Get Ready for Risk Off

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Tuesday’s steep -100.53 index point decline in the NASDAQ, a loss of -1.61% on the Composite and 20 decline on the S&P (down -0.81%) is yet another sign of weakening internal strength within an aging uptrend. By mid-day on Wednesday, nearly all of the S&P 500 decline has been retraced and a portion of the NASDAQ decline as well. Yet, Tuesday’s announcement regarding the postponement of the Healthcare Bill vote, and a lot of the discussion around that proposal seem to suggest that it may take quite some time to finally pass. Senators like Rand Paul appear fairly strongly opposed to the bill in its current form and there is wide disparity among the Senators who are against it, in terms of how to reconcile the bill. The suggestion now is that the Senate may need to work through the August recess until a plan is complete.

Yet, from the market’s point of view, it is imperative that the healthcare bill is moved along at a rapid clip, as any extended delay from here into August would mean that tax reform will likely not happen in 2017 and instead will be pushed into 2018. For stocks, that is a serious problem. It is also a serious issue for the Fed, which is anticipating a recovery and pickup in growth with tax reform being the key driver. Any delay would mean that expected growth may not increase as expected and that the Fed may have to step back from its planned sequence of rate hikes. For a stock market that ran up rapidly on the idea that a Republican controlled White House, House, and Senate would be able to quickly push through major changes in public policy (i.e. the end of gridlock), the gap between what current prices have now discounted in versus the potential disappointment regarding both how long legislation will take to enact, along with how significant the legislative changes end up being (should they be watered down)...well, that gap could now be a surprisingly wide chasm.

nasdaq composite

Above: NASDAQ Composite right on lower trendline and 50 day moving average support.

In Salem's view, stocks remain close to levels that could presage a full-scale break down. On Tuesday, the NASDAQ Composite closed right on its rising trend channel line that has been in effect for the last few months. It also closed just above the 50-day moving average which is reinforcing support at that 6100 level. As I noted in my 6/21/17 report (see Could Recent FANG Weakness Be Signaling the End of the Bull Run?), any significant move below 6100 on the NASDAQ Composite would have to be viewed as quite bearish:

The implication at that juncture would be that a larger Elliott Wave downward corrective move would be getting underway that would retrace a portion of the entire preceding bull market advance and with that, likely usher in an end of the friendly “passive” investing environment of the last several years. Alternatively, in the short term, we would be watching the 5630 level on the NASDAQ 100 (NDX) and 6,100 on the NASDAQ Composite as key zones of support. Any move below the lower boundaries of those ranges on the key NASDAQ Indices, combined with a move below 2,417 on the S&P 500, would negate the potential for new highs and signal a full on intermediate correction or bear market getting underway.

At the same time, the S&P 500 continues to hold above key support at 2420 and would need to break below 2420 by 8 to 10 points in order to signal an equivalent breakdown. That said, it is becoming clearer with each sell-off that the S&P is laboring internally. Wednesday’s strong rally led by Financials looks like it could be setting up some kind of potential right shoulder or final fifth wave. Either way, the composite price action of both markets seems to be pointing to an over-arching conclusion that, at this juncture, we could be seeing a broad distribution pattern tracing out, and that often happens at major tops.

spx arms index

Above: The S&P 500 ARMS Index is coming off very low, top value type readings.

In addition to the bearish chart configuration, it is also worth noting that the ARMS index for the S&P 500 is just coming off record low (“overbought”) values. Late in an extended move up, low ARMS Index readings can frequently be a major red flag for an advance. Finally, the McClellan Summation Index for Operating Companies Only crossed below its important short-term moving average yesterday. That could be the beginning of an important trend following sell signal. We note that this bearish crossover took place after the index has been higher for months, and the Summation Index has been sporting a bearish divergence over the same period of time.

spx summation index

Above: S&P with Summation Index - Present day

spx 1987 crash

Above: S&P with Summation Index in 1987, pre-October 19 Crash

spx 2007-2008

Above: S&P 500 with Summation Index in 2007-2008

Looking back at past major turning points, these kinds of extended bearish divergence periods on the Summation Index have often been a key ingredient attending major tops. When the Summation Index finally crossed over and started trending down in both 2008 and 1987, serious price damage started to show up in the major stock market averages shortly thereafter.

