Written by Jim Welsh
Macro Tides Technical Review 05 June 2017
The S&P bounded higher last week reaching 2440 despite economic news that isn’t conforming to expectations. Since May 2016, the correlation between the Citi Economic Surprise Index and the S&P has been fairly tight up until the last six weeks. It would one thing if the Citi Index was just trending sideways while the S&P gallops to new highs. But the run up has occurred with a plunge in the Citi Index and this chart doesn’t even reflect the weak housing and employment data from last week.
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The market rallied after the election in anticipation of better economic growth. When growth slowed more than expected in the first quarter it was ignored, since the consensus is that growth would really get better in the second quarter. Statistically, it is going to get better. Inventory liquidation in Q1 subtracted -1.07% from Q1 GDP, which was revised up from +0.7% to 1.2%. If inventories are merely maintained in the Q2, GDP will bounce back by 1%. This would boost Q2 GDP to at least 2.2%, but it really won’t mean much for organic nominal growth.
Click on any chart for larger image.
If better economic data has been absent, and Trump’s tweeting has not improved the odds of actual tax cut legislation, why is the market still going up? It’s going up because it’s going up, as selling pressure remains nonexistent and investors continue to chase the train even though it has left the station.
Investors are drawing comfort and confidence from the strength in the big cap tech stocks. As long as they keep running, investors will continue to feel it’s safe to be in the water. Any data points that don’t support the Q2 GDP rebound will be dismissed, as long as Amazon, Google, Apple, Netflix, Facebook, and Microsoft keep making new highs.
The late week surge healed some of the technical divergences as the new high was confirmed by the advance / decline line, a surge in 52 week new highs, and almost all of the market averages, with the exception of the Russell 2000 and the DJ Transports. Technically, the overall picture is good, which is why I have expected a rally to a new high after a 3% to 5% pullback.
Last week’s move up lowers the probability of a decline to 2350 and potentially under 2330, but it did not eliminate it entirely, and seasonality may have played a role. It is possible that the initial rally from the mid April low was wave a of B, the sharp drop on May 17 was b of B, with wave c of B from the low on May 18 almost complete. Wave 4 from the March 1 high would be complete once the S&P dropped below at least 2352 and potentially under the mid April low of 2322.
If wave C of wave 4 is to materialize, it should begin this week and be a sharp decline. If the S&P closes above 2450, the wave 5 to new highs I have expected since the March 1 high began at the mid April low. Waves 1 of wave 5 ended on April 26, with the sharp decline of May 17 and low on May 18 representing wave 2 of wave 5. This pattern suggests wave 3 of wave 5 is about to explode higher this week, since eave 3 is always the strongest portion of a rally or decline.
China
I discussed China at length in the May issue of Macro Tides and presented reasons why the Chinese economy is likely to slow in coming quarters. The downward acceleration in the China Caixin PMI is confirmation that the slowdown is already occurring.
Over the past month, the Shanghai A shares has rebounded as I expected even as liquidity conditions in China’s financial system continue to worsen. I thought the Shanghai A shares could rebound to near 3300 before rolling over and declining to a new low. On May 31 the Shanghai A shares reached 3291. The trend line on the chart below is from the low In February 2016 low, so the uptrend from that low has been broken. I don’t know of any other major stock index that has broken below its rising trend line from the low in February 2016.
The high in early April appears to be a double top with the high in late November. The rally form the mid May low is clearly a 3-wave bear market rally. This suggests it’s just a matter of time before the Shanghai A shares fall below the mid May low. Longer term, the Shanghai A shares could drop to the high in early 2013 around 2500.
If everything was Hunky-Dory in China, commodity prices wouldn’t be so weak.
Dollar
In the May 22 WTR I thought the dollar had more downside:
“The Dollar broke down on May 16 and could drop to 96.38. That is where the current decline would equal the initial decline of 4.96 points from the January high of 103.82 to 98.86.”
On Friday June 2, the dollar traded down to 96.65, not far above the target of 96.38. As the dollar made new lows last week, the RSI was diverging which is another sign that a trading low is coming soon. From the high at 103.82 to Friday’s low of 96.65, the dollar lost 7.17 points. At a minimum, a rally that retraces 38.2% of the decline seems likely. This would target a rally to 99.39.
Euro
The ECB meets on Thursday and it seems unlikely they will lower their QE monthly purchases of bonds from $60 billion. This may cause a quick pop in the Euro up to 1.1325 – 1.135. But the pattern in the Euro looks as if it is close to a short term high.
