In last month’s II Insight we put forward the theory that capitulation might be close at hand. This month in our regular bulletin, Tarquin Coe highlights the dramatic action that we have seen in our Buy/Sell Climax indicator and takes a look across overseas markets as the major indices attempt to form bases. Certainly, the technical situation has improved with the recent October rally, which saw the S&P500 post its best percentage gain since 1974. Our view is that last week’s action didn’t mean the bear market is over, but it does indicate significant progress in distributing shares in preparation of the next upmove. Index charts had positive movement to end last week and more bullish formations are shown with solid bases now in place that will support further gains. Now, the uncertainty of the election is out of the way, but we will need to see sustained improvement in our indicators before giving the stock market a clean bill of health. Rest assured, we will be updating our subscribers on developments on a daily basis.
Investors Intelligence is best known in the market for its work on P&F and sentiment based equity analysis, however many subscribers also benefit from our "Hotline" services for Currencies, Commodities, International Equity Indices and Fixed Income markets. In this report we highlight the extremely oversold condition of our unique commodities breadth indicator, contextualized against the major retracement for the CRB whilst colleague Dr Jackson Wong (London office) takes a view on Treasury Inflation Protected Securities (TIPS).
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Charts of the week
The first week of October experienced a sell off that wiped around 20% off the major indices. Back in the September issue when the S&P 500 was trading at 1300 and the FTSE 100 stood at 5636 we noted –
“a break of the July lows might be no bad thing in the long run, providing a much needed shake out and clearing the dead wood, making way for a broad sustained end of year rally. If those lows are violated we would watch for evidence of selling climaxes across our stock universe, as we did successfully in early July when there were 959 selling climaxes, the second largest in our history, surpassed only by 1,385 selling climaxes shown with the January 2008 bottom.”
Action during October has gone a long way to fulfilling the shakeout we proposed on the 2nd of September. The 10th of October saw 87% (2901 stocks) of the NYSE trade down to new 52-week lows. The final week of October provided global evidence of capitulation in the form of selling climaxes. The charts below show new weekly records for climax data for all areas: Europe, UK, Asia, Japan, Global and the USA.
The above evidence is compelling and suggests we are at or close to a significant bottom. We may get new lows in the indices, but those lows are likely to be short-lived. The medium to longer term prospects are excellent.
We analyze buy and sell climaxes in a weekly report every Monday as part our US Market Timing package.
October witnessed the worst month for equity markets since the early 1970’s. In the US, the Dow Jones Industrials found support at 8000 on the 10th October. Those lows have yet to be violated, despite other regions breaking lower, such as in Europe and Asia. If they can survive for the next couple of weeks, then that low is of major significance. However a break, would result in a sure test of the 1998 and 2002 lows, around 7500.
Our various indicators are deeply oversold and are pointing to a bottom; we would be very surprised if indexes are lower in one month from now.
Germany’s DAX Index has found support at 4000, a support shelf formed off a six month consolidation from 2004. The index remains one of the stronger performers in Europe.
One of the constituents, VW experienced an incredible short squeeze during the final week of October as Hedge Funds scrambled to cover shorts, aiding the indexes double digit gain on the week. A rebound is likely to encounter resistance at 5400 and then 6000.
In Asia, Hong Kong’s Hang Seng has had a colossal fall from its high in November last year. Last week the index enjoyed a bounce off trend line support drawn between the lows of 1998 and 2003. This trendline looks central to direction from here, violation of it could result in a visit down to 8300, horizontal support from April 2003. On the flip side, a bounce off it could be large, as took place in 1998 and 2003.
The CRB Index (CRY) is a basket weighted average of nineteen commodities (Crude Oil has the greatest weighting). The index has collapsed since hitting a high recently in July of this year. The index is down on a combination of factors, such as fears of a global slowdown, a rising dollar and the unwinding of leveraged positions by Hedge Funds. Crude oil had its worst month in history.
The index is now testing a Fibonacci level at 253, a 76% retracement of the rally from the 1999 low to the 2008 high. Additionally horizontal support sits at 250/260, formed from the highs in 1988 and 1985.
Momentum indicators have been oversold for some time, but the breadth has now reached oversold. The lower chart window shows the percentage of the broad commodities trading below their 30-week moving average. This indicator is now more oversold than it was in 1999, ahead of the nine year commodity bull market. The indicator is turning up from oversold as confidence in select commodities starts to return.
The sell-off is overdone and technicals point to a recovery from here.
Our Advisors Sentiment Index identifies extreme levels of optimism or pessimism. The survey monitors over a hundred independent newsletters from market advisors, categorizing their view as either bullish, bearish or correction. Since its inception 45 years ago, the indicator has proven to be a leading indicator of long-term market bottoms, and is well regarded with in the global investment community.
The Survey is now showing similar readings those witnessed at the start of previous recessions in the early and late 1970’s, plus the early 1990’s. However, it’s not all over for equity markets, as on each occasion, the markets embarked on sizable rallies within weeks. As experienced investors know too well, timing is everything. Catching the bottom too early, by even just two weeks, can be painful. On the flip side, not catching a bottom by as little as two weeks can see the best part of a recovery missed.
The bull/bear difference (bullish advisors minus bearish advisers) has now been trading around -30 for the last two weeks, an extreme reading that sits on the tail end of the distribution curve. Bearish extremes like this have not been seen for decades. The charts below show the markets reaction during previous economic downturns, following similar readings of a bull/bear difference of -30 (circled in red).
1970 1978 1990
On the occasions above, our readings followed a typical pattern: extreme pessimism, followed by a steady improvement in readings. The steady recovery in readings occurs during the final stages of the market bottoming phase. We saw the readings turn higher in the last week of October and look for more improvement (readings become less negative) in the weeks ahead. Should readings make this recovery, then the bottom would be confirmed.
The Japanese Yen has dropped to the bottom of a twelve year range following the rapid unwinding of the carry trade, a move that started at the end of July 2007. The wave of deleveraging looks to be over for the time being as support against Sterling has been found. Finding support at 148 (the September 2000 low) coincided with the Bank of Japan announcing a cut in rates to 0.25% in the last week of October.
In technical analysis, when the floor of a range is found and conditions are oversold, a rally back to the top of the range is the most likely outcome.It could take a number of years, but long-term a return to the 1998 and 2007 highs at 240 is expected. Breaking below the 1995 low at 129 would negate this view.
We analyze currencies in theFX Hotline, emailed direct to your inbox.
During October we have been noting out-performance in the more defensive ETF areas. The Pharmaceutical (PPH), Consumer Staples (XLP) and Utilities (XLU) have all shown strong relative uptrends against the S&P500.
On the other hand, ETFs vulnerable to a Strong Dollar have been whacked, in particular the commodities and currency ETFs.
We analyze ETFs each week in the ETF Review, emailed direct to your inbox.
In the past month or so, we have seen inflation-linked bonds hammered mercilessly. The US 2016 TIPS bond, for instance, nosedived a staggering 11 points, through the key support at 94-95, and ended the October at a multi-year low (see below). Technically, such a furious rate pace of decline is not sustainable beyond the short-term.
While investors are right to focus on the deflationary pressures brought on by the credit crisis, we believe that the bulk of the decline here may already have been made. A potential rebound should not be ruled out in the next few weeks; we watch to buy.
In contrast, we are not so keen on buying the Eurodollar future. Sparked by expectations of further rate cuts, the December contract has rallied towards 98, a level at which we anticipate some profit taking (see chart right).
Dr Jackson Wong, working with our London team analyses the major international benchmark bonds daily. Get the Fixed Income Hotline, emailed direct to your inbox.