Written by Jim Welsh
Macro Tides Weekly Technical Review 29 April 2019
As noted last week,
“There is accumulating evidence that the rally is running out of gas. The final piece of this puzzle will be provided when the NASDAQ 100 and S&P 500 break down below their rising trend lines or close below a prior reaction low.
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For the NASDAQ 100 that would be accomplished with a close below 7580 and 2870 for the S&P 500. As long as these levels hold, the small number of stocks leading the charge higher can continue to carry the day.”
The S&P 500 pushed to a new closing high and a new intraday all time high on April 29, along with the NASDAQ Composite and NASDAQ 100. The New York Composite Index is -1.7% below its September 2018 high and -4.4% under its January 2018 all time high. The Russell 2000 is -7.9% below its all time high while the DJ Industrial average is -1.2% short and the Transports are -4.1%. The fragmentation between the major market averages is not a sign of strength.
Despite the new high by the S&P 500, internal strength as measured by the 21 day average of Advances minus Declines has continued to weaken (blue arrows). This confirms what the divergences between the market averages indicate: Fewer and fewer stocks are lifting the S&P 500 higher, while the majority of stocks tread water or fade.
Click on any chart below for large image.
The same internal weakness is apparent in the NASDAQ market breadth.
Although the internal weakness in these measures is a caution sign, there are other indications that the market is stronger than it was in September and not quite ready to experience anything more than a short term pullback. The percentage of stocks above their 200 day average was 61% on April 26, modestly above the 56% last September but equally below the 68% reached in January 2018. Normally there is some deterioration in this percentage as more stocks weaken before the market becomes more vulnerable to a larger correction.
The NYSE Advance / Decline is making new highs, although the slope of the A/D line is flattening.
The seeming contradiction between measures of breadth momentum (21 day average of Advances minus Declines) and the Advance / Decline Line and percent of stocks above their 200 day average can be resolved with a short term decline which is followed by another rally to a new high. This sequence would likely provide evidence of further deterioration in measures of breadth momentum, continued divergences in the major market averages, and maybe the first signs of weakness in the NYSE A/D line and the percent of stocks above their 200 day average. My guess remains that the market can hold up until mid May or so.
However, the Call / Put ratio suggests the market is in the Zip Code of an approaching intermediate high. The C/P ratio is the highest it’s been since last September, June, and December 2017. As noted, the technical health of the market is stronger than in September so a big decline is not likely just yet. More likely is a pullback similar to the dip of -3.5% after the short term high in June 2018.
As long as the S&P 500 and the NASDAQ 100 don’t close below 2870 and 7580, the odds favor another rally to a higher high before mid May.
Dollar
Last week the Dollar finally broke above 97.70 first reached in mid November, which has been the expectation. Although there is the potential for the Dollar to rally to 99.00 – 100.00, the follow through has been weak and would be negated if the Dollar (cash) closed below 97.50.
As I have noted for weeks the positioning in the Dollar is excessively bullish as is sentiment. The next really big move is more likely to be down not up. Once a top in the Dollar is confirmed there is potential for the Dollar to decline by more than 15 points, which would equal the decline that followed the January 2017 peak. (103.80 – 88.25 = 15.55)
As discussed in March Macro Tides the expectation has been that the European Union and especially Germany would begin to show improvement once China stabilized and firmed up before mid year. Data suggests that China has indeed begun to turn the corner which should provide the EU and Germany a lift in coming months.
Sentiment toward the EU is uniformly negative since economic data has been slowing for months. This negative sentiment is clearly evident in the size of the short position that has been building in the Euro in recent months as traders expect economic weakness to persist. If data begins to show improvement, the negative sentiment will be replaced by optimism which may lead to a bout of short covering in the Euro. Once the Euro rallies the Dollar will suffer a larger correction.
When the Euro made a new low last week, its RSI made a higher low indicating that downside momentum is waning (second chart below). This is a positive and suggests that a turn higher may begin soon. The Dollar appears to need one more rally to complete the rally that began in March. The Euro looks like it needs one more decline below last week’s low to complete the pullback from its March high.
Although positioning is not quite as extreme as in January 2017, it is consistent with a level that has supported a rally of 6% or more in the last few years.
The ETF for the Euro is FXE. I would recommend a 50% long position in FXE if it declines below $106.00 using a close below $105.00 as a stop.
British Pound
A 100% position in the British Pound thorugh its ETF (FXB) was recommnded at an average price of 127.79.The instruction was to use stop on 50% of the position on a close below 126.10 with a stop of 125.70 on the remaining half. FXB closed below 126.10 on April 18. The stop on the remaining half was lowered last week to 1.2515 which was triggered on April 25 when FXB fell to 125.00. If the expectation of a large deline in the Dollar is correct, the British Pound is going to rally in coming months. For now, we’ll wait for confirmation of a top in the Dollar.
Gold
The positioning in Gold futures has continued to improve and suggests Gold is approaching an intermediate low. Large Speculators are holding their smallest long position since early August (green 6 line middle panel), while Managed Money is short (blue line bottom panel). In August Gold dropped another 3% as it spiked down to $1160 before stabilizing above $1180.
