posted on 18 April 2017
Written by Jim Welsh
Macro Tides Technical Review 17 April 2017
Treasury Bond Yields
Bonds have moved as I suggested they might a month ago. What's likely to come next?
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In the March 13 Weekly Technical Review I discussed the Treasury ETF (TLT) and its upside potential:
On March 14, TLT opened at 116.77 and then traded up and closed at 117.07. This appeared to be the reversal I was expecting and it occurred the day before the Fed meeting, which is classic. In recent weeks, I’ve thought a close below 2.3% should result in a bout of short covering which could bring the 10-year below 2.2%.
On Thursday, the 10-year yield fell to 2.220% and the RSI dipped to 28.2, which indicated that it was becoming overbought. Last July, as bond yields were making their low, the RSI on the 10-year Treasury fell to 26.7. This suggested selling into strength was prudent risk management.
Click on any chart below for large image.
On Thursday, TLT traded up to 123.74 and the advisors I work with sold TLT between 123.34 and 123.54. The rally from 116.49 to 123.74 could be wave (A) of a larger (A) up, (B) pullback, (C) rebound. My guess is that after dropping 40 basis points, the yield on the 10-year Treasury could bounce up to 2.34% - 2.42%. If this occurs, TLT could fall back to near 121.00.
Following the bounce in yields, the 10-year yield could drop 35 - 40 basis points and potentially close the gap at 2.12%, and maybe make a run at 2.0%. This would suggest that TLT could reach 126 or during waved (C).
The Dollar Continues to Act Well Enough
In the January 9 Macro Tides I wrote:
This statement provides a valuable insight as to how Trump might respond if the Dollar continues to increase in value in 2017. It suggests that Trump might not hesitate to talk the Dollar down, if he thinks it will help improve U.S. trade competitiveness and bring jobs back to the U.S.
As I noted in April 2014, all Draghi had to convey was the desire for a lower Euro and currency traders would be happy to accommodate the ECB’s wishes. Currency traders are nihilistic and would embrace shorting the Dollar and the profits it would generate.
Sometime in 2017, I expect Trump to convey to currency traders (via a tweet?) that the Dollar is too strong and that he will tolerate a weaker Dollar. His comments are likely to be more direct than Mario Draghi’s statements in March 2014 about the Euro and its impact on EU inflation. If this proves true, a reversal of the uptrend in the Dollar, since its low in March 2008, would likely have a meaningful impact on financial markets throughout the world.
Trump talked about the Dollar being “too strong" on January 17 and again in an interview with the Wall Street Journal last week. Given Trump’s penchant for talking the Dollar down, the question is whether the Dollar’s high on January 3 is THE high. It’s possible, but the chart still leaves open the potential of one more rally to a new high. In the January Macro Tides I wrote:
In the March 27 WTR I thought the Dollar was near a trading low.
As I thought likely, the Dollar bottomed on March 27, which I think is wave 4 from the May 2016 low. The trading action since then has been constructive. A close above 102.25 would shift the odds in favor of a new high above 103.82 posted on January 3. Conversely, a close below the March 27 low 98.85 (cash) and 99.33 (June futures) would be negative and pretty much eliminate the potential for a new high.
What could cause a rally in the Dollar above 103.82? The main ingredient would be a sharp decline in the Euro since it represents 57% of the Dollar index. What could cause a rally in the Dollar above 103.82 AND a drop in the 10-year Treasury yield to 2.0%? Geopolitical concerns that cause a flight to quality.
Corrections in the stock market are useful since they temper investor bullishness and allow the market to exhale after a good rally. Corrections can either be in price or time, or a combination of both. If the S&P falls by more than 10%, bullishness is going to drop quickly and the market will become oversold. If the market trades sideways with a modest downward bias, the S&P might fall 5% but it will take months before bullishness is tempered.
The S&P peaked on March 1 and has corrected a whopping 3% in six weeks. Despite the shallowness of the pullback, bullish sentiment is slipping. As measured by the weekly Investors Intelligence survey the plurality of bulls over bears has dipped from 46.7% in the week ending March 3 to 38.8% last week. This suggests that more time and price erosion is likely before a good trading low takes hold.
As I have previously noted, the S&P left three gaps as it marched higher during February. Traditional charting indicates that the gaps will be filled sooner or later. The S&P has filled the gap at 2371.54, and 2351.90. I expect the remaining gap at 2311.08 from February 9 to be filled.