The positioning in the futures market also suggests the rally in the euro is nearing a high. Large speculators have the largest long position since 2014 and not far from the largest position ever in 2011. Commercials now have a larger short position in the euro than in either 2011 or 2014. After a high in May 2011, the euro dropped from 1.4925 to 1.2050 in July 2012.
After peaking in May 2014 at 1.3993, the euro plunged to 1.045 in March 2015. In recent months there have numerous articles trumpeting the strength of the European economy and noting that it grew faster than the U.S. in the first quarter – 2.0% versus 1.2% – hardly, lights out. Some of the bullishness is also because the elections in the Netherlands and France were not as disruptive as feared. It’s possible the good economic news out of Europe is nearing a peak and will fade in coming months, which leads to a decline in the euro. We’ll see. The positioning suggests a decline is coming and the news will simply provide a reason to sell the euro.
Treasury Bond Yields
After being bullish in mid March when the 10-year Treasury was yielding 2.6%, I turned neutral on the bond market, after the short covering I expected drove the yield on the 10-year Treasury bond below 2.2%. I thought the yield on the 10-year could climb to 2.34% – 2.42%, and on May 11 it reached 2.423%. If the yield on the 10-year Treasury is going to fall below the April 18 low of 2.177%, it will be due to surprisingly weak economic data, which I don’t expect, or an event that causes a rush to safety. This would be supported by a wave C decline in the S&P. When the stock market had its one day swoon on May 17, the 10-year Treasury yield fell by more than 10 basis points.
The pattern in the 10-year yield supports the potential of a decline to 2.0%, which leaves open the possibility for another sharp decline in the stock market that may actually last for more than one day. If the 10-year drops under 2.05%, it may be time to short the bonds.
Gold and Gold Stocks
The positioning in the futures market has became a bit more negative as Commercials and Producers increased their shorts when gold traded from $1230 to above $1270. Large Specs increased their longs from 126,724 contracts to 167,090 contracts. I’m guessing Large Specs have added to their long position as gold traded above $1280 in recent days. The increase in bullishness by Large Specs suggests gold is vulnerable to another decline that could shake them out and bring gold down to near $1200. At a minimum, a pullback to $1245 – $1255 seems likely.
In the face of more upside in gold and silver, the ratio of the Gold stock ETF (GDX) to Gold deteriorated more last week. Since May 24, gold has rallied from $1256.50 to a high of $1286.00 this morning, a gain of 2.3%. The gold stock ETF GDX has declined from $22.97 on May 24 to $22.74 today, or down by 1.0%. As long as the ratio of the Gold stock ETF (GDX) to Gold is rising, it indicates that gold stocks are on balance underperforming. Prior to the rally in the first quarter, the ratio dropped below its moving average AND the rising thick black trend line.
Tactical S&P Sector Rotation Portfolio Model: 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. As discussed earlier, the MTI continues to indicate that a bull market is in force. The Technology sector (XLK) has been in the Top Four of the Sector Relative Strength Ranking since October 2, 2016, and has been in the number one position for weeks. The Financials (XLF) moved up into the Top 4 on October 28, just before the big run up after the election. In mid March I thought Treasury yields were likely to fall from 2.6% and drop to below 2.2%. This development would not be positive for Financials, which indicated analysis of the Financials ETF chart could be helpful, if XLF began to weaken. On March 17, the Financials ETF decisively broke below its rising trend line (chart below). The combination of fundamental analysis and technical chart analysis suggested reducing exposure to Financials was warranted.
This week the Financials dropped out of the top 4 and would have been sold at the opening this morning at $23.46, more than 4% lower than the technical sell signal on March 17 at $24.47.
The Utilities moved into the top 4 this week, but I would not buy them here (Chart below shows how over bought they are – RSI 81.4 on June 2). The 25% that has been in cash from the sale of the Financials since March 17 will remain in cash for now. The Industrials (XLI) made it into the Top 4 on November 18, 2016. The Russell 2000 entered the Top 4 on August 19, 2016, and remained in the Top 4 until it was replaced by Consumer Discretionary (XLY) on May 5.
I have said that the Financials are one of the keys to the market, since a real breakout above 2400 will need the participation of the Financials. The Financials ETF (XLF) dropped to its prior low on May 17 and the bounce so far has lagged the market. The price pattern suggests the low on May 17 is likely to be broken and that XLF may fall to $21.70 in order to close the gap. If this weakness occurs when the technology flyers come down to earth a bit, the S&P could test the May 17 low of 2353. Without the participation of the financials, I doubt the move above 2400 will be sustained. The S&P has moved comfortably above 2400 without the Financials. Unless wave C of wave 4 materializes, this supposition will have proven incorrect.