From its high in February Gold fell $64 and an equal drop from the secondary high of $1324 would target a low near $1260. A 50% position in GLD was recommended if Gold trades under $1265. Gold traded as low as $1266.61 last week before rebounding.
The 50% retracement of the rally from $1160 to $1347 is $1253 and the 61.8% retracement level is $1232. Gold may bounce to $1310 for wave b of wave E, and then fall to $1232 in wave c of E. The current decline is wave e of a triangle that began after Gold topped at $1375 in July 2016, after rallying from $1045 in December 2015. If this triangle analysis is correct, Gold is completing a consolidation pattern after the $330 rally in the first half of 2016, and may rally $330 from the low of wave e.
Gold Stocks
The relative strength of Gold stocks to Gold has weakened materially in the last two weeks and closed outside its multi-month channel last week (bottom panel). This increases the probability that GDX can drop under $20.50. In the April 8 WTR I recommended a 33% position if GDX fell below $21.60 which it did on April 17. Increase the position to 66% of GDX trades below $20.60. If Gold falls below $1250 and the relative strength of the Gold stocks weakens further, a Decline to $19.50 can’t be ruled out. Increase the position to 100% if GDX trades below $19.60.
Treasury Bonds
As discussed in the March issue of Macro Tides, monetary and fiscal stimulus in China was expected to stabilize economic growth in China and then help lift the European Union out of its economic doldrums, since the EU derives 47% of its GDP from exports and China is the EU’s largest customer. Recent data indicates that China is beginning to firm which should lead to an increase in demand for EU exports and better data out of the EU in the next few months.
Most investors expect the next move by the Federal Reserve will be to lower rates. Investors could be in for a shock if the dour outlook for the global economy proves overly negative and core inflation begins to inch up in the US.
As discussed in the April Macro Tides the term premium for the 10-year Treasury bond fell to -0.82% on March 29, which was barely lower than the -0.80% in July 2016. After the July 2016 low, the term premium rose to +0.20% by the end of 2016 which contributed to a rise of more than 1.20% in the 10-year Treasury yield.
“The term premium soared from -0.80 percentage point in July 2016 to +0.22 at the end of December 2016. During this period the 10-year Treasury yield jumped from 1.336% to 2.621% an increase of 1.285%. The increase of more than 1.0% in the term premium accounted for 78% of the 1.285% increase in the 10-year Treasury yield.”
The combination of better global growth, rising core inflation in the US, and merely the prospect that the Fed may have to consider raising rates before the end of 2019 could cause the term premium to soar just as it did in 2016. The net result is that 10-year Treasury yield could jump by more than 1.0% before the end of 2019.
For this scenario to play out it is going take more voices than mine to turn the tide and get people thinking this scenario might be possible. Scott Minerd is the chief investment officer at Guggenheim Partners, which manages $265 billion in assets, had this to say in an interview on CNBC on April 29:
“Some believe we may have seen the Federal Reserve’s last rate hike in this cycle, and that the next step from here will be a cut in rates. I believe that view is plainly wrong.”
Minerd said the U.S. economy is doing “just fine” while China’s economic growth is back on track with both fiscal and monetary stimulus in place. Meanwhile, the European Central Bank is working to stimulate economic activity in the region. Improving Chinese growth will also benefit Japan given their “close trading ties“:
“All this adds up to continued growth which will ultimately lead the Fed to increase rates again. Of course, markets will not wait for action by the Fed and will start to reprice in anticipation of possible future hikes. Currently, the bond market is priced for an ease. Ultimately, the market will take that back and more by the fourth quarter, which will lead to a steepening in the yield curve in coming months.”
It’s nice to know that if I’m wrong I’ll have some good company
Despite the recent decline TLT is not oversold as measured by its RSI, so a decline below $118.64 is possible, which may set up a short term buying opportunity before the trend for higher rates really kicks into gear. The bigger trade will be looking to short Treasury bonds in coming weeks after any rally.
Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking
The MTI generated a Bear Market Rally (BMR) buy signal on January 16, 2019 (green arrow) and climbed above the green horizontal trend line on February 26, as it did on March 30, 2016. This increases the probability that a bull market has been confirmed. Prior to a decline the MTI would be expected to at least flatten out as it did in September.
However, the reversal in January 2018 was so quick the MTI effectively topped as the S&P 500 peaked. With the MTI continuing to rise, the odds that the S&P 500 will rally after any short term dip are good.
If Treasury yields jump by more than 1.0% before the end of 2019, the S&P 500 will likely experience a decline that brings the S&P 500 below 2750 before Halloween. A rise in Treasury yields will cause a compression in the S&P 500’s P/E ratio which may open the door to a retest of the December low.
The Russell 2000 posted its highest close since October but its RSI is far below where it was in October (blue arrow). This raises the stakes a bit and the Russell 2000 needs to follow through in the next few days or its going to look ugly. I think it will rally some more but not enough to erase the huge divergence in its RSI.
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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