Written by Jim Welsh
Macro Tides Weekly Technical Review 23 March 2020
COVID-19 has basically brought the U.S. economy to a dead stop as 100 million Americans are responding after a number of states issued a “shelter in place” order. Millions more have been told to work from home and the majority of Americans are finally taking COVID-19 seriously and practicing social distancing. Movie theaters have been shuttered around the country, hotels are empty, airplanes are only 25% filled even after the airlines have slashed capacity by 80% or more.
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The list of industries severely impacted is far longer than these few. Hourly workers are absorbing the brunt of the cutbacks with the number of hours worked plunging by 50% in just the past 2 weeks and likely to fall further. The United States has never faced a crisis like this.
In the March 12 WTR Special Update I explained why this crisis was worse than the 2008 financial crisis:
“In 2008 the financial system seized up due to a lack of liquidity and the banking system as whole was brought to the precipice of collapse. In 2008 the Federal Reserve could address the root of the problem by adding liquidity, which bought time for the rest of the economy to heal once the financial system stabilized.
The unemployment rate rose to 10.0% in October 2009 one year after the peak of the financial crisis before beginning a slow descent. Even when the unemployment rate was 10.0% the vast majority (90%) of American workers were still working, although 20% to 30% of workers were probably worried that their job might be at risk and probably curbed their spending for a period of time. But importantly the vast majority of workers were still employed and continuing to spend which certainly limited the depth of the economic contraction.”
The difference between 2008 and the current crisis on workers and the unemployment rate were addressed in comments by Federal Reserve Bank of St. Louis President James Bullard on March 20. Bullard said:
“The U.S. unemployment rate could reach 30 percent in the second quarter because of the coronavirus pandemic.”
Bullard also said a 50 percent reduction in gross domestic product is possible in the second quarter given the shutdown of business throughout much of the country.
The Federal Reserve has done as much as it can to pump liquidity into the financial system and has provided more liquidity in the past week than it did with QE2 and QE3. On March 23 the Fed announced that it would begin buying corporate bonds which it did not do during the financial crisis. The American people are sheltering in place in large numbers which should limit the spread of COVID-19. American industry is ramping up the production of medical equipment desperately needed by medical personnel to protect them and assist them in providing care to all who need it.
The missing piece is Congress and especially those members who have somehow rationalized holding up the financial resources workers need to support themselves and their families, and support small and medium size businesses need to keep their doors open. Delaying the passage of legislation that is desperately needed is unconscionable in a time of national emergency and at the cost of more human suffering.
The political philosophy to never let a good crisis go to waste was advocated by Winston Churchill, but has certainly been practiced by both political parties in the U.S. Members of both parties need to put common sense and compromise ahead of ideology. COVID-19 doesn’t care if you’re black, white, brown, or yellow, or your religion, or your country. Imagine a day when humans treat each other the same – treating each other as each of us wants to be treated – With kindness rather than ego driven ideologies and labels.
No matter how well crafted the legislation Congress passes, some people will fall through the cracks and others will take advantage of what is intended for those in need. However, passing a bill that helps 90% of workers and families to weather this storm and a bill that enables more than 90% of companies to survive so workers have jobs to return to should be the only goal. And the time to act is now.
In the March 9 WTR I laid out the amount of aid and the goals of any legislation. A number of these ideas are being considered in Congress:
“Treasury yields have fallen to historic lows and the Treasury should take advantage of this opportunity to issue $2 trillion of 10-year Treasury bonds immediately. In order to limit any spike in the 10-year Treasury yield the Federal Reserve should stand ready to buy 10-year Treasury bonds if the yield rises to 1.30%. This ceiling is just below the low in yields in July 2012 and July 2016. The proceeds can be used to address a number of economic weaknesses that are likely to appear soon.
- As consumers change their behavior to limit exposure to COVID-19, small businesses are especially at risk if the economy experiences a sharp contraction. Short term loans must be made available to small business so they can survive if sales fall meaningfully.
- Making credit available to small businesses might help employers avoid laying off their workers if small businesses are provided a funding life line.
