Written by Jim Welsh
Macro Tides Technical Review 22 January 2018
Like most investors I thought TINA (There Is No Alternative) was born in the wake of central bank monetary policies that kept short term interest rates just above zero percent and pushed long term rates down to unattractive levels. In fact There Is No Alternative was inspired by Herbert Spencer who was an English philosopher, biologist, anthropologist, sociologist, and prominent classical liberal political theorist of the Victorian era who died in 1903.
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He believed in laissez-faire government and positivism and the capacity of technology and social progress to solve society’s problems. He was one of the principal proponents of evolutionary theory in the mid nineteenth century, and his reputation at the time rivaled that of Charles Darwin. To critics of capitalism, free markets, and democracy, he frequently responded, “There is no alternative“.
Spencer’s views were revitalized by Margaret Thatcher who served as Britain’s Prime Minister from 1979 to 1990. Responding to critics of her market-oriented policies of deregulation, political centralization, spending cuts, and a rollback of the welfare state, Thatcher used the phrase in a similar way as Spencer. To Thatcher free-market neo-liberalism had no alternative. Reagan and Thatcher shared this philosophy which is why they respected each other.
I don’t know when or who transferred the TINA acronym to stocks, but in a low rate environment accompanied by a rising stock market it certainly stuck. With 2-year Treasury bond yields rising above the S&P 500’s yield for the first time since September 2008, the sun is setting on TINA while the Fear Of Missing Out (FOMO) and (Fear Of Losing More) take over.
The relentless nature of the rally and the curve of the S&P 500’s ascent since the end of 2017 suggest that money is coming into the market because it is going up. The foundation for this was laid by the records the S&P has set by going the longest time in history without a 5% correction or even a pullback of 3%. Waiting for the market to exhale has not rewarded patience which has been replaced by the fear of missing out (FOMO).
Those intrepid investors who established short positions in anticipation that 2018 would bring a more normal trading pattern have covered their short positions due to the fear of losing more money (FOLMM). The sharp decline since the start of 2018 in the Total Short Interest of S&P 500 stocks suggests that short covering has played a meaningful role in the market’s recent surge.
The FOMO was given a big boost when Jeremy Grantham published a 13 page report on January 3 in which he stated:
“I recognize on one hand that this is one of the highest-priced markets in U.S. history. On the other hand, as a historian of the great equity bubbles, I also recognize that we are currently showing signs of entering the blow-off or melt-up phase of this very long bull market”.
Grantham compared the present market setup with the run-up to past bubbles, including the 2000 tech boom and the precursor to the 1929 crash. Grantham went on to show what a melt up might look like in 2018 and 2019:
“Exhibit 4 (shown nearby) represents our quick effort at showing what level of acceleration it might take to make 2018 (and possibly 2019) look like a classic bubble. A range of nine to 18 months from today and a price rise to around 3,400 to 3,700 on the S&P 500 would show the same 60% gain over 21 months as the least of the other classic bubble events.”
I wasn’t around for the melt up in 1929, but I do remember how the market raced higher in 1987 and the dot.com bubble in 1999-2000. I also remember how they ended, which Grantham addressed should the S&P experience a melt up before the end of 2019.
- A melt-up or end-phase of a bubble within the next six months to two years is likely, i.e., over 50%.
- If there is a melt-up, then the odds of a subsequent bubble break or meltdown are very, very high, i.e., over 90%.
- If there is a market decline following a melt-up, it is quite likely to be a decline of some 50%.
I suspect investors were more than happy to embrace the first point but will not be so vigilant or prepared for the second and third point.
What most investors may not remember is the Dollar was quite weak in 1986 and 1987 and Treasury bond yields rose sharply before the Crash on October 19, 1987. From early 1986 until October 1987, the Dollar lost more than 18% of its value. The yield on the 20-year Treasury bond rose from 7.3% in January 1987 to 8.8% in late August an increase of 20.4%. The S&P topped on August 24, 1987. In the first week of October 1987, the 20-year Treasury yield topped 10.0%, up 37% from where it was at the beginning of 1987.
Since peaking in January 2017, the Dollar has fallen by 13.0% and is likely to fall further in coming weeks. At the end of 2017, the yield on the 10-year Treasury bond was 2.40%. To mirror the increase of 20.4% in 1987, which led to a top in the stock market in 1987, the yield on the 10-year Treasury bond would need to climb to 2.88%. The yield would have to reach 3.29% to match the percentage increase in 1987 just before the stock market crashed. Today the 10-year yield closed at 2.665% so it’s not even close to 2.88%. In the very short term, FOMO and FOLMM are likely to remain in control until yields rise enough to get the market’s attention.
It is certainly possible that a melt up in the DJIA and S&P 500 has begun since the S&P has broken out above the trend line connecting the prior highs in 2016 and 2017, although I’m not convinced.
Click on any chart below for large image.
My guess is that if there is to be a melt up, it is likely to commence after the 10-year yield has neared 3.0% and the S&P has suffered at least a modest correction of 5% or more. The only way the 10-year yield increases to 3.0% is if inflation increases more than expected and the bond market over reacts to what it thinks the Fed may do in response to higher inflation. The February employment report which will be released on March 9 could be pivotal since wage growth is likely to reflect the increases in the minimum wage mandated by states, WalMart’s wage increase for the 1.5 million U.S. employees, and the one-time bonuses more than 200 companies have announced.
If the 10-year Treasury yield does rise to 3.0%, it seems likely that an extended trading range could develop as the bond market realizes the Fed is willing to allow inflation to run modestly above 2.0% without feeling compelled to increase the federal funds rate more than 4 times in 2018. If this scenario plays out it would allow the stock market to rally anew in anticipation of better economic growth and corporate earnings without the fear of a more aggressive Fed and higher interest rates.
