Written by Jim Welsh
Macro Tides Technical Review 04 December 2017
The stock market vaulted higher last week in anticipation of the Senate passing the tax reform bill which was accomplished on Saturday morning. The bill will go through the reconciliation process that allows members of Congress to negotiate the differences in the House and Senate bills. It is almost certain to make it to President Trump’s desk and maybe in time for Christmas. The S&P zoomed from 2601 last Monday to an intra-day high this morning of 2665 before closing at 2639.
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Under the surface there were extraordinary moves into some sectors and out of others. The Technology sector has the largest weighting in the S&P 500 of about 25%. Last week it lost –2.0% while the Industrial sector rose 3.0% and the overall S&P was up 1.5%. The most extreme rotation was between the Semi-Conductors which shed –6.0% and the Transports that soared 6.0%. In the past 35 years that has only occurred once before, back in March 2000 which coincided with the dot.com top.
The rotation was so dramatic that it reminded me of Linda Blair in the 1973 movie The Exorcist which won 6 Academy awards including Best Picture and Best Supporting Actor for Linda Blair. In one of the famous scenes, Linda Blair, who is possessed by the devil, undergoes an exorcism during which her head spins 360 degrees.
Foul language Warning:
Here is the Wall Street version:
Click on any chart below for large image.
The performance of Value and Growth stocks within the Russell 1000 has been fairly tight since the bull market commenced in March 2009. In early 2017 that changed dramatically as the spread between Growth stocks and Value stocks widened to its largest spread since 2000.
One way to measure this is comparing the relative strength of the Russell 1000 Value Index to the Russell 1000 Growth Index. The Value stocks consistently underperformed the Growth stocks from April 2014 until January 2016 (red down trend line). From April 2016 the Value stocks modestly outperformed the Growth stocks until December 2016 and then broke below the rising green trend line in March 2017.
Last week’s improvement in relative performance follows two prior attempts that failed to reverse the trend – in June and September as noted by the blue lines. When the relative strength line (black line) is above the blue 134 day average, it indicates that Value is doing better than Growth and weaker when it is below the moving average.
Despite last week’s fireworks, the jury is still out on whether last week’s trading represents a true reversal since the black relative strength line is below the red trend line and blue moving average. During February and March 2016, the relative strength of the Value stocks built a small trading range (base) before decisively breaking out in April. I suspect something similar will occur between now and the end of January.
The rotation out of big name growth stocks last week (FANG) is likely to be used by some investors as an opportunity to buy the big name growth stocks. If this does take place, the Value stocks will lag for a time. It is premature to determine whether the shift into more cyclical oriented sectors like Industrial, Financial, and Transportation stocks is the beginning of a multi-month trend or just a quick rotational blip
As noted last week 68% of the stocks on the NYSE were above their 200-day average when the S&P posted a new high of 2557 on October 13. On Friday 61% of NYSE stocks were above their 200-day average, with the S&P almost 4% higher at 2647. The relative weakness in the value stocks partly explains why the percent has fallen from 72% in February even as the S&P has been carried to new highs by the big cap growth stocks. If the rotation toward Value stocks is real, the percent of stocks above their 200-day average could rise even if the Growth stocks falter a bit.
Since the Growth stocks have a larger capitalization on average than Value stocks, it is possible the S&P could decline if the Growth stocks suffer a larger correction, while the percent of stocks above their 200 day average doesn’t fall much. This would provide additional confirmation that the rotation to value is for real and lasting.
The percent of NYSE stocks making a 52 week high continues to diverge significantly with its mid October level despite all the excitement during the last week.
The percent of NYSE stocks that participated in the recent push to new highs as measured by the Net percent of advancing stocks over the last 21 days didn’t improve that much last week.
The High-Low 21 Day Net % and the A/D 21 Day Net % are thrust indicators that measure how much energy is behind a rally or a decline. They are showing that there hasn’t been much OOMPH! in the rally despite the new highs and the Big News about Tax Reform. The Advance / Decline line has managed to post a new high which suggests the risk of a decline of more than 7% is minimal, especially with the strong seasonal bias going into year end.
That said today’s reversal shouldn’t be ignored. The market gapped higher and proceeded to sell off throughout the trading day which shows the urge to ‘sell the news’ was rampant. If the Nasdaq 100 gaps down tomorrow and closes below 6225, additional selling pressure is likely. If it materializes it will be instructive to see how well the value stocks hold up.
Dollar
Unless the Dollar rises above the neckline of the inverse head and shoulders at 94.25, the downtrend is intact. According to the sages of Wall Street markets are a discounting mechanism. Since December 2016 the Federal Reserve has raised the federal funds rate three times with a fourth hike coming on December 13, and the US economy has produced two quarters of better than 3% GDP growth for the first time since 2014. The Dollar Index will have declined more than 10% from 103.00 on December 15, 2016 so what exactly was the Dollar discounting in December 2016? So much for the direction of interest rates in dictating the direction of a currency! A test of the September 8 low at 91.01 is coming, but may not occur until January. As noted last week, I sold my position in the Dollar ETF (UUP) at $24.43 on November 14 after buying it on August 29 at $23.83.
