Every Cloud Has a Silver Lining: An Intermarket Analysis

Tue, Dec 18, 2018 - 1:27pm

There is no question a dark cloud is looming over U.S. financial markets. That cloud just got a little darker over the past two days as key support levels in all of the crucial equity indices were violated. This sends a loud and clear signal to pay attention.

The new closing lows in the Dow Jones Industrial Average and the Dow Jones Transport Index confirmed the bearish trend that began in October and constitutes a Dow Sell Signal. That changes the bias investors should apply to the market from the past month’s buy-the-dip/sell-the-rally to just plainly: sell-the-rallies.

But even the darkest of clouds has a silver lining. Certain risk-on areas can provide hope and should be followed more closely in the coming days and weeks to identify whether a more significant rally may unfold. There is plenty of bearish market commentary now so no need to add to it. My goal here is to highlight some contrarian points of view on an otherwise gloomy market perspective.

First the Looming Clouds

Before moving on to key areas of the market that have improved, let’s first focus on where the damage is and what needs to improve if a rally takes hold. Energy and Financials are crucial. Oil has been in a freefall from $77 to $47 finally breaking below $50 today. That isn’t helping growth concerns as oil is a barometer on the economy. The S&P 500 energy sector index surpassed the bullish 2016-2018 trend and is currently breaking through a key demand zone. If a rally doesn’t take the index back into the demand zone, it puts the 2016 lows in view. The announced OPEC cut to production failed to encourage any stabilization as growth concerns and excess supply carry the day after last week’s disappointing Chinese economic announcements as well as disheartening flash Purchasing Managers’ Index data for Europe and the U.S.

Source: www.StockCharts.com, Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The financial sector of the S&P 500 also continues to suffer. The yield curve has been flat and the spread between the 2-year Treasury and the 10-year Treasury continues to narrow. That doesn’t help financial institutions who borrow on the short end of the curve to lend out on the long end of the curve. A narrow spread equates to lower profitability and can eventually cut off financial institution’s ability to lend.

Source: FRED.

News of the 2,3, and 5-year inversion a couple weeks ago sent the financials reeling. While the relative strength of the financial sector versus the S&P 500 improved in November on news Powell considered rates just below neutral, that event has whipsawed on the inversion news and the financials continue to be a source of pain for the bulls.

Source: www.StockCharts.com, Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The Silver Lining

This past summer I discussed the weakness in semiconductor stocks on our Financial Sense Newshour podcast. The semiconductor industry is the brains of modern electronics and represents America’s fourth largest export to the world. This industry is the number one contributor to labor productivity. From an intermarket analysis perspective, the industry often leads the market at tops and bottoms. While a top has been in place since October, and the trend is down, the underperformance of the sector started back in June. That has recently reversed and is a warning that semiconductors are outperforming the market through the recent weakness. This is an industry group that tends to lead risk appetites and it will need to be monitored closely in the days and weeks ahead.

Source: www.StockCharts.com, Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The iShares MSCI Emerging Market ETF (EEM) which is based off the MSCI Emerging Market Index, has been a thorn in the U.S. equity market’s side since January. This was one of the primary reasons Financial Sense Wealth Management has been defensive this year. Growth concerns showed up here first as they have done in the past. Eventually, the U.S. played catch up and that took longer this time than we anticipated.

Below you can see another silver lining in an otherwise gloomy market. The chart below shows the Index has been holding above the October low despite weakness in the U.S. equity markets. Relative strength shows this clearly in a new uptrend. The long-term trend is still down and will take more time to develop a bottom on the chart. This is just a silver lining that will need to be monitored closely in the days and weeks ahead. The index has 30 percent exposure to China – its largest area of concentration geographically. If trade developments continue to be positive with the U.S., the Emerging Market Index could become more bullish.

Source: www.StockCharts.com, Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

Summary

The bears have clear control of the market as seen by a market that fails to rally from oversold conditions and from the violation of key support levels over the past two days. That is the most important item for investors to see. There are key areas where the damage is currently, as well as key areas that foretold of this correction, and they are only now showing signs of relative strength. Relative strength (the comparison of one market to another) is not enough to be bullish on these areas. There needs to be continued improvement in price and time for a bottom to develop. Tomorrow’s Fed policy decision is expected to be a positive catalyst if the Fed dials back on its future rate projections. It is felt they will drop to only two rate hikes in 2019 versus three. Whether that is enough for the bulls to take charge remains in question. Tune in tomorrow to the Fed at 2:00 p.m. EST as investors wait with great anticipation.

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About the Author

Chief Executive Officer, Technical Analyst
ryan [dot] puplava [at] financialsense [dot] com ()