Written by Jim Welsh
Macro Tides Weekly Technical Review 26 March 2018
In my Weekly Technical Review sent to subscribers on Monday March 12, I offered this advice:
“If the S&P 500 trades above 2789 and you don’t like the idea of watching the S&P 500 subsequently fall to 2533 or possibly 2449, you should: 1) hedge your portfolios, 2) do some selling, or 3) go short using a stop above 2840″.
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On March 13 the S&P traded up to 2802 before reversing lower. In the March 5 Weekly Technical Review I calculated why the S&P 500 might top between 2800 and 2806:
“Based on how the S&P 500 has traded since the January 26 high at 2873, it is possible to guestimate a price target for (C) of (B). The 78.6% retracement of the 340 point decline from 2873 to 2533 is 2800. Wave (A) traveled 256 points (2789 – 2533 = 256). If wave (C) of (B) is 61.8% of wave (A), the S&P 500 would reach 2806 (256 * .618 = 158 + 2648 = 2806). So using two different measurement techniques, there is a price target of 2800 and 2806.”
The S&P 500 peaked on March 13 at 2802. In my March 19 Weekly Technical Review I offered this advice:
“If the S&P 500 trades up to 2730 – 2740, it will provide another opportunity to 1) hedge your portfolios, 2) do some selling, or 3) go short.”
The chart below was presented last week as the projected route the S&P 500 would take if it followed the pattern analysis.
Click on any chart below for large image.
After the Fed’s rate announcement on March 21 the S&P traded up to 2739 on March 21 before reversing lower and plunging to 2585 on Friday as the updated chart below illustrates.
On Friday March 23 the S&P 500 traded down to 2585 and in the process touched its 200-day average (red moving average chart below). At its intra-day low on February 9, the S&P 500 tested its 200-day average at 2538 before mounting a strong rally and closing at 2619, 77 points above that day’s low. In the following weeks, the S&P 500 continued to rally before peaking on March 13 at 2802.
The S&P 500 has rallied 73 points from its low on Friday March 23, which raises an obvious question. Is a rally similar to the last time the S&P 500 touched its 200-day average likely? While anything is possible, the odds are low that the S&P will rally 269 points in coming weeks.
At the low on February 9, the S&P 500 had completed a 5 wave decline from its January 26 high (chart above). This indicated that a significant retracement of the 340 point decline was coming. The only question was whether it would be a 61.8% retracement or something larger. As it turned out, the S&P 500 rallied to 2802 which was a mere 2 points above the 78.6% retracement target of 2800 I discussed in the March 5 WTR as a potential stopping point for the rally.
At the low on March 23, the S&P 500 had only declined in 3 waves before the big bounce today (top chart pg. 2) which has the potential of being wave 4 of the decline which began on March 13 at 2802. The pattern analysis which helped identify the highs at 2802 and 2730 – 2740 suggests the S&P 500 is likely to drop below 2585 and complete a five wave decline from 2802.
The market was deeply oversold at the February 5 and 9 low as measured by the 21-day average of advances minus declines which fell to -546 and -514 respectively. On Friday March 23 the 21-day average of advances minus declines was only down to -303, far less oversold than in early February. This is another reason why the market is unlikely to rally as much as it did after the February 9 low. After today’s rally the 21-day average of advances minus declines finished at -133. It won’t take as much of a rally to get the market back to neutral and set up the wave 5 decline.
Although the odds favor another decline below last Fridays’s low of 2585 to complete wave 5, there are other pattern options. It is possible that the S&P 500 may be developing a triangle. This pattern would become more likely if the S&P 500 exceeds 2696 before it falls below 2585. After topping at 2802, wave 1 brought the S&P 500 down to 2695 which completed wave 1 (2nd chart in this article). One of the rules of pattern analysis is that wave 4 cannot overlap the low of wave 1. If the S&P 500 rallies, after making a wave 3 low and overlaps the wave 1 low, the pattern changes to an A-B-C. In this case that would mean the decline from 2802 to 2585 was an A-B-C corrective decline and would rule out an immediate decline below 2585.
When I recommended going short if the S&P 500 traded above 2789, I suggested a stop at 2840. I also suggested going short if the S&P 500 traded between 2730 – 2740. The stop on these positions can be lowered to 2696. In anticipation of a bounce off the S&P 500’s 200-day average, I sold 20% on my short in the S&P 500 at the close on Friday.
Federal Reserve
As expected the Federal Reserve increased the federal funds rate by 0.25% to 1.50% – 1.75%. The FOMC did increase its forecast for GDP growth in 2018 and 2019 and lowered its estimate for the unemployment rate for 2018 and 2019. The surprise is the FOMC didn’t increase its forecast for inflation even though the FOMC expects stronger economic growth and a tighter labor market.
For a long time the FOMC has been surprised that inflation has not moved higher and Janet Yellen went so far as to describe it as a ‘mystery’. In terms of inflation the current members of the FOMC have all moved to the Missouri the ‘Show Me’ state and will only be convinced that inflation has arrived after they see it in the numbers.
As I will discuss in the April Macro Tides, inflation is likely to move higher in coming months as GDP growth accelerates after a slow first quarter, wage growth improves, higher import prices adds to inflation, and more companies increase prices to offset higher material costs and wages. In the short run, tariffs will also add to price pressures but could impair economic growth if anything close to a trade war develops. It would take a meaningful slowdown in the economy to dissuade the Fed from increasing the federal funds rate three times in 2018, and the appearance of inflation to force them to consider a fourth increase.