The S&P fell 79 points from its high of 2401 on March 1 to last Monday’s low of 2322. An equal decline from last week’s high at 2378 would close the gap at 2311 and test 2300, and potentially complete the wave 4 correction I’ve discussed since March 1. I think the S&P is in Wave (5) of the bull market that began in March 2009, after wave (4) ended in February 2016. The current correction is wave 4 of (5) and should be followed by a sizeable rally to above 2401 before Labor Day.
Gold and Gold Stocks
Two weeks ago I said a close by Gold above the high on February 27 at $1268.10 (June futures) would turn the short term trend positive and probably rule out the decline below $1200 I have been expecting. On April 11, Gold closed above $1268.10 and today traded as high as $1297.40 and its RSI finished at 74.4. Gold is overbought.
Sentiment has turned quite bullish, with more than 85% of traders being positive, the highest since Gold topped last July. The odds favor a pullback to at least $1245, and the potential of a decline below $1200 still exists. But geopolitical risks are such that normal technical analysis may get run over if a shooting war erupts with North Korea.
The divergence between the Gold Stock ETF (GDX) and the Junior Gold Stock ETF (GDXJ) has persisted and become larger. As the gold stocks were coming off their intermediate low in December, GDXJ led the way and outperformed until the gold stocks topped in the first week of February. GDXJ’s underperformance since March 16 may again be leading the way, but this time lower. As noted previously, there is a gap on GDX from December 28 at $19.43 that I still expect to be filled.
Not much has changed. Three weeks ago, the RSI on the Emerging Market ETF (EEM) registered a lower high even as EEM was making a new high. The last two times an RSI divergence developed, EEM corrected 6.35% and 10.3%. The first target is the March 9 low of $37.39, but there is the potential of a decline to $36.50. Longer term, EEM could experience a rally to $44.00 - $45.00, testing the highs of 2015, 2014, and 2013. A close above $45.00 would open the door for a move to the 2011 high near $50.00.
Tactical S&P Sector Rotation Portfolio Model: Relative Strength Ranking
Technology stocks took over the leadership of the rally after the financial sector and small caps began to falter after peaking on March 1. Based on the weakening technical indicators of the Nasdaq 100 and Nasdaq Composite that I first discussed in the March 27 WTR, I expected technology stocks to correct in coming weeks along with the overall market. So far that’s exactly what’s occurred.
I also thought if bond yields continued to fall as I expected, the Financials could correct more than they had. On Friday, the Financials ETF (XLF) fell to support (black horizontal line) and its RSI was oversold at 28.0. This combination suggested that the Financials were primed for a bounce, with XLF possibly reaching 24.00. From its high of $25.29, the Financials ETF (XLF) dropped in 5 waves, which suggests any bounce is likely to be followed by another decline. An equal decline from its recent high at $23.99 would bring XLF down to $21.67, just below a gap from November 11 at $21.70.
The Technology ETF (XLK) has a similar pattern. Although its RSI only dropped to 36.2 on Thursday, it was down from 83.4 on February 24, so on a relative basis it was oversold. XLK had also fallen to its horizontal support line, so a bounce was likely.
I think XLF and XLK are likely to fall below their respective support lines which should lead to weakness in the overall market and a decline in the S&P to 2311.
The Tactical US Sector Ranking must be used in conjunction with basic chart analysis. In recent weeks, I have highlighted the fundamental reasons why I expected the financials to correct. Falling Treasury yields and a narrowing of the yield curve would not be positive for banks. Lending has also been on the decline which is bank’s meat and potatoes. On March 17, XLF convincingly broke below the rising trend line from the November 4 low and a trading low on February 8. The combination of the fundamental and technical analysis indicated that exposure to Financials should have been reduced no later than March 17.
The technical action in the Nasdaq 100, Nasdaq Composite, and XLK argued strongly that tech stocks were poised for a correction, and an opportunity to lighten up.
The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Russell 2000 Index is a small-cap stock market index of the bottom 2,000 stocks in the Russell 3000 Index. The Nasdaq 100 is composed of the 100 largest, most actively traded U.S. companies listed on the Nasdaq stock exchange. All indices, S&P 500, Russell 2000, and Nasdaq 100, are unmanaged and investors cannot invest directly into an index.
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