Divergences are marking major turns

At significant market turns, such as we are now in, divergences between related markets proliferate and become stark.  We have them in stocks and gold/silver.

Such is the case in stock markets where the leaders in the current stock market push are getting thinner with fewer generals leading the weary troops who are flagging badly. This shows up in the divergent action in the various indexes with the Nasdaq (and to some extent the S&P) containing the tech stars are firm, while the Russell 2000 small caps is lagging.

Here is the latest tech-heavy generals of the Nasdaq action

The blue tramlines have contained the upward action since January 2016 and I consider them super-reliable lines of support and resistance. And last week, the lower tramline support held firm.  The  A-B-C rally off Monday’s bounce on the tramline is very strong as Apple showed the way with stunning gains.  But note I have a pink internal trendline that captures all the minor lows and also sports a nice PPP of 3 July.  That pink line represents strong resistance.

The market has rallied right to the underside of that trendline and is planting a kiss.  If this is a genuine kiss, expect a Scalded Cat Bounce down next week.

But how different is the Russell 2000 index (comprised mainly of domestic US small caps)

This market broke its lower multi-month tramline decisively on Friday 27 July to indicate a trend change,and since then, has pushed up in three waves right to the underside of the tramline in a traditional kiss.  Has it started the Scalded Cat Bounce down?

The troops in the Russell 2000 are lagging badly the generals in the Nasdaq!  And if I have located a turn in the Nasdaq, next week promises good times for the bears.

But still, bullish sentiment remains extreme, despite the elephant in the room in the shape of the US-China trade/tariff war which seems ot be hotting up day-by-day.

They certainly have got the message in China – here is the index of the 50 largest companies

After completing a classic Double Top in January (on the same date the Dow topped), the market is in hard down mode. Interestingly, with the yuan in free-fall, this devaluation is certainly not coming to he aid of Chinese shares – quite the contrary. Chinese investors are reckoning that this is not a phony war, as do US investors.  One of them  is right!

And this contrary behaviour is telling me to expect a lot more downside to come in Chinese shares.  As I posted a while ago, the Chinese debt bubble is bursting and companies are starting to go under.  This is the start of the great global deflation I have been forecasting.

I really cannot see the US and China kissing and making up any time soon (if at all).  First, it is well known that the Chinese are prime exponents at ‘saving face’ and backing down voluntarily is not in their psyche.  Also, Trump leans towards intrasigence and is not prone to giving in.

But in the West, animal spirits are still running rampant.  Here is one of my favourite gauges – the HIgh Yield (Junk) Bond index

which is making new highs, despite the crude price under pressure.  Many junk bonds are issued by the US frackers.  This divergence with US Treasuries is stark.  While highly risky junk is soaring, the ultra-safe T-Bonds are under pressure

But lurking under the surface, the New Highs minus New Lows data on the NYSE is telling a different story.

chart courtesy elliottwave.com

The New Highs (generals) minus New Lows (troops) generally made new highs (more generals) in the bull market that terminated in January.  Since then, this figure has made lower highs (fewer generals) on the bear market rallies.  Note the subdued reading on last week’s rally.  This is not a sign of a healthy bull market – in fact, it is a mark of a bear market.  Those lower highs on higher index readings is a massive divergence.

And I believe an imminent turn down in shares has coincided with a large divergence between the gold and silver markets.  These are the charts I posted to VIP Traders Club members yesterday

We have a new low in gold but not in silver for a large divergence. And at major lows, these divergences are common.  With hedge funds still piling into short bets for a record bearish extreme, the stage is set for a very sharp rally phase

And crucially, the commercials (smart money) reduced their long and short exposure considerably.  Hmm.

The dollar remains firm – for now

This is the scenario for the euro I have been highlighting – a typical textbook wedge in five waves for wave 4, leading to a new low in wave 5

From a trading perspective, I have always maintained that fourth waves are the trickiest in the book – and this was no exception.  My task now is to identify the upcoming fifth wave low.

To terminate the fifth wave. all I need is a new low below the wave 3 low at 1.15.  After that, I expect to see the start of a multi-week euro rally/dollar decline that should coincide with the gold/silver rally phase I am expecting.  And a bear trend to resume in shares.

The summer is shaping up to be as exciting as I predicted.