Charts That Signal Only A Moderate Correction

Since we warned of the weakening technical picture and bearish cycles into October, there are a few very encouraging developments that could signal only a moderate correction in the months ahead.

First of all, the Dow Jones Transport index rallied strongly and reached a new high on Monday, negating the bearish Dow Theory signal. This is a very bullish signal in our view. Remember, a divergence between the Dow Jones Industrial and the Dow Jones Transport is often an early warning signal of a correction, last seen in early 2015.

Second, sector rotation. Since June 21st, commodity stocks are up 8% (STOXX 600 Basic Resources – SXPP) while the STOXX 600 has lost 2%. In the same period, banks gained 6% (STOXX 600 Banks – SX7P). These underperforming sectors have taken the lead again. Sector rotation should be seen as very healthy and reduces the risk of a sharp correction.

The chart of the STOXX 600 Basic Resources ETF looks increasingly bullish. Following sharp gains in 2016, basic resources stocks pulled back during the past 6 months. Now, the price chart itself and the RSI are both breaking their 2017 downtrend. Support is coming from copper. After our anticipated pullback in the first half of 2017 (successfully retested the 2011 downtrend), a break of the RSI downtrend and a bullish crossover in the MACD, we expect further gains in the metal.

Banks got a lift from hopes of further buybacks following the positive stress test in the U.S. and from rising yields. The U.S. 10yr yield has retraced exactly 38% of the July 2016-March 2017 rally. A bullish signal in the weekly RSI and record long positions in U.S. treasury futures are bullish signs. We expect the U.S. 10yr yield to retest 2.60% in the second half of 2017.

Our expectation of only a moderate correction doesn’t change our roadmap. Following a correction/consolidation into October, markets should make another rally attempt before reaching a major top in early 2018.

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