In The Week Ahead: Evidence For A Pullback Is Mounting
The post-election rally stalled last week, following the prior week’s big advance. While most major U.S. indices closed relatively unchanged, the small-cap Russell 2000 was the exception. After hitting a high of 1,393 on Dec. 9, essentially meeting the 1,400 upside target I initiated in June, the index fell 1.7% last week.
#-ad_banner-#Interestingly, all sectors of the S&P 500 finished last week in negative territory except for health care (+1.1%), utilities (+0.9%) and consumer staples (+0.02%), which are all defensive sectors. This was a complete reversal of the previous week’s broad-based rally. This internal weakness warns that a deeper decline may be coming between now and early next year.
Another Sign The Market Is Too Complacent
In last week’s Market Outlook, I discussed the potential for an additional 3% rise in the Dow Jones Industrial Average to 20,400 before historically weak January/February seasonality kicks in. But I also pointed out that the market remains too complacent, according to the Volatility S&P 500 (VIX), for it to go much higher without a pullback first.
This week’s first chart shows that put-to-call ratios are corroborating the extreme complacency in the VIX. The lower panel plots the 5-day moving average of the CBOE Put/Call Ratio in reverse scale so that it moves up and down with the corresponding chart of the S&P 500 in the upper panel.
The CBOE Put/Call Ratio plots the daily ratio of put volume versus call volume on the Chicago Board Options Exchange. Essentially, it shows when investors are buying insurance (put options) against an expected stock market decline and when they are not. Right now, it’s the latter.
The CBOE Put/Call Ratio is a contrary indicator, and previous instances when it was this low (i.e., least bearish) — indicating relatively few puts being purchased versus calls — have closely coincided with near-term peaks in the S&P 500.
So, especially when accompanied by a historically low VIX, which finished last week at 12.2, this metric suggests the post-election rally is probably nearing an end and an overdue corrective decline that brings the market back into balance is coming.
Dow Transports Failing At 2014 High
Now that we know a market pullback is probably right around the corner, the next step is to try to determine when it will start. One way to do this is by keeping a close eye on the Dow Jones Transportation Average, which is testing — and, thus far, failing — at its 9,310 November 2014 high.
The index finished last week at 9,167 after trading as high as 9,490 on Dec. 9.
If the transports remain below 9,310 this week, I will view it as evidence that the broader market pullback I’m expecting may be slowly getting underway.
The good news is that, even if this important market average does continue to pull back from 9,310 resistance, it has an unmet upside target of 9,700 to go along with my 20,400 target in the Dow industrials. I expect both targets to be met by early to mid-2017.
Editor’s note: You don’t have to sit idly by and wait for a pullback before making your move. In the past year, one expert has used market pullbacks similar to the one John is predicting to capture huge returns in a matter of days (without shorting stocks). These include 62.4% in nine days, 33.8% in four days and 18.5% in a single day. Find out how to get positioned for the next market sell-off here.
Treasuries Testing Major Support
Last week, I mentioned that the yield of the benchmark 10-year Treasury note may peak near the 2.5% to 2.63% area. These yields closed at 2.6% on Friday and have spiked 100 basis points since the end of September.
Yields move inversely to bond prices, so while yields are testing 2.63% resistance, the iShares 20+ Year Treasury Bond (Nasdaq: TLT), which tracks long-term bond prices, is simultaneously testing formidable underlying support at $114.50.
This support, which is situated 2.3% below Friday’s close, represents the intersection of the June 2015 low and the major uptrend line from February 2011. Considering the incredible jump in long-term interest rates this quarter, $114.50 is a likely place for at least a meaningful corrective rebound in TLT to begin.
Secular Trend Change In The U.S. Dollar?
While long-term interest rates have been spiking, the U.S. dollar (USD) has been in the midst of an equally impressive advance against the euro (EUR).
The weekly chart of the EUR/USD, which moves inversely to the greenback, recently broke down below its 1985 secular uptrend line, which is currently situated at 1.092, and finished last week at 1.0449.
The EUR/USD has actually been negotiating this major trendline for almost two years and is now just starting to break below it.
As you can tell by looking at the chart, the U.S. dollar historically trends for long periods of time. Accordingly, this emerging EUR/USD breakdown suggests a new major trend is getting underway with a stronger dollar versus the euro.
Considering the dollar’s long-term inverse correlation to precious metals prices, which is attributable to the effects of inflation, a strengthening dollar indirectly supports my current negative bias on gold (see Nov. 28 report) and silver (see Dec. 12 report).
Putting It All Together
Although my overall outlook on the U.S. stock market is positive heading into early to mid-2017, I continue to expect a corrective pullback to occur between now and early next year. This pullback should be accompanied by a rise in long-dated U.S. Treasury prices (and decline in yields), driven by a defensive allocation of assets as investors move out of stocks and into safer bonds.
Meanwhile, the euro is finally breaking its 30-year secular uptrend versus the dollar, and according to long-standing intermarket relationships, the dollar’s strength should drive gold and silver prices even lower into early 2017.