In the present circumstance, there are a number of parallels to 1987 and 2007-2008. These include very low VIX Index readings, ultra low Put-to-Call Ratios on the S&P, burgeoning weakness in Emerging Market Debt and High Yield credit markets, softness in Energy, and investor apathy toward contrary assets like Gold. For the S&P 500, the Price-to-Earnings Ratio over the VIX Index indicator (see below) now resides at virtually all-time high territory.

complacency

This gauge is just screaming the word “complacency”, ironically, at the very same time our Fed Chair is waxing on about no more financial crisis in our lifetime. These various signposts form a broad mosiac that points to a sea change that might be underway. The underlying message: get ready for risk off.

Gold and Gold Stocks:

On a major trend basis, Gold stocks appear to be putting in a potentially significant bottom. The key questions for now center on the nuances as to whether that low is already complete, or is still developing. On Tuesday, Gold Stocks pulled back with the GDX Gold Miners ETF slipping by -$0.30 or -1.3% to close at $22.26. At present, the very short-term outcome is still somewhat unclear as to whether Gold Stocks put in the final low back on June 20th at $21.76 (GDX) or whether a retest decline of that low could still lie ahead.

Typically, markets either bottom with a “V” shaped low, or a “W” type bottom. At the moment, GDX has retraced about half of the recent gains coming off the June 20th lows and has essentially closed a small open gap that was open at a price of $22.13. With the price at $22.26 at the close on Tuesday and prices slightly higher on Wednesday, the question at hand will be to see if GDX is able to make a new short-term high above the recent highs at $22.78. If it does, odds will be increasing that a “V” bottom has been seen and that still higher prices will follow.

gdx hourly

Above: GDX Hourly

Alternatively, there is some short-term resistance on GDX at $22.48 and if prices cannot move above that over the next few days, then there is a chance we could see a retest of $21.75 or even a test of the May 4th lows at $21.00, which should be very good support. GDX and XAU do remain substantially oversold and the XAU Intermediate Selling Intensity gauge surged to new highs for the last two years on Tuesday. At the close, this gauge ended at 3.78, which moved it above the high on 10/12/16 (which was a serious panic low) at 3.73, and above the high of 11/6/2015 which was also a panic low and peaked at 3.74. Today’s value of 3.78 is the highest reading seen since 7/30/2015 at 4.02 and that was almost two full years ago.

gdx xau selling

Above: GDX with XAU Selling Intensity Gauge now near multi year highs.

Another very intriguing aspect of the current environment is the ultra-low levels of volatility for the mining stocks. As of last night, the XAU Bollinger %B gauge (which measures the spread between the close and the lower band relative to the overall width of the Bollinger Bands) is telling us that volatility is currently reaching low levels not seen in several years. In addition, a number of leading gold miners are also sporting ultra-low %B data points. Ultra-low volatility implies that a big move is very likely to unfold soon and in the mining stocks, most often, (but not always) very low levels of volatility have had a tendency to mark important bottoms.

xau gold silver

Above: XAU Gold and Silver Mining Index from 1978 to present, Intermediate Volatility now pressing record low levels

Near term, I suspect that GDX is going to take its cues going forward from physical gold, which traded positively overnight and is slightly higher on Wednesday morning. Any move from here above $1265 on spot gold would be very bullish and should go a long way to putting in a significant low.

With respect to the price action of Gold, using the GLD ETF, I have constructed a volume based Selling Intensity Gauge, which is also now spiking very sharply and resides at readings that are consistent with a number of prior important bottoms. In addition, there has been a big increase in put option purchases on GLD, which on a contrary basis is also a positive sign.

gold selling intensity

Above: GLD which tracks the price action of physical gold with Selling Intensity Gauge now at fully oversold values. Chart above is daily price action from 2007 to present.

gld puts calls

Above: GLD Puts to Calls Ratio has moved up across the range to where there is now fear in the market, a good sign on a contrary opinion basis.

For more information on Salem Partners or their services, please go to www.salempartners.com.

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About Frank Barbera CMT

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