Macro Analysis 3/30/2012

The market advanced again this week with all the major averages posting gains of between 0.23% (Russell 2000) and 0.98% (Nasdaq 100).  Some of the concerns I identified earlier in the week in my blog posts (posts of 3/28 & 3/29) remain.  Bullish sentiment remains robust and the prevailing view seems to be that the market will trend higher and that some kind of pullback would be healthy.

 The financial markets are always a challenge to discern but it seems to me that they are getting more difficult to understand these days.  I've been a bull since the first LTRO last December 21st but I'm concerned about multiple divergences and skewed inter market relationships.  I've been purposely trying to stay away from following the financial news as what I'm reading seems to be at odds with these divergences.

I'll be identifying these divergences in this week's commentary and offering up an appraisal of where these markets may be headed.

Here's the Wilshire 5000 Index which is the entire US Stock Market:

(click on chart for larger image)

There's nothing in the price action that speaks to weakness but the momentum indicators in the upper panels show a clear divergence.

Here's the Russell 2000:

The momentum divergences are much more pronounced on this chart and the Russell has struggled in a tight price channel delineated by the two blue dashed lines since early February.  It appeared to break out decisively last Monday only to drop back into the channel by the end of the week.  The two panels above the chart show significant divergences and the MACD indicator is getting ready to give us a "sell" signal as the MACD line (black) is in the process of crossing under the signal line (red).

It must be remembered that the Russell is a small cap index and small caps (capitalization) stocks led the present rally we had that commenced in December, 2011.  Relative strength in small caps is a positive for the market so weakness is not good.

Now here's one more divergence but one I've posted before:

This is a six month daily ratio chart of the  S&P 500 Equal Weight Index divided by the S&P 500. This chart clearly shows that the majority 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.  If readers want a detailed explanation of this ratio chart my blog post of 3/16 explains the theory behind the chart.

So why are stocks weakening?  The popular rationale is that the present rally is "long in the tooth" and the market needs a healthy pullback to shake out some of the speculative froth that's been building up.  To this I would not disagree and the Treasury market seems to be confirming this thesis:

Here's a weekly chart of the 10 Year Treasury yield and you can see from both the MACD indicator above and the Rate of Change (ROC)indicator below that even with the relative strength in the US debt market in the past two weeks rates are still clearly trending higher.  As a refresher, yields react inversely to prices.  As bond prices drop, yields rise and as bond prices rise, yields drop.  If the US Treasury market was sensing great danger yields would be dropping precipitously and this is not happening.  For now, the Treasury market is saying the momentum divergences I've identified in stocks are signaling a "garden variety" correction.

The US Dollar index is also signaling that all is well with stocks:

 The Dollar has been bouncing along its 61.8% Fibonacci retracement level for the past week and while that could mean its consolidating before a move higher the two momentum indicators above and below the chart are foretelling future weakness.  In the present market paradigm we find ourselves in a weak Dollar is a positive for stocks.

So what am I worried about?  Commodities!  I've written much about this massive inter market divergence in the past two months and I touched on my concerns in the previous two blog posts this week.  Simply, in a strengthening global economy you cannot have significant weakness in commodities, especially industrial commodities, that we have seen in the past two months.  And in the past five trading days this weakness has spread to oil and even livestock.  Here's an updated chart of the Goldman Sachs Industrial Metals Index:

The price action is weak and the momentum indicators are confirming the weakness.  The only glimmer I see is Friday's price action formed a "doji" candlestick (blue arrow) which is indicative of indecision.  The only reason why I see this as a positive is because the Goldman Sachs Agricultural Index which was also starting to significantly deteriorate had a significant spike higher in the index on Friday as well, wiping out the previous four days selling pressure.  If it wasn't for the turn around in the Agricultural Index I'd be immediately fearful of a grand deflation scenario developing.

Folks, we need to see this index turn around or the divergence is going to catch up with stocks.  You can't have industrial commodities prices falling and equities rallying!

Here's another concern:

Oil is breaking down.  Yeah, and after all the hype about $5.00/gallon gasoline!  We've broken a trend line and pierced a Fibonacci retracement line in West Texas crude.  And MACD in the upper panel is confirming the weakness.  And this is going on with a weaker Dollar!  For a better understanding of the Dollar's relationship with oil prices see my commentary of 3/23 on this blog.

Finally, let's look at Gold:

I've been watching the right shoulder of a possible inverse head and shoulders formation developing which, if it came to fruition, would be predictive of a price of $2,075.00/$2,100.00 for the yellow metal.  However, Gold is going nowhere and MACD (bottom panel) is flat.  If Gold could complete this potentially bullish formation it would go a long way in assuaging my mind regarding the deflation thesis I've been concerned about.

Conventional wisdom says the weakness in commodities is tracking a China slowdown and I won't dismiss this thesis but with weakness across the board among all commodities, not only industrial commodities, I have to consider the deflation scenario as a real one.  I've posted more than a few pieces since I started this blog regarding this topic. And for those of you who have read my pdfs over the past few years I've given a lot of supporting documentation to show that central banks are "pushing on a string" at this point in their efforts to mask and somehow repair the trillions of dollars of wealth that vanished in 2008.  As far as I'm concerned, the verdict is out and the price action in commodities and precious metals are warning signs of impending danger.  We need to see a turn around very soon in the commodity complex to confirm not only the strength we're seeing in equities but the ongoing slow recovery in the global economy.

This will be my last post on the blog until at least Monday, April 9th.  I'm taking a hiatus to meditate on and consider the momentous events that took place in Jerusalem two thousand years ago.  One "typical" execution took place on a little hill outside that city.  But oh, what was thought to be typical was nothing of the kind. The God/man was executed but death could never conquer Him.   And in that solitary death and resurrection the world changed forever.

Happy Easter!

NOTHING IN THIS COMMENTARY SHOULD BE CONSTRUED AS AN OFFER OR ADVICE TO BUY OR SELL ANY SECURITIES, OPTIONS, FUTURES OR COMMODITIES. THE OPINIONS ARTICULATED ARE ONLY THIS AUTHOR'S WHO IS NOT A LICENSED INVESTMENT COUNSELOR OR BROKER.