- Accelerated enrollment and enhanced unemployment benefits that replaces 90% of weekly wages for workers who lose their job due to the dislocation from COVID-19.
- Funding for employers to pay sick workers, even if they don’t work. This will encourage nonsalaried workers who don’t have sick leave compensation to stay home if they are ill.
- Funds for infra-structure projects will provide the economy a lift 6 to 12 months from now to sustain the recovery after the short term impact has passed.
- An increase in the supply of 10-year Treasury bonds will cause the yield curve to steepen which would be good for the banking system and a better cure than another rate cut by the FOMC.
- A modest increase in Treasury yields would calm investors and take some of the pressure off the stock market.
- Issuing new 10-year Treasury bonds will save the government interest costs by replacing higher yielding Treasury bonds with new 10-year bonds with a lower yield, and extend the duration of Treasury debt.
During World War II the Federal Reserve helped fund the war effort by purchasing government debt at low rates. From July 1942 through June 1947 the Federal Reserve bought Treasury bills at 0.375%, oneyear bills at 0.875%, 7-year to 9-year bonds at 2.0%, and long term Treasury bonds at 2.5%. This precedent can be repeated to address this national emergency and implemented at much lower rates than during World War II.”
Last week Congress was debating a bill that would total $700 billion, but now the total under consideration is closer to $2 trillion. While that seemed sufficient on March 9, the rapid spread of COVID-19 indicates that the total should probably approach $4 trillion. U.S. GDP is $21 trillion or about $400 billion per week. This average obviously doesn’t address the bulge in GDP activity that falls in December.
There is a strong likelihood that the shutdown could last 8 weeks, which would translate to $3.2 trillion. The recovery will not be V-shaped as so many are hoping, so the hangover for consumers and businesses could easily last into the third quarter. This time frame assumes that Congress acts soon and COVID-19 peaks in the next 4-6 weeks.
I am hopeful that the combination of hydroxychloroquine and azithromycin can be applied and help save lives and prevent infections becoming life threatening for the majority of those infected.
There is a review of how the drugs works to suppress COVID-19 and review of the Chinese and French studies.
Start listening at 17:00 minute mark through 25:30 for information: https://www.peakprosperity.com/chloroquine-a-promising-coronavirus-treatment/
On September 29, 2008 Congress voted on the Troubled Asset Relief Program (TARP) and it failed to pass leading to a big decline. Less than a week later Congress did pass TARP and the stock market swooned.
It is understandable that investors expect the S&P 500 to rally once Congress passes the Exchange Stabilization Fund. There probably will be a knee jerk positive reaction that allows the S&P 500 to rebound a bit.
However, the decline in the S&P 500 since its peak in mid February has been so swift that institutions may very well sell into any rally after Congress passes the Exchange Stabilization Fund (ESF) in coming days.
As noted in the March 12 Special Update:
“The next level of support that is the most obvious is the December 2018 low of 2347 on the S&P 500. If Congress acts over the weekend, the S&P 500 has the potential to rally at least 150 points and could extend up to 2680 – 2734. (This rally occurred on March 13.) Once this rally runs out of steam a decline to near 2350 is likely.”
In the March 16 WTR I explained why I didn’t think the support at 2347 would hold:
“The S&P 500 closed at 2386 on March 16. Although a bounce can take hold at any time, it seems likely that 2347 will not hold as selling pressure remains extreme. If the S&P 500 fails to hold 2347, the next potential area of support is 2250 (higher green trend line) followed by the lower green trend line at 2080. If the peak in infections is 8 to 12 weeks, instead of 4 weeks, a decline to the February 2016 low at 1810 (red horizontal trend line)can’t be ruled out, as extreme as this seems.”
In the March 15 WTR Special Update the pattern in the S&P 500 suggested that it would drop below 2280:
“A quick review of how the S&P 500 has stair stepped lower since topping at 3136 indicates only 7 small waves. Regular moves comprise 5 small waves. Extended moves that encompass a larger price move can have either 9 or 13 small waves. Since the drop from 3136 has only 7 waves it implies that the S&P 500 will bounce for wave 8 and then drop below 2280 for wave 9.”
