Macro Analysis 3/16/2012

Stocks had another good week on expanding volume as better than expected domestic economic reports continue to move these markets higher.  Most of the major indexes finished the week up 2+%. 

Here's a daily chart of the Wilshire 5000 which represents the entire US equity market:

(click for larger view)

Momentum is reasserting itself after a brief respite (blue arrow in upper panel) and the index continues along a path delineated by two support/resistance lines (blue and purple).  The bottom two panels are both money flow indicators for different time periods.  We can see that buying pressure has been diminishing on the 20 day indicator but on the 63 day it is in a strong uptrend.  The fact that both time periods are positive in conjunction with the price action and the positive momentum indicates this market is going higher.

Here are my concerns about stocks:

This is a weekly chart of the Russell 2000 showing support and resistance levels.  The Russell is continuing to be sandwiched in between support and resistance and we need to see a breakout to the upside in this index to confirm broad based participation by small cap stocks in this rally.  The bottom panel is a price relative of the Russell and the S&P 500.  Since early February the Russell, which initially led this present rally, has been under performing the larger cap stocks.  This concern of mine is further highlighted in the following ratio chart:

This is a weekly ratio chart of the Rydex S&P Equal Weight ETF divided by the S&P 500 going back to the March 2009 "V" bottom. What I'm attempting to show with this ratio chart is that the bulk of stocks in the S&P 500 are not participating in the present rally and that the index is being carried by a minority of large issues.

Here's a detailed explanation of how to use the chart.  The S&P 500 is a market capitalization index of the prices of 500 large cap stocks actively traded in the U.S. A capitalization weighted index is an index whose components are weighted according to the total market value of their outstanding shares. The companies with the largest market capitalization, or the greatest values, will have the highest weights in the index. As an example, a gigantic company like Exxon Mobil would exert much more pricing influence on the S&P than the smallest market capitalization stock in the index.

The Rydex S&P ETF, on the other hand, tracks the same 500 stocks as the S&P but instead of weighting each stock by its market capitalization, it gives equal weight to every individual stock in the index.

It is clear from the chart above that the bulk of small cap stocks are still not participating in this rally and this must change soon if we're going to sustain this upward move into the rest of the year.

Treasuries fell out of bed this week and I had been pointing to this happening for weeks.  Here's the weekly chart of TLT (iShares Barclays 20+ Year Treasury Bond Fund) which traders and investors use as a proxy for the long end of the yield curve:

As per our inter market relationships this is a positive for stocks in the short term.  I'm now looking for TLT to challenge resistance at 115.  As long as the US economy cointinues to gather upward momentum I believe TLT will fail to breach this resistance area.

The Treasury market and the US Dollar hold the keys in assisting us in understanding where equities are headed in the intermediate term.  And so far, both market's message is that stocks are headed higher!

Here's the US Dollar as of Friday's close:

I've circled the price action and drawn a sharp uptrend line (brown dashed) but the Dollar has been turned away at a long term 50% Fibonacci retracement zone and momentum is starting to wane (bottom panel - red arrow).  Fundamentally, there is nothing on the horizon that would portend unusual Dollar strength save an Iranian crisis and I'm sensing that the strict inverse correlation between the Dollar and stocks which have been a trading assumption since the Great Financial crisis may be weakening.  Regardless of whether my thesis is correct, until the Dollar breaks thru the 50% Fibonacci zone this also is a positive for equities.

Finally, let's look at Gold:

I've identified what I believe may be the final touches on an inverse head and shoulders formation that would be very bullish for Gold and project a price up to the $2,025.00 level.  However, I'm presently ambivalent on Gold's direction based on what I'm starting to believe was a "blow off" top in August/September 2011:

Here's a long term chart of the great Gold bull market of the past decade.  All bull markets tend to end with parabolic moves such as we experienced with Gold last year.  The "gold bugs" I know say this wasn't a "blow off".  If this wasn't a "blow off" I don't know what is!  Maybe an island reversal pattern?

I'm not predicting that the gold bull market is over.  What I am saying is that my confidence in it continuing has been undermined by the chart above as well as the price action of the past few weeks.  A consummation of the inverse head and shoulders pattern I identified above and a new all time high would allay these concerns.

Have a great week!