Macro View Into Stocks

We took a look at the micro-sector based view, which revealed that stocks are starting to turn to the upside, but cautioned that majority of the sector-based transitions in bias were on weak demand. We're not in the clear quite yet. The market feels like its trying to develop and stabilize at current levels, but we're not seeing any initiative buying coming off the short covering rally last Monday (May 21st).


Below, the Nasdaq 100 (NQ) mini future is stabilizing between monthly structural lows at 2575 and weekly structural lows at 2468. Any meaningful activity from the long side will have to take this market above the monthly lows at 2575 and get accepted. More importantly, from a Major monthly structural perspective, the market must close above the 2575 monthly low by the end of the week. Otherwise, going into June, we will have the first lower monthly closing since August 2011, which is more significant in light of the prolonged Jan-April up-trending condition. Monthly boundaries are very important from the perspective of longer term bias and sentiment and coming off an 8 week correction that has taken the NQ down > 300 pts, any monthly lower closing that violates the monthly trend in place could be perceived as weak and would imply continued correction into the summer. If the NQ closes back in the monthly channel (> 2575 by the end of the week) then we can expect a sideways condition to develop as was the case in 2011 with a possible retest of the April highs going into August.

We can also observe from above that the NQ mini future approached the 2011 highs at 2440 indicated by the black horizontal line across the chart. Any market that approaches old significant highs should find buyers and support. The NQ came back into 2468 lows last Monday (May 21st) from which we had a short covering rally that turned the short term trend back up. This short covering rally coincided with a 38% Fib correction of the August 2011 lows - April 2012 highs, which fits in with the thought process that a technical rebound could be due to develop. A weak scenario would see the NQ mini fail to close > 2575 monthly low support and proceed to get rejected above the 2011 highs below 2440. This scenario cannot be taken off the table just yet, given the macro-euro erosion that has come back to the forefront.

In the image below, I show the short term trend of the NQ on the 15min intraday chart with 3 day regression overlays and LE-2536.5 implied short term buy signal coming off short covering rally. So far, the market has not gained any acceptance > 2550 nor < 2500 level. The short term bias remains long with risk and the market trades above 3 day regression implying a short term trending nature may be developing.

The same logic applies to the the DJIA (YM-mini futures) as the market trades < monthly support at 12678. A June 1 closing < this level would imply weakness and sustained correction into summer. We can also see that the Dow mini is finding support at the trend line connecting 2011 highs projected into this year. Short term support should be found at these levels. This market has been accepted below 2011 highs, implying need for continued development of price at lower levels. Any weekly closing < 12318 would signify deeper correction.

We can also use the deflationary 'flight to safety' rally in the US 30yr and the USD as indications that reflation in risk is off the table short term. But, can make the argument that USD is short term overbought market that may need to take a break, which may coincide with relief rally in the stocks.

US 30yr bond market looks to be getting support at monthly upper boundary, just as stock appear to be losing support at monthly lower boundary - this inverse correlation is the implied risk in a long stocks position at this time. We would need to see the Bonds break down below monthly upper support, coinciding with a breakout in the stocks with a move back above monthly support.

Sector Screen Update

We can take a bottom-up structural sector based approach to examine whether there is 'micro' evidence of support for the major US stock indices within the current stage of market correction that has been ongoing for 2 months (since early April). We'll also have a look at the day charts of the major US averages to see if we can refute any of the thought processes we arrive at. 

When examining the condition of the stock market, we need to observe the intersection of a series of component parts; likened to observing independent pieces of a puzzle. Though, unlike a puzzle, where we can start with the end in mind and work backwards to assemble the pieces - in markets, we can't know the end with certainty (however that may relate to our investment time frame), but we critically examine the pieces, develop a working hypothesis (or image) while staying flexible enough to adapt if we have overlooked or misinterpreted aspects of our input (changing image). 

From above, we can observe a screen shot of US sector ETF's and corresponding signal types that reflect the nature of the buying or selling and the respective directional bias of each individual product. The list also takes into consideration a variety of US sector ETF products from the same group so as to observe the signal across different holdings within each ETF as issuer's do vary from to product in the ETF universe. The ETF screen shot is but one approach of gaining directional insight into the major averages.

The 2 signal types above are seen from 'IntraS' and 'CloseS' columns and offer up information on short term directional bias. Whether the bias is long vs short (green vs red colour overlay), as directional 'swing' traders or 'trend' traders and even as investors, we are looking for clues in the auction process that indicate whether urgent buying or selling is initiating a trend signal.  This urgency is revealed by the signal type 'Intra' vs 'Close' and tells us whether a directional change is momentum based (IntraS).

The sector based approach is one way that helps determine the 'state' of the major index. So, if I'm looking to take a position in the S&P500 index futures (ES), then knowing the nature and type of short term activity systematically within the context of larger structural inputs at the level of Sector group and sub-group  can greatly improve our odds of winning in the ES futures (S&P 500) as it is a composition of its sector and sub-sector parts.

I like to see urgent buying (as revealed by IntraS column above) by funds at the Sector level coming off a prolonged 8 week correction if we are to see some evidence of stabilization or rebound in the major averages. We can see a lot of bullish changes (green) in the past 3-4 trading days, evidenced above by both closing and intraday signal types.  The majority of sector products have transitioned long on closing signals, implying weak underlying transition into the long side, structurally.

The Intraday momentum signals that we are interested in has come from Healthcare, Biotech, Internet Index, Industrials, Materials, Gold, Silver, Oil Equipment and Services sectors. We are not seeing momentum breadth into real economy sector based ETF's (Home Builders, Financials, REIT's, Retail).