On March 23 the S&P 500 fell to 2192 so it is now possible to infer that Wave (3) may be complete. If so, the S&P 500 could mount a rally to 2450 to 2550 this week for Wave (4).
The 5 day and 21 day Advances minus Declines oscillators posted a higher low even as the S&P 500 recorded a lower low on March 23. This is consistent with the potential of a short term low and rally.
However, the Major Trend Indicator has dropped below the horizontal line that indicates that it has become Deeply Oversold. When this condition has developed since 1928, the S&P 500 has more often than not retested the original low, which is Wave (3). The retest occurs after the Wave (4) rally is followed by Wave (5). As you can see, this is exactly what occurred in 1987. The economic conditions now are very different than in 1987 but the technical aspect is quite similar.
However, the Major Trend Indicator has dropped below the horizontal line that indicates that it has become Deeply Oversold. When this condition has developed since 1928, the S&P 500 has more often than not retested the original low, which is Wave (3). The retest occurs after the Wave (4) rally is followed by Wave (5). As you can see, this is exactly what occurred in 1987. The economic conditions now are very different than in 1987 but the technical aspect is quite similar.
The Federal Reserve announced it would buy corporate bonds which led to a 7% rally in the corporate bond ETF LQD on March 23. The stock market is not likely to enjoy any sustainable rally until the corporate bond market calms down and today was the first step in that direction. This short You Tube video recorded on March 20 explains why I thought the Fed would soon buy corporate bonds.
Last week Treasury yields rose as the stock market declined which was another indication that a massive liquidity squeeze was affecting every market. On March 23 Treasury yields dropped and performed as expected with the S&P 500 falling to a new low. This suggested some measure of normalcy had returned to the Treasury market on March 23.
Since the S&P 500 has dropped by more than 20% the consensus is that the bull market from March 2009 has ended. In the current environment that is readily accepted and who could blame anyone for coming to that conclusion. There is however a chance that this devastating drop is actually the end of the correction that began after the S&P 500 recorded its high in January 2018 on the highest weekly RSI level in history.
So once the S&P 500 has completed 5 waves down, it will also complete Wave C of Wave 4. If this pattern develops, the S&P 500 will subsequently rally above 3500 to a new all time high and could reach 4000. For this scenario to play out much has to go well in coming weeks.
Until there is evidence that the number of cases are peaking, and the combination of hydroxychloroquine and azithromycin can be applied and help save lives and prevent infections becoming life threatening for the majority of those infected, treading lightly is appropriate. If everything falls into place, the combination of Fed liquidity and fiscal stimulus would provide the ignition for a monster rally.
Chart analysis was instrumental in anticipating the decline in the S&P 500 as I laid out in the February 2 issue of Macro Tides:
“Since there is no way of knowing whether the coronavirus will prove mild or far worse than expected, monitoring chart levels and trend lines for the S&P 500 may provide some additional guidance. If the S&P 500 falls in a 5 wave decline as it tests or breaks below 3100, it would suggest the subsequent rally will represent a shorting opportunity. A 5 wave decline and break below 3100 would suggest the coronavirus will prove more deadly than currently assumed, depress global growth, and short circuit any second half rebound in the U.S.”
If the S&P 500 falls below 1800 it will likely signal that the risk of a depression is higher than fully appreciated. Ideally, Wave C of Wave 4 will bottom above 2000 in coming weeks.
The response by the Federal Reserve is not a surprise, since I expected the Fed to massively expand its balance sheet to ward off the next recession whenever it arrived. This is a quote from the June 2018 issue of Macro Tides and the February 2019 Macro Tides.
“During the next recession, the Fed’s balance sheet could easily balloon to $10 trillion or more, as it attempts to prevent an outright deflationary debt collapse. The debt issued to support the economy and purchased by the Fed amounts to free money for the government, as the Fed remits the interest it collects back to the Treasury. With a slight alteration to the Dire Straits song Money for Nothing, the lyrics would be: “That’s the way you do it. Money for nothing, get your programs funded for free.” Bernie Sanders and Elizabeth Warren would be happy to sing that tune!” The Fed’s balance sheet is likely to exceed $10 trillion by the end of 2020.
