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posted on 17 May 2016

Technical Review 16 May 2016

Written by

Federal Reserve

The minutes from the April 27 FOMC meeting will be released on Wednesday (18 May) at 2pm E.S.T., which could prove market moving. As I surmised in the Weekly Technical Review (WTR) on April 25, I thought the hawks on the Fed board would make the case for a rate hike in June. The hawks are concerned that the Fed could fall behind the inflation curve and be forced to raise rates more aggressively in 2017, which could cause more volatility in the stock market and threaten the economy. I also thought that if there was a chance for a rate hike in June, the hawks on the Fed would suggest that the Fed needed to 'communicate' this potential to markets.

hawk.380x190

During the week of May 2, three district presidents (Williams San Francisco, Lockhart Atlanta, Dudley New York) gave a speech or an interview in which they supported the Fed's projection of 2 rate hikes in 2016, with John Williams saying 2 or 3 increases were possible. Last week, three more Fed district presidents made speeches or statements that appeared to suggest that they were open to a rate increase in June. Eric Rosengren, Boston Fed president, said in a speech:

"It's early in the second quarter, but data is consistent with gradual improvement. The market is too pessimistic about the fundamental strength in the U.S. economy."

Rosengran said the likelihood of future rate hikes is "higher than is currently priced into financial markets." He also noted that the April jobs report was still enough to gradually tighten labor markets, and that higher wages and hours worked should be positive drivers for future consumer spending. The reason Rosengren's comments are noteworthy is that he is considered one of the doves on the FOMC. He also said that waiting too long to move rates higher can lead to speculative behavior or force the Fed to abruptly raise rates down the road, echoing my comments in the April 25 WTR.

Cleveland Fed president Loretta Mester said she saw signs that inflation was moving higher toward the Fed's target of 2%, while Ester George , Kansas City Fed president, said interest rates are too low for the current U.S. economy:

"The economy is at or near full employment, and inflation is close to the FOMC's target of 2%, yet short term interest rates remain near historic lows."

George's view is not a surprise since she was the lone dissenting vote at the April 27 meeting, but Mester is not considered a hawk.

In an interview with the Washington Post published today, Jeffrey Lacker, president of the Richmond district, said:

"I never completely make up my mind before a meeting, but at this point it looks to me as if the case for raising rates looks pretty strong in June."

Although Lacker is not a voting member of the FOMC this year, he has been at the Fed since 2004, so he has some longevity stature during any discussion.

During the last two weeks seven Fed presidents have raised the potential of a rate increase at the June 15 meeting. Although the Fed is data dependent, notably the May employment report which will be released on June 3, the unanimity of opinion from so many Fed presidents is unusual. Whether the Fed actually does increase the federal funds rate at the June meeting is secondary to the perception between now and the June 15 meeting that the probability of an increase is more than the 8% forecast by the Federal Funds futures contract.

The minutes of the April meeting will confirm the amount of discussion regarding the potential of a June increase, and markets will respond immediately. If I'm right, the stock market is likely to sell off, along with gold, emerging markets, and oil. Although it seems counter intuitive, I think the bond market will sell off less than these other markets.

Dollar

The dollar continues to trade in a manner that is supportive and consistent with the analysis identifying the low on May 3 as being the end of the 14 month correction than began after the dollar peaked in March 2015. This low represents wave 4 from the dollar's low of 70.00 in March 2008. If correct, the dollar is destined to rally above 100.51 in coming months in wave 5. My guess is that the dollar could rally to 106.00 - 110.00.

Last week I said that,

"In a perfect world I would like to see the dollar hold above 93.62 on any correction, and will likely run into some selling pressure between 94.80 and 95.21."

On May 11, the dollar pulled back to 93.65 before rallying to 94.845 on May 13. Should the dollar manage to close above 95.21, it would further solidify the intermediate trading low on May 3. As noted last week, in mid April the dollar tried to climb above 95.20, but failed on April 14 (95.21) and then on April 22 (95.18). If my Fed analysis is on target, a close above 95.21 could happen after the Fed minutes are released on Wednesday.

