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posted on 19 September 2017

Short Term High Is Nigh

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Macro Tides Weekly Technical Review

As noted last week:

" At the close today, the 21 day average of net advances minus declines is now almost overbought (red trend line), which suggest the upside could be around 1%."

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Last Monday the S&P close above 2488 and today’s high was just over 2508, less than 1% from a week ago. The 5 times since last December the 21 day average of net advances minus declines has become fully overbought, as noted by the green arrows, the S&P has stalled and traded sideways for 1 to 2 months. The high on February 13 was followed by a 2.7% push higher into the high on March 1. But by the end of April the S&P was back down to the 2330 level of February 13.

Click on any chart below for large image.

On Friday, the Call/Put ratio climbed to its highest level since May 16. The S&P hit a high of 2405 on that date. Although the S&P pushed up to 2419 on June 19, it subsequently pulled back to 2406 on July 6. Effectively the S&P treaded water for 6 weeks after the high in the Call/Put ratio in mid May.

Based on how overbought the 21 day average of net advances minus declines has become and the elevated level of short term bullishness as measured by the Call/Put ratio, the odds favor another period of sideways trading, or an actual pullback. Imagine that!

Treasury Bonds

The estimates of losses from the twin hurricanes have climbed and are now expected to be between $60 billion and $100 billion. The economic impact has led economists to cut their estimate for third quarter GDP by 0.5% to 0.8%. The Atlanta Fed’s GDPNow forecast was lowered from 3.0% to 2.2%, while the New York Fed’s Staff Nowcast is 1.3% down from 2.0%.

Historically, large weather events depress economic growth in the short run, but then add more than they take away in the ensuing two or three quarters. The Fed is aware of this pattern and will look past the short term decline in GDP in the third quarter. That said incoming data in the next few months will be noisy and difficult to accept at face value.

The Fed meets tomorrow and Wednesday which has almost always resulted in a rally in the S&P either on the day before the meeting, the day of the meeting, or both. This time might be more interesting since the Fed will not raise interest rates, but will announce that it is proceeding with a modest shrinking of its balance sheet. This is widely expected so it is unlikely to move the markets.

What could have a greater impact is the dot plot, which charts where individual Fed members expect interest rates to be over the next few years and is updated every quarter. Attention will be particularly focused on 2018. In June, the majority of Fed members projected at least 4 rate increases in 2018, with 5 members expecting more than 4 increases. In total there are 19 members on the FOMC - 12 district Fed presidents and 7 permanent members on the FOMC board. Currently, there are only 4 members on the FOMC board, which is why there are only 16 dots shown on June’s dot plot. This is monetary policy’s version of a Rorschach test.

The markets will be attuned to whether the majority of the dots reflect an expectation of a rate increase in December and whether the FOMC stills expects 4 increases in 2018. I think the Fed would prefer to keep the markets expecting a hike in December and 4 more next year. The dots aren’t carved in stone and the Fed can always choose to rescind an increase if incoming data doesn’t support one. From the Fed’s perspective, it is better to have the markets expecting more and do less, than expecting less and doing more.

This logic also applies to where the Fed thinks the terminal level for the federal funds rate will be for this business cycle. In the June dot plot, the majority thought it would be 2.75% and 3.0%. Recently, speculation has emerged that the high for the federal funds rate for this cycle could be closer to 2.0% than 3.0%. I doubt the new dot plot will show the peak in the federal funds rate below 2.5% in 2019 or the longer run.

During the press conference after the June meeting, Chair Yellen sounded fairly hawkish, and emphasized that the decline in inflation was due to ‘temporary’ factors. By July 12, in testimony before Congress she adopted a much more dovish tome. Which Yellen will show up on Wednesday?

My guess is that bond yields will rise initially and then fall. This expectation is based almost entirely on the charts of the 10 and 30 year Treasury bond yields. Bond yields bottomed on September 8 and have been climbing ever since. The yield on the 10-year has jumped by 20 basis points and 16 basis points on the 30-year.


As outlined last week,

“If the Dollar trades below Friday’s low of 91.01 it would provide another opportunity to go long. A move above 92.94 (61.8% of the decline from 94.14 to 91.01) would increase the odds that the low is already in place. A move above 93.35 would break the pattern of lower highs and lower lows and suggest a change in trend has occurred."

The high in the cash dollar index over the last 5 trading days was 92.66, so the Dollar has not yet confirmed that a trading low has been established. If the Dollar trades below Friday’s low of 91.01 it would provide another opportunity to go long. I expect the Dollar to rally a minimum of 4.5 points and maybe 7.5 points from whatever price low marks the trading low. I’m still long the Dollar ETF UUP.

Gold and Gold Stocks

As I have discussed for a number of weeks, Commercials (red line middle panel) have continuously added to their short position as Gold has rallied since the low in July and breakout in August. Large Speculators (green line middle panel in chart below) and Managed Money (blue line lower panel) are trend followers. Almost by definition, they end up being too long at market tops and too short at lows.

In recent weeks, each category has increased their long position and as of last week was the largest since Gold topped out last July.

Conversely, the Commercials, who are considered smart money, have their largest short position since last July. This positioning led me to conclude that it wasn’t worth the risk to chase Gold (cash) after it broke out above the highs in April and early June near $1295.

I also pointed out that Silver had not confirmed the breakout in Gold which was not a good sign:

“Silver has not confirmed the move up in gold by exceeding its April high as gold was breaking out above its April-May highs. Trends in the metals are confirmed as Gold and Silver agree by making new highs or lows together. When they diverge, as they have in recent weeks, it is often a warning of a trend change."

After topping at $1357 on September 8, Gold (cash) fell below $1305 today. Since Gold is just above the breakout level of $1295 and near a round number ($1300), a bounce is likely. If Gold closes below $1295 as I expect, a decline under $1260 is likely. A drop to under $1225 is possible.

After trending sideways for weeks, the ratio of Gold Stocks to Gold weakened notably as Gold sold off last week. Given the relative weakness the Gold stocks have displayed for many weeks, this was expected. As I have discussed in recent weeks, the longer this relative weakness persists Gold stocks could be vulnerable to a sizable decline, especially if Gold closes below $1295 (cash).

At the next good buying opportunity in Gold stocks, I would expect the relative strength of the Gold stocks to improve significantly as it did between late December and mid February. That improvement was a great indication that the Gold stocks were really ready to rally strongly. Today’s weakness in the Gold stocks pushed the ratio higher.

Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking

The Sector Relative Strength Ranking is based on weekly data and used in conjunction with the Major Trend Indicator (MTI). 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 MTI crossed above its moving average on February 25, 2016 generating a bear market rally buy signal. The MTI confirmed a new bull market on March 30, 2016. The MTI continues to indicate that a bull market is in force.

Although the Major Trend Indicator is positive, the MTI has been posting lower highs since peaking in early March. This is one reason why the Tactical U.S. Sector Rotation Model Portfolio is 100% in cash based on the probability of a 5% correction. In my judgment, upside potential is limited relative to the current level of risk. The S&P has not experienced even a 3% for almost 10 months. To put this into perspective, since 1928 the S&P has experienced a 5% correction on average three times a year.

Through August 31, the Tactical Sector Rotation program is up 8.52%.


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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