Euro
As long as the Euro holds above the neckline of its head and shoulders pattern near 1.1675, the trend is up and a rally to 1.2200 seems likely.
Treasury Bonds
The 10-year Treasury yield remains tethered to the 10-year Bund yield in Germany with a spread of about 2.0%. The German Bund has been holding below .40% which has helped the yield on the 10-year Treasury bond to hold below 2.40%. Last Thursday, the yield ticked up to 2.437% before falling back below 2.40% on Friday as yields in Germany fell. The 10-year German Bund yield is likely to climb above 0.50% in the first half of 2018. If and when it does, it will represent a technical breakout and suggest a move up to 0.75% – 0.90% could follow quickly. If the spread between the 10-year Bund and 10-year Treasury bond holds near 2.0%, the Treasury yield would breakout above the March high at 2.62%. This would open the door for a move to the December 2013 high of 3.03%.
A move up to 3.17% to 3.20% on the 30-year Treasury bond, the highs last December and in March is likely before year end or in the first quarter. It took nine months for the yield to rise from 2.20% to 3.20%. An equal move in yield and time suggests the yield on the 30-year Treasury could approach 3.75% by June of next year.
Gold and Gold Stocks
Not much has changed for Gold and the Gold stocks. The positioning in the futures market continues to suggest a decline below $1260 is likely since Large Speculators are still holding a large long position while the smart money Commercials increased their short position from –225,056 contracts to –246,541 contracts last week and Producers are short –184,757 contracts. From a high of $1357.09 on September 8, Gold dropped to $1260.72 on October 6. If Gold does rally to $1310, an equal decline of $97 would bring Gold down to under $1220. This process could take 2 to 4 weeks.
Gold broke below the trend line connecting the July low and a series of intra-day lows during November. As long as Gold holds below the trend line ($1287), the risk of a decline below $1260 remains likely.
Last week I thought that the Gold stock ETF (GDX) looked like it was preparing to break below the blue trend line near $22.60, and noted that a close below $22.20 should usher in a new leg lower. GDX closed below the trend line on Wednesday, failed to reclaim it on Friday, and closed today at $22.20. The path of least resistance looks lower. If Gold does fall below $1260, my guess is that GDX could fall to the green trend line currently near $21.15. If Gold falls below $1220, GDX could drop to the black trend line near $20.70. The relative strength of the GDX versus Gold continues to weaken and hold above the black trend line, which is not a good sign.
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. Since late July, the odds of the S&P continuing the streak of no corrections of either 3% or 5% seemed quite low based on historical patterns and signals from a number of reliable technical indicators.
The Tactical U.S. Sector Rotation Model Portfolio has been 100% in cash since July 24 based on the probability of a 5% correction. In my judgment (so far incorrect), upside potential has been limited relative to the level of risk. Through November 24, the Tactical Sector Rotation program is up 9.6%. Although the Major Trend Indicator is below its peak registered in early March, the MTI continues to hold above the green horizontal line which is another sign that the market is not yet vulnerable to a decline greater than 10% or a major trend change.
On November 27, Robert Kaplan, President of the Federal Reserve of Dallas gave a speech entitled “A Balanced Approach to Monetary Policy”. Kaplan’s speech was remarkable for its frankness, specificity, and for addressing a number of issues that I’ve written about in recent months. In his November 27 speech Robert Kaplan addressed the issue of financial imbalances:
“Excesses can also manifest themselves in financial imbalances. While I would prefer to rely primarily on macroprudential policy tools to manage financial imbalances, I am nevertheless monitoring various measures of potential financial excess. I monitor these and other market measures because I am aware that, as excesses build, we are more vulnerable to reversals which have the potential to cause a rapid tightening in financial conditions, which in turn, can lead to a slowing in economic activity. The U.S. stock market capitalization now stands at approximately 135 percent of GDP, the highest since 1999/2000.”
In the October issue I showed the chart of the Buffett indicator which compares the capitalization of the stock market to GDP as a percent.
This is what Kaplan had to say about the lack of volatility in the stock market:
“Measures of stock market volatility are historically low. We have now gone 12 months without a 3 percent correction in the U.S. market. This is extraordinarily unusual.”
In my October 9 Weekly Technical Review I made the following comment about the absence of a correction in the stock market during 2017:
“We’re more than 75% through 2017 and the largest decline in the S&P has been a scary -2.9%. Since 1914 that is the smallest decline in any year, which means the odds of this occurring as we entered 2017 was less than 1%.”
Since mid August I have tried to identify special situations that were uncorrelated to the stock market and oversold. On August 24 I purchased the Powershares DB Agriculture fund (DBA) at $18.66 and sold it on November 15 at $19.02. On August 29, I purchased the Dollar ETF (UUP) at $23.83, since I thought the Dollar was poised for a rally. This position was sold on November 14 at $24.43. On October 27, I purchased the VanEck Oil Services ETF at $23.67. This position was reduced by 40% on November 8 at an average price of $25.79. The balance was sold today at $25.42.
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.
