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posted on 24 April 2017

Irrational Exuberance From France

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Macro Tides Technical Review 24 April 2017

Viva La France

With 97% of polling stations declared after 69% of France’s 42 million registered voters cast their vote, Emmanuel Macron was leading the field after receiving 23.9% of the votes, with far-right populist Marine Le Pen finishing second with 21.4% of the vote. The election for president will be decided on May 7.


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Global financial markets sighed with relief and rallied strongly, especially in Europe. One minor detail overlooked by investors: Neither candidate hails from the establishment parties that have dominated the country for decades.

In order to govern, the 39 year old Macron (the presumptive winner according to the polls) will have to stitch together a coalition of parties that have the courage to address two decades of subpar growth and corrosively high unemployment, particularly for those between 18 and 25 years old. Since 2000, GDP growth has plodded along at roughly 1.5% and unemployment has remained stubbornly high. Nine years after the financial crisis the unemployment rate is still above 10%.


One of the more revealing French labor market facts is that there are twice as many companies with exactly 49 employees as companies with more than 49 employees for one simple reason. Once a company hires the 50th employee about 3 dozen labor laws kick in, which on average raise labor costs by 10%, according to a London Business School study. Once the election celebration is over, investors are likely to see that the situation in France is SNAFU. I’ll let you look up what SNAFU meant in WWII.


In response to the French election, U.S. stocks gapped higher at the open this morning, but made little progress after the first 30 minutes of trading. The S&P finished within a point of where it was trading after 30 minutes, while the Nasdaq 100 and Nasdaq Composite gained less than 4 points.

Despite a number of technical divergences in recent weeks, the Nasdaq 100 and Nasdaq Composite each made new highs. The S&P is about 1% below its high of March 1 and the DJIA is 1.8% below its prior all time high.

This inter-market divergence between the major averages is a negative, but understandable. Five stocks (Apple, Amazon, Facebook, Google, Microsoft) represent 41% of the Nasdaq 100 and have accounted for more than 40% of the gain in the S&P 500 so far this year. Such concentrations often become a negative when the infatuation with the select few dims.

The current fever surrounding passive investing will break when these stocks begin to pull market averages down, rather than up. I have no idea when that day will arrive, but am fairly certain arrive it will, and the lambs will be led to the shearer in the next bear market.

The advance / decline line for the Nasdaq Composite has been lagging since it peaked on February 21. The Nasdaq 100 is up almost 3% since February 21, but the majority of Nasdaq stocks as measured by the A/D line have been losing steam. The Nasdaq 100 is approaching a resistance trend line (red trend line) connecting several prior highs starting on March 1.

Click on any chart that follows for large image.

From the Brexit low last June, the S&P rallied from 1991 to 2401 on March 1, for a gain of 410 points in just over 8 months. To date, the low for the wave 4 correction has been 2322, or just 19.3% of the 410 point rally. The wave 4 correction theoretically ended on March 27, less than 1 month from the high. If this is all of wave 4, it is incredibly shallow and short in duration.

Investors are so certain that the tax cut is coming, and with it a pick up in the economy and earnings. Selling stocks before cashing in on that good news would be foolhardy. The allure of the tax cut has kept selling pressure almost nonexistent, despite the GDP slowdown in the first quarter, the inability of Republicans to pass any substantive legislation, and the prospect of a conflict with North Korea.

While it is certainly possible wave 4 is complete, it just doesn’t feel right, since the market never got even close to being oversold and sentiment is still fairly optimistic. If correct, the French bounce should be over by Thursday, with Friday’s close below today’s close of 2374. If instead, the S&P closes above 2401, the Russell 2000 closes above 1315, and the DJ Transports close above 9570, the odds would shift that wave 5 to 2500 is underway.

The Dollar Continues to Act Well Enough, Just Barely

The Euro jumped to a new rebound high in response to the French election, which drove the dollar to a new low. This could be wave e of a triangle from the January 3 high. Wave e is often a reaction to news, briefly breaks below the low of wave c, and proves to be the end of wave 4 correction. Wave 4 triangles are usually followed by a thrust in the direction before the triangle began, which in this case means up. If the dollar is going to rally to a new high above 103.82, it should happen quickly, and the Euro should make a new low and potentially approach 100.00.

I can only think of one event that could cause such a flight to quality, and it has nothing to do with the French election. A new low pretty much eliminates the potential for a new high in the Dollar.

Treasury Bond Yields

I thought Treasury yields were likely to fall rather than rise, since I expected the economy to slow in the first quarter and the positioning in the futures markets suggested there were too many investors already short in anticipation of higher yields. I thought the yield on the 10-year Treasury bond would fall from 2.6% to 2.2%. Once it closed under 2.3% intense short covering would push the yield down to 2.2%, which is pretty much what happened last week.

On April 18, the yield on the 10-year Treasury dipped to 2.177%, before rebounding. After dropping 40 basis points, I thought the yield on the 10-year Treasury could bounce up to 2.34% - 2.42%. This morning the yield reached 2.313% before closing at 2.273%.

The positioning in the futures market has changed significantly. Large Speculators (hedge funds, trend followers) have reduced their large short position by about 80%, so the fuel to spur a further decline in yields from short covering is mostly spent. Commercials (smart money) have cut their large long position significantly, so they were selling while the large speculators were buying and covering their short positions. I think yields are likely to drift higher with the yield on the 10-year climbing to 2.34% - 2.42%.

If the yield on the 10-year Treasury is going to make a run at 2.0%, it will be due to surprisingly weak economic data, which I don’t expect, or an event that causes a rush to safety. The odds thus favor not much happening in the short run.

Gold and Gold Stocks

Last week I noted that sentiment had turned quite bullish, with more than 85% of traders being positive, the highest since Gold topped last July. The positioning in the futures market has also become less favorable. Since March 17, Commercials have increased their short positions from -123,287 contracts to -211,064 contracts, as gold rallied from 1230 to 1290.

Large Speculators have increased their long position from 106,038 contracts to 195,768 contracts. The wild card is whether a shooting war erupts with North Korea. That aside the odds favor a pullback to at least $1245, and potentially a decline below $1200.

As you can see, prior to the huge rally in the gold stock ETF (GDX) in 2016, the ratio between GDX and gold began to fall. This indicated that the relative strength of GDX was improving and signaled that a rally was beginning. The ratio bottomed in late August just as GDX was topping out, which provided a good warning of the coming decline. The ratio broke below the rising trend line in late December, just as GDX began its rally from $19.00 to over $25.00 in early February.

Gold stocks have been underperforming gold in recent weeks, which has caused the ratio to climb above its moving average. This is a negative for both gold and gold stocks. As noted previously, there is a gap on GDX from December 23 at $19.43 that I still expect to be filled.

Tactical S&P Sector Rotation Portfolio Model: Relative Strength Ranking

Last week I noted that the Financials ETF (XLF) had fallen to support (black horizontal line) on April 13 and its RSI was oversold at 28.0. This combination suggested that the Financials were primed for a bounce. I thought XLF might reach 24.00. Today, XLF trade as high as $23.81, so the bounce is probably almost over.

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 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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