makes sense to use the election dates rather than the inauguration dates given that the financial markets will begin to discount the economic effects of a new president immediately after the election result is known.

First, F.D.Roosevelt probably led the most anti-business administration in US history, but during FDR’s first 4-year term the stock market had a phenomenal gain of about 160%.

Second, Ronald Reagan was supposedly a very pro-business president, but during his first 4-year term the stock market gained only 26%. The stock market’s gain during Reagan’s first term was not only a tiny fraction of the gain achieved during FDR’s first term, it was also less than the roughly 40% gain achieved during the first term of the supposedly anti-business Obama Administration.

Third, the stock market did much better during Reagan’s second term, enabling Reagan to chalk up an 8-year stock-market return of about 120%. This, however, wasn’t substantially better than the 90% gain chalked up by the anti-business Obama and pales in comparison to the 240% gain achieved by the Dow over the course of Bill Clinton’s two terms.

Fourth, two of the worst stock-market performances occurred during the supposedly pro-business administrations of Herbert Hoover and GW Bush. The Dow was down by a little more than 10% over the course of GW Bush’s two terms and by an incredible 70+% during Hoover’s single term in office.

To summarise the above, the historical record isn’t consistent with the view that a more pro-business President results in a stronger stock market.

Continue reading A Pro-Business Government Does NOT Lead to a Stronger Stock Market

A-D Line New High

By Tom McClellan

A-D Line New High
February 03, 2017

When the NYSE’s A-D Line hits a new high, it conveys a clear message that liquidity is plentiful.  The market might encounter other types of problems, such as investors’ emotions suddenly swinging, or a big news event rocking the market.  But if liquidity is strong, the market can more easily recover from such problems.

The DJIA has been in a concerted uptrend since making a final corrective low in February 2016.  The DJIA’s upward progress has been in fits and starts, while the NYSE’s A-D Line has made a more steady uptrend.  At several times, there were disagreements between the A-D Line making higher highs while the DJIA made lower highs, and in each case the A-D Line turned out to be right about where both were going.

Trouble has historically come when there is a bearish divergence between the A-D Line and the DJIA.  Here are some notable examples:

NYSE A-D Line 1988-2017

So the fact that we have just recently seen a new A-D Line high says that we are not in one of these extreme bear market risk conditions.  The market may still be subject to ordinary garden-variety corrections, but not the really big sorts of drawdowns.

I wrote about this point here in 2014, noting that during the 3 months following a new 3-year high in the A-D Line, drawdowns are typically limited to 10% or less.  Here is an updated version of the chart from that earlier story.

Drawdown after new A-D Line high

This chart also makes the point that when the Federal Reserve puts its thumb on the scale, then “normal” market relationships can be bent or broken.  There were drawdowns of greater than 10% after the end of both QE1 and QE2.  Each time, the A-D Line was correctly stating that liquidity was plentiful, thanks to all of the money that the Fed was pumping into the banking system.  But then forcing the market to quit its addiction to that free money cold turkey had bad effects.

Eventually the “experts” at the Fed learned their lesson, and so when they ended QE3 in late 2014, they did not stop it all at once.  Instead, they “tapered” the injections down to progressively smaller amounts.

I liken this to hydroponic versus organic gardening.  In hydroponic gardening, all of the nutrients that the plants need are artificially provided, and the results can be impressive.  But you cannot switch a plant from hydroponic conditions to growing in real soil with natural nutrients, and not expect the plant’s health to suffer.  2015 saw the market chop sideways as it worked to find more organic sources of liquidity, without the Fed’s meddling, and it appears to have done that.

I am expecting that we are going to see a brief market correction this spring, as I have been detailing in our twice monthly McClellan Market Report and our Daily Edition.  But the message from the strong A-D Line is that the risks of a big price drawdown during this upcoming corrective period are pretty minimal.

Subscribe to Tom McClellan’s free weekly Chart In Focus email.

Related Charts

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A-D Line New High Offers Some Immunity
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Chart In Focus Archive

Are Stocks Set Up for a 2011-Like Plunge?

By Chris Ciovacco

2017 Momentum Has Been Waning

The S&P 500 has been treading water for six weeks, which means bullish momentum has been getting weaker and weaker. Given what we know as of January 23, what are the odds the S&P 500 plunges this week in a manner similar to the 2011 plunge shown below?

Yellow Flags Typically In Place

Markets can do anything at any time; an expression that applies to all markets, including the present day market. Having said that, waterfall plunges typically do not come without some type of observable deterioration already in place. The 15% plunge in 2011 occurred between the close on July 28 and the intraday low made on August 9.

How Did Stocks Look Before The 15% Plunge?

Prior to the 15% drop, the S&P 500 had been moving sideways for six months (orange line below), which speaks to indecisiveness and waning momentum. The market had also made two discernible lower highs (1 and 2 below) relative to the high made in early May 2011.

Compare and contrast the 2011 chart above to the 2017 chart below. Instead of a six-month period of indecisiveness, 2017 has seen six weeks of consolidation, meaning the loss of momentum was much greater before the market plunged in 2011. Instead of making two discernible lower highs, the 2017 market made a new high 17 calendar days ago (point A below). In 2011, the last new high was made 87 days before the 15% drop.

How Much Damage Was In Place Before The 2011 Plunge?

In the next set of comparisons, we will remove price from the equation and focus on trends. Moving averages help us monitor the never-ending tug of war between bullish conviction and bearish conviction. Remember, the plunge in 2011 occurred between the close on July 28 and the intraday low on August 9.

Continue reading Are Stocks Set Up for a 2011-Like Plunge?

Active vs. Passive Investing: And the Winner Is …

By Elliott Wave International

The chart below comes from a new report from our friends at Elliott Wave International.

It’s as straightforward as it looks — not much need for animation.

But, perhaps you’re not completely clear about the difference between passive vs. active funds — or about WHY that difference is even worth talking about — then please stick with me as I offer a fast summary.

Active funds include the human element — as in, a fund manager or managers.

Investors who invest in active funds want a manager who can identify trends in a securities market or market index, of stocks or bonds or money market instruments — the fund manager sees opportunities in that market, and decides to allocate the fund accordingly.

The vehicle of choice for passive investing is, the Index Fund. Put simply, these funds track an index — like the Dow or NASDAQ — and wherever the index goes, the fund follows.

Index funds were created in the bear market years of the 1970s. Yet, participation was almost nonexistent until after 1985 — when the great bull market was already underway.

Yet, unlike U.S. stock indexes — which saw two huge declines in the first decade of the 2000s — the growth of index funds has gone in only one direction — up for three decades.

The index funds share of equity mutual funds today exceeds 35% percent, and the trendline is getting steeper.

Total index investing today exceeds 4 Trillion dollars.

So, back to the chart above.

What this chart shows us is how the passive investing trend accelerated in 2016. For the year, 286 billion dollars flowed OUT of active funds — a record amount…

… And it’s no stretch to infer that at least some of this outflow became the inflow into passive funds — some 428.6 billion dollars flowed into active funds in 2016 — also a record.

So the question is — why? Why has the share of index fund investing gone from basically zero in 1985, to more than 35% in 2016?

Why have an ever-greater number of U.S. investors entrusted their money, not to experts, but to the assumption that the stock market itself can just take care of their investment?

These and MANY other questions are answered in Elliott Wave International’s annual State of the Global Markets Report. See below for more details.

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This is the fifth year EWI has created our annual State of the Global Markets Report. And since many markets around the world are at a critical juncture, this may be the most-timely edition of the State of the Global Markets Report yet!

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Get your 21-page State of the Global Markets Report — 2017 Edition now.