Is the flight to quality (stock/bond) reversal imminent?

Cycles

The Cycle Projection Oscillator (CPO) is a technical tool that employs proprietary statistical techniques and complex algorithms to filter multiple cycles from historical data, combines them to obtain cyclical information from price data and then gives a graphical representation of their productive behavior. Other proprietary frequency domain techniques then are employed to obtain the cycles embedded in the price.


S&P 500

The CPO has produced several sell signals during the last year that have failed to take. Each signal usually shows hope with a couple of down days, but the market invariably returns to its bullish ways after a slight hiccup. The CPO shows that the S&P 500 will drift lower in Q1 2018 before entering a much more significant bearish phase in Q2. The move could challenge the lows for Q4 2016 before turning higher mid-year. This could be the one. 


30-YEAR U.S. TREASURY BONDS

U.S. Treasury bonds have been in a steady decline since September after regaining ground from the huge move lower from their all-time highs from the summer of 2016. The persistence of the near four-decade bull market has made analysts a little shy about declaring the multi-decade move over. The CPO is indicating that there may be one last gasp rally. To be more specific, two, as the CPO expects the long bond to make two moves higher in 2018. The first should persist through Q1 and be followed by a brief retracement. That is expected to be followed by a stronger move higher that could test the 2016 highs. Currently, the 30-year is close to oversold territory indicating a solid buying opportunity, especially given the nature of the bull equity market. A flight to quality rally is long overdue. 


EURO 

After flirting with the much anticipated challenge of par with the U.S. dollar in late 2016, the euro currency has been in a massive move higher. After correcting in Q4 2017, the euro has taken out its 2017 highs and has continued its rally. However, the CPO expects this current bull move to end, though the sell-off, which is expected to last through mid-2018, will not come close to parity with the dollar. The most euro bears can hope for is a move to the 110-115 area, which will be followed by another move higher, possibly taking out current highs around Q4 2018. 
 

CRUDE OIL

Six months ago the CPO correctly forecast the recent bull move in crude oil, though it did expect the move to stall late in the year (see “Golden arches, gold and the beauty of pairs trading,” page 80). Currently, the CPO is indicated that crude oil is nearing overbought territory just as it is expected to enter a significant downturn. This is as strong of a bearish indicator as the CPO can produce. The weakness is expected to persist through mid-2018 before reversing higher, and could challenge the lows from the summer of 2017 around $42 per barrel. 


HEATING OIL 

Perhaps more impressive than the projection for crude oil is the bearish pattern setting up in heating oil. The market has had an impressive up move thanks to the polar vortex hitting the Eastern and Midwestern portion of the United States early in 2018. Despite the impressive move, the CPO is not indicating that heating oil is severely overbought, but the projected sell-off look to be more dramatic than that of crude oil. Based on the projection, heating oil should easily take out the 2017 mid-summer low around $1.15 per gallon. That would be a move of more than 30% during the next six months. 


GOLD

Gold is in the midst of an impressive rally gaining more than $100 per ounce since early December. Gold has risen in fits and starts since finding support just above $1,100 in late 2016. Currently, the CPO shows that gold is overbought and a possible strong short. The long-term CPO outlook for gold in 2018 is for a steady appreciation in price lasting into Q4. Gold does not like to move slow and steady, so any major spikes in either direction could provide a good reversion trade as gold will likely not take out its high or low of the last two years.  

About the Author

John Rawlins is a former member of the CBOT with more than 30 years of experience in trading and research.