Written by Jim Welsh
Macro Tides Weekly Technical Review 16 April 2018
Can Earnings Be the Market’s Hail Mary Pass?
In the past six weeks the stock market has been buffeted by a number of stormy events. On March 2 President Trump initiated tariffs on imports of aluminum and steel, which elicited a tariff response from China, followed by more tariffs on Chinese products, and then tariffs on U.S. agricultural products levied by China.
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On April 10 the President of China appeared to signal a time-out when he opened the door to trade discussions. It won’t be known for another month or two whether trade negotiations with China will yield substantive results or merely represent a pause before the game of tariff tennis resumes.
If trade and other economic news is boring, one can always tune into CNN the most trusted name in news. Occasionally CNN interrupts its regular broadcasting to discuss trade, economic data points, or a mass shooting. But after a commercial, CNN is back to its non-stop Breaking News, which usually consists of more rehashing of everything about Stormy Daniels, the Playmate, Mueller’s investigation, Trump’s personal lawyer, former FBI Comey’s new tell-all, and whether Trump will instigate a Constitutional crisis by firing Mueller.
Sometimes I can watch about 10 minutes of CNN’s babel, but not often. I rarely tune into MSNBC or Fox since the only difference is the shrillness of the opinions being offered by more ‘experts’. In the meantime the demographic clock is ticking and the looming funding crisis in Social Security, Medicare, Medicaid, underfunded public pensions, and ever growing federal debt is ignored, even though those issues will directly impact far more Americans than today’s Breaking News. But CNN’s ratings are up!
Despite all the ‘news’ stock market bulls have noted that earnings are forecast to be up 17% to 20% from a year ago, which will help the market weather any storm. As I noted in the April monthly issue of Macro Tides:
“While first quarter corporate earnings are expected to be very good, it is certainly possible that investors will use the good news to sell.”
On Friday April 13, a number of the major banks reported their first quarter earnings and as expected they were uniformly good if not better than expected. After an initial pop, bank stocks across the board were hit by a wave of selling that spread to technology stocks and then the rest of the market. The Financial ETF (XLF) hit a high of $28.24 before slumping –3.3%, while the Regional Bank ETF (KRE) fell –3.1% after spiking up to $62.10. The reversal in each of these ETFs occurred at key resistance levels, which makes the reversals more important. It would be a big plus for the market if XLF and KRE could close above the upper blue trend line in their respective charts.
Conversely, a close below the lower blue trend line would be negative for the banks in general and the overall market since banks have the second biggest weighting (14%) in the S&P 500.
Click on any chart below for large image.
I suspect the majority of companies that beat their earnings estimates will be spared the Bronx cheer afforded the banks. If correct, the S&P 500 can not only hold up for another couple of weeks but push higher. After repeatedly testing its 200-day average since February 9, I noted last week that sentiment had become progressively negative. This suggested the S&P 500 could mount a stronger rally that would carry it above its resistance at 2675:
“The extraordinary day-to-day volatility has caused CNN’s Fear and Greed Index to fall to its lowest level since the intermediate low in February 2016. The Exposure Index of the National Association of Active Investment Managers has fallen to its lowest level since May 2016. The NAAIM Index measures the level of exposure that active advisors have to the market. In mid December the NAAIM Index was 120.56 which meant they were so bullish they were using 20% leverage. Amid all the volatility and the decline in the overall market, these active managers have lowered their exposure to 49% two weeks ago and 55.5% last week. At the S&P 500’s low in February 2016 their exposure was below 25%. CNN’s Fear and Greed Index and the NAAIM Index are contrary indicators since they are low near market trading lows and show a lot of optimism near market tops. The current readings are supportive of a short term rally.”
I also discussed why the positioning in the Volatility products could give the market a lift especially if the VIX fell below 17.00:
“The positioning in the VIX futures has swung from a record short position in January to a record long position in early April since 2008. In January traders were positioned for lower volatility, now they are positioned for higher volatility. From a contrary point of view, these traders were off sides in January and are now potentially off sides with expectations for higher volatility, after the highest spike in volatility since 2016. It is interesting that as the S&P 500 has continued to test its 200-day average in recent weeks the level of volatility is far lower than it was in early February. It is a positive that even with the S&P 500 barely above the lows of early February, the VIX is far lower. If the S&P 500 rallies in coming weeks, volatility will fall and force these traders to sell VIX their long VIX futures. Just as their buying in early February contributed to selling pressure and the sharp decline in the S&P 500, their selling of VIX futures would likely add to upward momentum in the S&P 500. The shift in sentiment would be enough to lift the S&P 500 above resistance at 2675, potentially approach 2730 – 2740, with an outside chance of testing 2800. If the S&P 500 does manage to rally above 2675 and approach the higher targets it doesn’t change the bigger picture outlook. The expectation remains that the S&P 500 is likely to trade under 2500 before Labor Day.”
