Written by Jim Welsh
Macro Tides Technical Review 13 June 2017
What a Strange Trade It’s Been
Since late April technology stocks have been a one-way street led by the FAANG stocks. The more appropriate acronym should be FAMANG, which stands for Facebook, Amazon, Microsoft, Apple, Netflix, and Google, since the charge has been led by these six stocks rather than the Jiving Five of FAANG.
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Last week I called this one-way trade ‘Mindless Momentum’ since it didn’t seem to matter if the economic news in recent weeks didn’t support the bulls’ expectation of a strong rebound in the second quarter with GDP pushing to 3.5%. In late April the Atlanta Fed’s GDPNow forecast was projecting an increase of 4.3% in Q2, which has now sunk to 3.0% as of June 9.
As discussed in detail in the June issue of Macro Tides, an increase of even 3.0% is likely to prove optimistic. Trump’s pro growth agenda seems to be fading into the sunset with each new tweet he sends out. It reminds of the movie Tin Cup when the announcer is pleading with someone to tell Kevin Costner he doesn’t have to keep swinging. I doubt the movie’s enjoyable ending won’t be repeated as long as the President has a cell phone in hand. We can only sigh at what might have been
But a funny thing happened on Friday as the DJIA, S&P 500, Russell 2000, and the Nasdaq Comp and 100 were all making new all-time highs. Sellers appeared in the FAMANG stocks! What made it doubling interesting is that there was no reason for the selling, which makes it more significant. On the surface it appeared that money was flowing out of the FAMANG stocks and into the Russell 2000, Financials, and most surprising of all Energy stocks.
Even as the S&P has tread water after reaching 2400 on March 1, the rotation under the surface has been extraordinary. In this respect the events on Friday was merely more of the same with a dose of steroids added. The question is whether the Financials and Energy stocks are capable of moving from the dog house to carrying the mantle of leadership for the market. One never knows, but I doubt it.
The bank stocks rallied after the House passed a bill reforming Dodd-Frank on June 8 which will now be sent to the Senate. The hope that the burden of heavy handed regulation would at least be somewhat lifted particularly goosed the regional bank stocks. The Regional Bank Stock ETF KRE vaulted 7.5% from a low on June 8 to a high this morning, while the Financials ETF XLF popped 4.0%. I don’t know how long it will take to get through the Senate but I doubt it will happen next week.
Although the Fed will increase the federal funds rate on Wednesday, long term rates are not likely to zoom higher so the yield curve isn’t going to widen much. Lastly, there is the small issue of bank lending which continues to fall. As I have discussed previously, bank lending has nose dived since the election as the majority of companies large and small are waiting for the tax cuts to become legislation and they know exactly how to best borrow and make business investments.
Until more clarity arrives, most companies seem content to simply wait. It’s tough to see how financials can assume a leadership role until Congress and the administration can get their act together.
Energy stocks have been the dogs this year and it seems unlikely they can sustain a rally unless the price of oil and natural gas stops going down. In the short run, there is simply too much supply. This perception could change if Trump’s pro growth agenda was enacted. The lack of progress is creating a measure of pent up demand that will be unleashed and push GDP above 3.0% at least for a quarter or two if his agenda becomes reality.
As long as domestic growth is held in check while everyone waits for tax cuts, consumer and business spending should remain muted. This has the potential of also keeping a lid on the small cap stocks in the Russell 2000, so a sustained rally in small caps seems like wishful thinking.
As long as Congress is stymied, there is a risk that investors’ frustration turns into concern, especially if U.S. growth shows signs of faltering in the summer. The selling squall that hit the extended tech stocks on Friday could engulf the rest of the market as earnings projections are marked down for the second half of 2017.
As discussed last week, 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 completing at the high on Friday.
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. I thought that if wave C of wave 4 is to materialize, it would begin last week and Friday’s reversal is supportive of this pattern. 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.
Click on any chart below for larger image.
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 June 6, the dollar traded down to 96.52, 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 96.52, the dollar lost 7.30 points. At a minimum, a rally that retraces 38.2% of the decline seems likely, an increase of 2.6% to 3.4%. This would target a rally to 99.05 to 99.80.
Euro Even though the ECB made no changes to its QE policy, the Euro didn’t rally to 1.1325 – 1.135. The high last week was 1.1285. The positioning in the futures market as discussed below suggests waiting to short the Euro until it gets above 1.13 may be missing an opportunity. The pattern in the Euro looks as if it is close to a short term high.
The positioning in the futures market discussed last week has become even more extreme with Large Speculators increasing the number of long contracts they hold, while the Commercials have increased their short position. In January, as the Euro was making its low, large speculators had a fairly large short position in anticipation of the Euro declining further.
As the Euro rallied, large speculators were forced to cut losses on their short position by buying Euros. Their buying and buying spurred by the improving European economy and the elections going well, is why the Euro has rallied more than 8% versus the dollar in less than 6 months. Large speculators are now holding their largest long position since 2014 and 2011.
Since large speculators are trend followers, they are usually caught being too long at tops and too short at bottoms. After peaking in May 2014, the Euro dropped 25.2% by March 2015. After peaking in May 2011, the Euro subsequently fell 19.4% before bottoming in July 2012. History suggests the Euro could be vulnerable to a meaningful correction in the next six to twelve months at a minimum.
Treasury Bond Yields
The FOMC will increase the federal funds rate when they announce their decision tomorrow (Wednesday). The bond market pretty much expects this action, so the FOMC statement and Janet Yellen’s press conference holds more potential to move bonds and stocks than the rate increase.
In recent years, the majority of FOMC members have looked for reasons NOT to increase rates, which is why they voted to increase the federal funds rate just once in 2015 and 2016. The bias to look for reasons not to act seems to have given way this year. Now the FOMC seems to need reasons why it should not increase rates.
The increase on Wednesday will occur against a back drop of slowing job growth, no measurable pick up from the 2.5% in annual wage growth, inflation slipping further below the Fed’s target of 2.0% in recent months, weakness in the auto sector which had previously been a contributor to growth, tepid growth in housing, and the dimming prospects of Trump’s growth oriented fiscal policies being passed in 2017.
The apparent shift in the FOMC’s bias has not been recognized, let alone acknowledged, by the financial markets, at least not yet. Yellen’s press conference could provide clarity about additional rate increases before year end and the Fed’s intentions to shrink its balance sheet.
Gold and Gold Stocks
The positioning in the futures market has become even more negative as Commercials and Producers increased their shorts, while Large Specs increased their longs as gold traded above $1280. 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.
As long as the ratio of the Gold stock ETF (GDX) to Gold is rising and above the red trend line, 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 red 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.
A number of sectors made an initial peak on December 9 and a secondary high on March 1. The level of sector rotation within a relatively tight range during the last six months, and especially since March 1 has been head-spinning.
If Financials, Energy, and the Russell 2000 are unable to assume leadership or least stop being a drag on the market, the next time the Tech stocks sell off these sectors are not likely to provide a counter weight as they did last Friday. With the correlation between sectors being quite low in recent months, a sell off that engulfs all the sectors could be just what the market needs to establish the wave 4 low in the market, before most if not all the sectors participate in wave 5 to meaningful new highs.
If Congress decides not to leave Washington for their normal August recess, the prospects for the Trump agenda being passed before the end of 2017 would increase enough to get the market going to the upside. The potential for a blow off and a run for the roses is a real possibility as investors would have no reason to sell and the prospects of a surge in GDP and profits.
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.