Treasury Bonds This was last week’s analysis which still applies:
“Despite the Federal Reserve slashing the federal funds rate from 1.50% on March 2 to 0.125% on March 15, and implementing another round of Quantitative easing with $700 billion of bond purchases, Treasury yields have gone up significantly. This is not an indication that the Treasury market is discounting a rebound in economic activity as some would like to think. It is more likely a sign that investors are selling Treasury bonds since they are one of the few assets that are still up on the year. If correct, the weakness in Treasury bonds is a reflection of an asset liquidity problem. As long as this condition persists it won’t be good for the stock market.
“If the economy weakens as seems likely in coming weeks (months?), Treasury yields are likely to head lower after bouncing around.”
The economy is likely to remain weak after Congress passes the Exchange Stabilization Fund, as companies wait for demand to reappear. After such a negative demand shock company executives will need to see and believe a recovery is in hand before they bring furloughed or laid off employees back onto their payroll.
It will take time for many consumers to return to the normal rhythm of life after undergoing the trauma of facing an unseen deadly virus. There is a good chance that Treasury yields will fall to their spike low reached on March 9 before mid year.
Gold
Last week’s analysis was on the mark:
“Today’s low likely marks a short term low and may set the stage for a bounce back to $1550 to $1575.”
Gold jumped to $1578 on March 23. The 61.8% retracement of the drop from $1700 to $1453 comes in at $1605, so there may be a bit more in the tank. Positioning is still quite negative and if the stock market establishes a Wave C and Wave 4 low in coming weeks, Gold could be vulnerable to a wave of liquidation as the rush to safety ends.The next leg lower could take Gold down to $1400 – $1425 before a more significant trading low is in place.
Gold Stocks
The volatility in GDX has been stunning even in a period of extraordinary volatility. After hitting a low of $16.18 on March 16 GDX traded up to $25.50 on March 17. Unbelievable! Although GDX can trade higher in the next few days, another drop seems likely. A close below $19.00 may provide the first signs of a low since GDX’s RSI will likely show a meaningful positive divergence.
Dollar
“The rebound in the Dollar opens the door to a pattern that would allow the Dollar to rally above 101 and potentially back to its January 2017 high of 103.82. Dollar strength during a period of slowing global growth is not a positive for U.S. corporations or the global economy and especially not for Emerging Markets.”
The Dollar rallied to 102.99 on March 20 before trading down to 101.65 on March 23. It is important that the Dollar weaken in coming weeks as it will signal that liquidity is flowing into the foreign exchange market and it will lower some of the pressure on emerging markets as I discussed in this short video.
Emerging Market
In the February 3 WTR I discussed how EEM could fall to $32.00 in coming months:
“The long term price pattern in the Emerging Market ETF (EEM) suggests that EEM could drop to $38.00 or so to complete a big A-B-C correction since the high of $51.76 in January 2018. If the Wave (C) decline from $46.32 is equal to the Wave (A) drop (51.76 – 37.35 = 14.41) EEM could fall to $32.00 (46.32-14.41).
If the global economy slows more than expected a decline to $38.00 seems plausible. The only way a decline to $32.00 occurs is if the global economy is admitted to the ER. No worries though. Central banks will cut rates repeatedly.”
EEM traded down to $30.10 intra-day on March 23. EEM potentially has the same pattern as the S&P 500 after peaking in Wave 3 in January 2018, and could establish an important low if it bottoms in Wave (C) of Wave (4). This video is from February 10 and discusses why I thought Emerging Market were vulnerable.
Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking
Once the S&P 500 closed beneath 3214 (the intra-day low on January 31 and February 24), which was the expectation discussed in the February 24 WTR, an intermediate peak was confirmed. The unrelenting decline that has followed has caused the MTI to drop sharply. The MTI fell below the blue horizontal line on March 11, confirming the onset of a bear market.
Disclosure
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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