The Bottom Line: North American equity markets are intermediate overbought.

Posted by Don Vailoux - Timing the Market

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North American equity markets managed to record modest gains last week. The S&P 500 gained 0.8% and the TSX Composite improved 1.1%. Once again, currencies had a major influence. The U.S. Dollar broke a key support on Friday when it fell below 78.33 to an eight month low. The Canadian Dollar broke a key resistance level on Friday at 92.64 to reach a ten month high. Weakness in the U.S. Dollar helped to buoy U.S. based international stocks and commodity sensitive stocks. Commodity prices jumped sharply near the end of the week in conjunction with the breakdown in the U.S. Dollar. Notable was strength in the price of gold on Friday.

Despite strength in major U.S. equity indices, they have yet to move above levels set in the first week in May in Canadian Dollar terms. The S&P 500 Index in Canadian Dollars currently is 2.0% below its May 7th high.
The seasonal gold trade between July 12th and October 9th remains intact. The seasonal gold equity trade from July 25th to September 27th also has “clicked in” nicely this week.

Grain prices finally started to show seasonal strength late last week just in time for the seasonal trade in the agriculture sector from the beginning of August to the end of December. The grain ETF (JJG) jumped from $36.50 to $39.02 last week with most of the gains coming on Friday. The move on Friday can be attributed partially to the breakdown in the U.S. Dollar and partially to a comment by a prominent weather forecaster that the Canadian prairies and northern U.S. states could experience a frost in mid August. A frost this early could significantly damage crops.

Momentum indicators for U.S. equity indices remain intermediate overbought, but have yet to show significant signs of rolling over. Traders are watching RSI for the Dow, S&P and NASDAQ for signs of technical weakness. Historically, a move by RSI above 70% and subsequent correction below 70% has recorded a valid intermediate sell signal. RSI for the S&P 500 Index currently is at 71.27%, RSI for the Dow Industrials is at 72.37% and the RSI for the NASDAQ Composite Index is at 71.65%.

RSI’s for several U.S. sectors already are flashing a warning signal. A week ago, RSI’s were at or above the 70% level for information technology, utilities, staples, health care, materials and consumer discretionary sectors. On Friday, RSI had fallen below the 70% level for utilities, staples, health care and materials.

Bond yields on both sides of border slipped last week. The yield on U.S. 10 year bonds eased from 3.70% to 3.48%.

The VIX indicator is flashing a cautious sign. Last week it rose from 23.09% to 25.92%.

According to the U.S. Presidential Cycle, U.S. equity markets have a history during the year after a Presidential election of peaking at the end of July and trending lower until the middle of November. The period of weakness corresponds to the time when investors become disenchanted with the President’s proposals following his “honey moon” period. Sound familiar? History is about to repeat itself.

Most of the important second quarter earnings reports have been released. Generally, earnings were higher than consensus due to lower costs, but revenue growth was elusive. Look for more of the same from remaining reports.

The Bottom Line: North American equity markets are intermediate overbought. History tells us that now is the time when an intermediate correction is likely. Ironically, weakness in the U.S. Dollar likely will dampen the impact of the correction. Preferred strategy remains the same. Recent strength has provided an opportunity to take profits on strength in most sectors. Exceptions exist, most notably in the gold, agriculture and technology sectors. They remain “Buy on weakness” candidates.

Technical Analysis and comment by the highly respected Don Vialoux of Timing the Market CLICK HERE for more information.

Don Vialoux has 37 years of experience in the Investment Industry. He is a past president of the Canadian Society of Technical Analysts (www.csta.org) and a former technical analyst at RBC Investments. Don earned his Chartered Market Technician (CMT) designation from the Market Technician Association in 1995. His CMT paper entitled “Seasonality in Canadian Equity Markets” was published in the Spring-Summer 1996 edition of the MTA Journal. Don also has extensive experience with Exchange Traded Funds (also know as Index Participation Units) as well as conservative option strategies. In 1990 he wrote a report that was released in the International Federation of Technical Analyst Journal entitled “Profiting from a Combination of Technical and Fundamental Analysis”. The report introduced ” The Eight Phases of the Stock Market Cycle”, an investment concept that continues to identify profitable entry and exit points for North American equity markets.   He is currently a member of the Toronto Society of Fundamental Analyst’s Derivatives Committee.   Now he is the author of a daily letter on equity markets available free on the internet. The reports can be accessed daily right here at www.dvtechtalk.com.