After trading as high as 2686 at its intra-day high today, the S&P 500 closed at 2677.84. While this is not the strong breakout one would want to see after so many tests of 2675, it is still a breakout. Since its close of 2604 on April, the S&P 500 has rallied 2.8% but sentiment is still fairly restrained. CNN’s Fear and Greed index has only climbed from 13 on April 6 to 26 today. This suggests there is more upside likely as investors become less negative.
As the S&P 500 was recording its highest close since March 21 today, the VIX index closed below 17.0 and its 89 day moving average. This will pressure those who are long the VIX to sell which will push the VIX lower. I suspect there are open call option positions at 2700, 2710, and 2720 on the S&P 500 that were initiated as part of call writing programs. These ‘short’ call positions can force additional buying as the S&P moves higher and could act as a magnet before options expiration this Friday.
From its secondary low of 2554 on April 2, the S&P 500 rallied 118 points to a high of 2672 on April 5. An equal rally from the low of 2586 on April 6 would lift the S&P 500 to 2704. This becomes the next level for the S&P 500 to overcome based on the equality of the moves but also since 2700 provided important support for the S&P 500 for a period of time.
Sentiment suggests a more likely stopping point is 2730 – 2740, which represents the wave 2 high recorded on March 21. This high was followed by the sharp gap below support at 2700 (red trend line) on March 22.
As discussed last week, the tension surrounding the issue of trade will need to dissipate in order for the S&P 500 to really sustain a rally above near term resistance. If the S&P 500 has a prayer of nearing 2800, it will probably take news like an agreement on NAFTA in the next two weeks to provide the necessary boost.
Before the S&P 500 traded up to 2802 on March 13 and 2730 -2740 on March 21 I recommended:
“1) hedge your portfolios, 2) do some selling, or 3) go short.”
My goal is to identify the next trading high since, “The expectation remains that the S&P 500 is likely to trade under 2500 before Labor Day.” If the S&P closes rallies to 2730 – 2740, and subsequently closes below 2670, I would suggest getting very defensive or going short.
Crude Oil
In February 2016 the glut in crude oil inventories compared to its five year average was more than 350 million barrels. The production cutbacks by OPEC, Russia, and other producers, along with continued economic growth have gradually whittled down the level of crude inventories. Inventories are now near their five year average and the lowest since late 2014. The decline in the overhang of excess oil inventories has not gone unnoticed. Large Speculators and hedge funds have loaded up on WTI crude oil futures as WTI crude has rallied from a low of $42.05 in June 2017 to $67.76 on Friday April 13.
Large Speculators are trend followers and frequently hold their largest Long position as prices are peaking or largest Short position when prices are near a low. In the summer of 2014 WTI crude oil was trading above $107.00 a barrel, which is about 50% higher than its current price. In June 2014 Large Speculators were long 458,000 contracts. As oil prices plunged, Large Speculators were forced to sell their long oil contracts which only intensified selling pressure and led to lower WTI oil prices.
When WTI oil bottomed in February 2016 at $26.05 a barrel, Large Speculators were only holding 159,000 contracts long. On April 10, 2018 Large Speculators were long 707,080 contracts, a position that is 54% larger than they held in June 2014.
The price pattern in WTI oil has reached an interesting juncture. From the low of $26.05 in February 2016, WTO oil rallied to $51.67 in June 2016, an increase of $25.62 a barrel. WTI oil then traded in a choppy mostly sideways pattern before falling to $42.05 in June 2017 from a high of $55.00 in February 2017. An equal rally of $25.62 from the June 2016 low of $42.05 targeted a high of $67.67. On Friday April 13 WTI oil traded up to $67.76 and $67.74 on April 16 before falling by more than 1.5%. For a long term WYI oil bear, the rally from the February 2016 may be counted as an A-B-C which will be followed by a significant decline during the next two years. For a long term WTI oil bull, the rally from the February 2016 may be counted as wave 1, wave 2, with Friday’s high representing wave 3. This would set WTI oil up for a wave 4 price decline to $58.00 – $62.00, before wave 5 takes oil to a higher high in coming months.
