From the desk of Thomas Bruni @BruniCharting
A few weeks ago global equity markets began to mean revert to the upside after many met downside targets and momentum positively diverged. For examples of this check out my posts from then here and here. The same failed breakdowns and bullish momentum divergences that sparked a rally globally are now present across many of the US sectors and indices.
Of the 41 US indices / sectors I follow, 28 of them have bullish momentum divergences on the daily charts and have either confirmed, or are working on confirming, a failed breakdown by trading back above a prior low.
A chart of the S&P 500 cash index is a good example of the conditions I’m referring to. Last week prices made new marginal lows and quickly reversed while momentum put in a higher low. If prices can close above the August lows, it would confirm the failed breakdown and bullish momentum divergence. Structurally this remains a bear market, but with prices 9% below the 200 day moving average the weight of evidence suggests that a counter-trend rally could develop from here.
In addition to the presence of bullish momentum divergences and failed breakdowns throughout the US equity markets, there are a number of inter-market factors pointing toward a counter-trend rally in US stocks.
The first factor is the substantial improvement in breadth relative to the January lows. Despite the NYSE making new marginal lows in price last week, the New Highs-New Lows Index registered a reading at less than half of what it was at the January lows. Fewer stocks are making new lows.
The second factor is the Yen. The Yen has rallied roughly 10% in 10 days and momentum diverged negatively at its recent highs, suggesting a retest of the breakout area near .0086 is likely. A pullback or consolidation in the Yen should provide a tailwind for stocks in the short-term as it has a strong negative correlation with US equities and risk assets in general.
The third factor I’m looking at from an inter-market perspective is the potential tradable bottom in Crude Oil. Last week prices traded below the January lows and quickly reversed while momentum diverged positively. With Friday’s close above the January lows, price confirmed the bullish momentum divergence and failed breakdown. Again, this is a counter-trend rally, but any strength in Oil should provide a lift to US equities as they’ve been positively correlated over the past month and quarter.
Lastly, it’s worth noting that those global equity markets that have under-performed year-to-date (like parts of Europe and China) are also putting in bullish divergences, suggesting that they could start to participate.
The Bottom Line: The current weight of evidence suggests that US equity markets put in a tradable bottom late last week and should see further upside in the short-term. As I mentioned at the top of the post, equity markets around the world put in tradable bottoms a few weeks ago and should continue to lead on a relative basis. With that being said, US stocks finally look like they’re ready to participate in the mean reversion happening elsewhere, at least on an absolute basis.
If you’re looking to trade the counter-trend rally the risk is well defined versus the January lows in many of the US indices and sectors. If this type of setup doesn’t fit your plan then you can use this opportunity to cover tactical shorts and look to re-short equities at higher levels.
Final Note: When bullish divergences fail it usually leads to aggressive selling, so if prices can’t follow through to the upside and instead proceed to break the recent lows, it’s likely best to get out of the way.
JC here – What’s going on is simply that a majority of stocks and countries bottomed out last month (and in most cases Jan 20th). This improvement in the market can be seen in breadth but not in the prices of U.S. Indexes. Globally a lot of these markets have been ripping higher, especially the economies with energy, mining and metal exposure. The risk reward here tactically continues to lean towards the bulls here in the U.S. as it plays catch up to a lot of other new emerging leaders (pun intended). Also, there are bullish momentum divergences, like the one Bruni mentioned in the S&P500, in some of the other U.S. Indexes as well. I still like them higher. I also like how he mentioned the reproductions of bullish momentum divergences that lead to lower prices. The collapses can be devastating. I’ve seen that a lot over many years. I don’t believe this is the case this time around. But it’s good to keep it in mind, especially here where the risk is so well-defined and skewed in our favor.
Tags: $SPY $6J_F $CL_F
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This post originally appeared on AllStarCharts.com on 02/15/2016.