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Treasury Yields
Two weeks ago the 30-year Treasury bond yield was expected to drop below 3.05% which it subsequently did on March 15 by falling to 3.042%. On March 22 the 30-year yield fell to 3.032%. The decline in yields was expected to be wave 4 of the pattern from the low in early September. Once wave 4 is complete, and last week’s low may have been the end of wave 4, the 30-year yield is expected to exceed its prior high of 3.221% on February 21. The 30-year yield rose from 2.651% to 2.933% or 0.28% for wave 1. If last week’s low of 3.032% is followed by an increase of 0.28% for wave 5, the 30-year Treasury yield may top near 3.31%.
In mid February I recommended the purchase of the Treasury bond ETF TLT if it traded below $117.50, which it did on February 21. Two weeks ago I suggested selling a portion of TLT If the 30-year yield fell below 3.05%. On March 15 TLT traded as high as $120.49 and on March 22 it traded as high as $120.84.
The positioning in Treasury futures continues to indicate that yields are likely to decline after wave 5 is complete. This suggests that if Treasury yields rise above 3.221% on the 30-year and 2.944% on the 10- year it will represent a buying opportunity. The Commercials (red line middle panel) are holding almost as many contracts long as in January and February 2017. This position was taken just before the 10-year Treasury yield peaked at 2.62% in March and subsequently dropped to 2.03% in early September. The 10-year Treasury bond rose from 123.0 to 128.0.
Dollar
n recent weeks I’ve noted that the Dollar continued to chop around which left open the potential for a decline to a new low. It now appears likely that the Dollar will decline below 88.25 before an intermediate low is established. Since the Dollar’s peak in January 2017 the decline has formed waves (1) February 2017, (2) March 2017, (3) September 2017, with wave (4) ending near 95.00 in November 2017.
It appears that wave (5) has completed wave 1, 2, 3, and wave 4 on March 1 when the Dollar topped at 90.93. Wave 5 of wave (5) should bring the Dollar modestly below 88.25.
The Dollar should also draw support from the highs in 2008, 2009, and 2010 which were 88.00 – 89.60. In coming months, the Dollar has the potential to rise to 95.00. Buy the Dollar ETF (UUP) below $23.15 in anticipation of a subsequent rally to $24.50 to $24.70 in coming months.
Euro
The ambiguity in the Dollar allowed for the potential of the Euro rallying to a new high above 1.2555 before it establishes an intermediate high. The positioning in Euro futures shows that Large Speculators hold the largest long position in history. Large Specs are typically hedge funds and trend followers who are expecting the Euro to go higher after the ECB announces that it will be lowering or eliminating its QE purchases after September 30. Logically this ‘tightening’ of monetary policy ‘should’ cause the Euro to go up. Markets don’t always work according to logic as the 14% decline in the Dollar from its January 2017 peak illustrates, even though the Federal Reserve increased rates 3 times in 2017 just as the FOMC projected in December 2016.
On February 16 I established a partial short position in the Euro inverse ETF (EUO) which is leveraged 2 to 1 at $20.89. After Trump announced his decision to proceed with tariffs, I sold my position in the Euro inverse ETF EUO at $21.38 on March 1. I reestablished the position on March 8 at $20.25. If the Euro marches to a new high I will add to this position. The trend line connecting the high in 2008, 2011, and 2014 comes in near 1.2630 which I expect to contain any Euro rally.
Gold
Last week I noted that Gold had dipped under $1310.00 on four separate occasions since February 8 and managed not to breakdown. My conclusion was that:
“The odds are increasing that Gold may bounce to $1350 or so.”
Gold rallied to $1355 today which brings Gold to a critical juncture. My bias is that Gold is not likely to breakout so shorting Gold if it rallies up to near $1360 is a trading opportunity, using an intra-day stop above $1373.50. If Gold fails to breakout, a close below $1306 would set Gold up for a decline to $1275 and potentially $1250. A close above $1368.00 would represent a breakout and likely be followed by a rally above $1400.00 and potentially up to $1450.00. Longer term I still expect Gold to rally above $1450 so the challenge is finding a good entry point, without enduring the pain if Gold does suffer a quick swoon to $1250. Go long if Gold does breakout and closes above $1373.50, with a stop on a close below $1360.
Last week I thought the Gold stock ETF (GDX) could enjoy a quick bounce to $23.15, if Gold rallied to $1350.00. Although Gold rallied to $1355 today, GDX was only able to push up to $22.51 at today’s high. Although the relative strength of Gold stocks has stopped weakening, it hasn’t shown much improvement either.
If Gold breaks out above $1373.50, GDX has the potential to rally above $23.15 and potentially reach $24.75 – $25.50 if the relative strength really improves. If Gold breaks out, buy GDX above $23.20 using a stop of $22.45. If Gold fails to break out and subsequently drops below $1306, GDX could decline to $20.50 and potentially to $19.43.
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. Based on the buy signal, a 100% invested position in the top 4 sectors was adopted. 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 MTI has weakened significantly since peaking in late January. If the S&P closes below 2585 the MTI suggests the S&P could be vulnerable to a more significant decline than merely a retest of the intra-day low of 2533 on February 9.
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.