On January 16, the stock market gapped higher before reversing sharply lower. The number of stocks making a new 52 week high ballooned to 412 on the NYSE and 437 on the Nasdaq. All the major averages made a new high today, but the number of stocks making a new 52 week high dropped to 281 on the NYSE and shrunk to 374 on the Nasdaq. These are still strong numbers.
The Weekly Relative Strength Index (RSI) for the DJIA and S&P 500 reached their highest level in history last week. Markets very rarely top out on peak momentum which suggests that even after a price high is achieved the downside is likely to be limited. Of course, if the S&P 500 does experience a decline of more than 3% some investors may feel a wake is in order.
Interest Rates
As forecast, the 10-year Treasury yield has broken out above 2.63%. The move to date has resembled a methodical grind higher rather than a sprint. Based on the chart, the 10-year yield should continue to march toward 2.80% were there may be temporary resistance (red line) from highs in April 2014. The more important target remains 3.03% (Green horizontal line) which was the high on December 31, 2013.
The yield on the 10-year Treasury bottomed in July 2016 at 1.33%, rose to 2.62% in the first quarter of 2017, dipped to 2.03% in September, and has since trended higher. What is fascinating is that money flows into bond mutual funds have continued to soar.
This indicates that investors are reacting to higher yields by investing more money since they are so hungry for income. If yields continue to climb, retail bond investors are going to open their monthly statement at some point and realize the bond allocation in their portfolio has lost value. How will they react? For those who truly need the income they are likely to continue to hold onto their bond funds. I doubt many will feel compelled to sell their bond funds and move into equity funds.
The 10-year German Bund continues to yield more than .50% and has not reversed as it did in early July after popping above .50%. Bund yields ‘look’ like they want to go higher.
Gold and Gold Stocks
Last week I provided this assessment for Gold:
“Although it is certainly possible for Gold to break above the trend line connecting the August 2016 high with the September 2017 peak, the odds favor a test and then a pullback. This suggests selling a portion of the Gold position above $1344 or using a decline below $1326 as a stop.”
On January 17 and January 18 Gold closed just above $1326.00. If Gold does managed to rally above $1344, selling most of the position may be warranted since sentiment has turned overly bullish and the positioning in the futures market has become far less supportive. Large Specs have increased the number of long contracts they hold from 107, 068 contracts on December 11 as Gold was making a low to 211,711 as of January 15. While this isn’t as high as the 224,417 contracts they held on November 27, its high enough to suggest that Gold is less likely to breakout above $1357 and more likely to pullback to $1300 or so. Longer term a rally above $1400 is possible if inflation picks up as I expect.
Last week I noted:
“On Friday January 12, GDX broke above the red down trend like connecting the August 2016 high and the September 2017 high. The path appears clear for a run above $25.00 and a test of the black horizontal trend line connecting the February and September 2017 highs. Unless gold breaks out above $1357, I will likely sell another 25% of GDX if it trades above $25.00.”
When Gold pulled back from $1344 to $1326, the Gold stocks acted poorly as measured by their relative strength to Gold. The high on January 2 was $23.84 which I felt should not be touched again if GDX was going to rally above $25.00. On January 18 my stop at $23.85 was triggered on the remaining portion (50%) of my position. The average sell price was $23.91. The cost basis on the GDX position is $21.73.
On January 2, the Junior Gold stock ETF GDXJ traded up to $35.17 which I felt should not be touched again if GDXJ was going to rally above $37.00. When Gold pulled back from $1344 to $1326 on January 17, GDXJ traded down to $34.90, which indicated that its relative strength to Gold was weakening. On January 18 my stop at $34.82 was triggered on the remaining portion (50%) of my position. The average sell price was $34.93 and the cost basis on the GDXJ position was $32.035
Dollar
In the January 8 WTR I noted:
“The price pattern looks as if the Dollar could drop again below 91.75 which would likely register an RSI positive divergence and set up a better rally.”
The Dollar did fall below 91.75 but at the low on January 16 did not produce a RSI divergence. This suggested that the Dollar was likely to post another lower low after any intervening bounce. The Dollar bounced and then posted a new low of 90.11 on January 11. The ECB meets on Thursday and the Euro could get a boost if the ECB confirms that a change in its inflation target is being considered. Sentiment is so bearish the Dollar that looking for a good trading low in the first quarter is appropriate. However, the technical picture is just not positive enough to recommend a long trade.
Euro
The Euro is approaching the underside of a trend line that connects lows in 2005, 2010, and 2012. This suggests that a pause is likely. However, if the ECB drops it commitment of continuing its QE program until inflation reaches 2.0% as I expect at their March meeting, the Euro may be able to vault over this trend line and up to longer term resistance.
The Euro topped on May 5, 2014 at 1.3993 and dropped 0.3652 until bottoming on January 2, 2017 at 1.0341. A 61.8% retracement of that large decline would carry the Euro back up to 1.259. A look at the longer term chart of the Euro suggests it could rally back to the down trend line connecting the highs of April 2008 at 1.6008, May 2011 at 1.4938, and May 2014 at 1.3993. This suggests that the Euro could make a major high between 1.23 and 1.26 in the next 1 to 3 months. Technically the pieces are not yet in place to confirm a bottom in the Dollar or a top in the Euro.
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. Past performance may not be indicative of future results.
The rally since mid November has been strong and has pushed the MTI to a level that suggests a meaningful correction in the S&P (greater than 7%) is likely months away.
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.