(Click on any chart for larger image.)

welsh.weekly.2016.fig.1.600x400

Gold

Gold's peak of $1303.90 coincided with the low in the dollar on May 3. Gold then declined $45.60 in three waves, (down, up, down) to a low of $1258.30 on May 10, which was followed by a three wave rally (up, down, up) to this morning's (Monday 16 May) high of $1290.40. An equal decline of $45.60 would bring gold down to $1244.80, which is also where a rising trend line from the lows since late March comes in.

If the Fed minutes confirm the discussion about raising rates in June, gold could break below this trend line, setting up a decline to $1220. My guess continues to be that gold will test and likely break below $1207, and GDX could dip under $21.00 by the end of June, if the dollar rallies as I expect. If the dollar is unable to close above 95.20 and stay above that resistance, gold may be able to hold above the trend line. If gold rallies above Monay's high of $1290.40 it is likely to push above the $1303.90 high as well, irrespective of the positioning in the futures market I have discussed.

welsh.weekly.2016.fig.2.600x400

Stocks

Last week I thought the S&P would rally to 2075 - 2090, before the next decline would set in. The S&P rallied to 2085 before selling off to a low of 2043 on Friday. If the Fed minutes reflect the possibility of a rate hike in June, the S&P is poised to close under 2040. The high at 2111 is 71 points above 2040, which has been tested on several occasions.

A close below 2040 would set up 1970 as the next target (2040 - 71= 1969). This is reinforced by the small head-and - shoulders pattern that has formed in the S&P since late March, with the neckline being 2040. As noted last week, a 38.2% retracement of the 301 point rally from the February low of 1810 would target 1996, while a decline to 1960 would represent a 50% retracement.

welsh.weekly.2016.fig.3.600x400

Tactical S&P Sector Rotation Portfolio Model Relative Strength Ranking

The Sector Relative Strength Ranking is based on weekly data and used in conjunction with the Major Trend Indicator. As long as the MTI indicates a bull market is in force, the Tactical Sector Rotation program is 100% invested, with 25% in the top four sectors. When a bear market signal is generated, the Tactical Sector Rotation program is either 100% in cash or 100% short the S&P 500.

The Major Trend Indicator generated a bear market signal on January 6, when the S&P closed below 1993, and was confirmed on January 14. The Tactical Sector Rotation program went 100% short when the S&P closed at 1990.26 on January 6. The short position was reduced to 50% on February 8 when the S&P closed at 1853, further lowered to 25% early on February 24 as the S&P traded under 1895, and closed on February 25 when the S&P was 1942. The S&P's average 'cover' price on the short trade was 1885.75. The short trade earned 5.2%. Past performance is no guarantee of future results.

The MTI crossed above its moving average on February 25, generating a bear market rally buy signal. The MTI confirmed a new bull market on March 30. As noted in the Weekly Technical Review on February 25, I allocated a 25% long position in the Utilities ETF (XLU) at $47.28, and a 25% long position in the Consumer Staples ETF (XLP) at $51.65. These positions were liquidated on March 15 for a gain of .92%. Past performance is no guarantee of future results.

For the first quarter, the Tactical U.S. Sector Rotation program was up 6.1%. I also recommended via email on December 31 a 10% position in the gold ETF (GLD) and a 10% position in the gold stocks ETF (GDX). These positions were closed during February with a gain of 1.0% for GLD and 1.8% for GDX. The total return for the first quarter was 8.9%, which does not include management fees. Past performance is no guarantee of future results. The total return for the S&P 500 in the first quarter was 1.4%.

The Tactical Sector Rotation program is 100% in cash as I await a pull back to below 2040 and potentially as low as 1970.

welsh.weekly.2016.tactical.rotation

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