Whether one is a bull or a bear, WTI oil is likely to fall to $62.00 or lower in coming months. On Friday April 13 I shorted oil by buying the short oil ETF (SCO) at $18.45, using a stop of $69.00 on June WTI. SCO is levered 2 to 1.
One of the investment themes coming into 2018 was the synchronized global recovery which in 2017 included all 45 major economies included in the OECD data. Solid global growth is supportive of higher demand for crude oil and higher oil prices. However, the supply of oil coming from U.S. production has been setting an all-time high in recent months and is likely to continue to set new records. This suggests that crude oil could be vulnerable if signs of slowing in the global economy appear in the second half of 2018 as this would lower estimates of demand for crude oil. If demand concerns materialize, WTI oil could drop to below $53.00.
Treasury Yields
After spiking higher in early February, volatility in the 10-year Treasury bond has virtually collapsed from over 6.0 to 3.5 on Friday. A similar pattern developed in November and December 2016 after the 10- year Treasury yield soared from 1.80% to 2.62%. In that instance volatility jumped from under 4.0 to 7.0 and then slumped to 4.3 in February 2017, before rising to 6.25 when the 10-year Treasury yield tested the December high at 2.62% in March 2017.
The lower high in volatility in March 2017 set the stage for a pronounced decline in the 10-year yield from 2.62% to 2.03% in September. A similar pattern could emerge in coming weeks if the yield pattern develops as previously outlined.
The yield pattern for the 10-year Treasury still indicates that its yield should rise above the 2.943% on February 21, while the 30-year yield is expected to exceed its prior high of 3.221%. A rise in the yields would represent wave 5 and complete the rise in yields from the low in early September. After wave 5, a more significant decline in yields is likely to take hold which is consistent with the Commercials long positioning. If 10-year and 30-year yields do rise to a higher high and volatility for the 10-year Treasury bond fails to exceed 6.0, the positive divergence in volatility would be supportive of a subsequent drop in yields.
In the April 2 WTR I recommended shorting Treasury bonds by buying either the 1 to 1 short bond ETF (TBF) or the 2 to 1 short bond ETF (TBT). On April 3, TBF opened at $22.77 and TBT at $36.45. If the 30- year yield falls below 2.920% and over laps the high for wave 1, the pattern may be different than what I’ve presented. A decline below 2.920% should used as s stop for TBF and TBT.
Dollar
In the April 2 WTR I suggested establishing a partial position (up to 50%) in the Dollar ETF (UUP). On April 3 UUP opened at $23.64. I recommended adding to the position if UUP trades below $23.15. In coming months, the Dollar index has the potential to rise to 94.50 – 95.00 and lift UUP to $24.50 to $24.70.Please note these instructions are for qualified accounts since UUP will send a K-1 for tax purposes in March 2019 for taxable accounts. For nonqualified (taxable) accounts that want to avoid the hassle of a K-1, the Profunds Dollar fund (RDPIX) tracks UUP closely and is a good alternative.
Euro
Not much has changed since the Euro continues to chop sideways in a trading range. On February 16 I established a partial short position in the Euro inverse ETF (EUO) which is leveraged 2 to 1 at $19.89. After Trump announced his decision to proceed with tariffs on March 1, I sold my position in the Euro inverse ETF EUO at $20.38. I reestablished the position on March 8 at $20.25. If the Euro rises 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
On April 11 Gold spiked up to an intra-day high of $1364.36 before closing at $1353.03. This is the third attempt since January 25 to push and stay above $1360. Each attempt has been ‘rejected’ as strong selling came in to knock Gold down. This reinforces the importance of a close above $1368 and why it would likely be followed by a quick move toward $1450. My bias is that Gold is not likely to close over $1368 and instead will work its way down to test $1310 in coming weeks. A close below $1306 would set Gold up for a decline to $1275 and potentially $1250.
If Gold does breakdown below $1300 it will likely set up a great buying opportunity. Longer term I still expect Gold to rally above $1450 so the challenge is finding a good entry point. Go long if Gold does breakout and closes above $1368.00, with a stop on a close below $1356. The trade can also be executed with the Gold ETF GLD.
Late last week the relative strength of Gold stocks (GDX) to Gold improved modestly and then weakened today. The RSI on GDX is already up to 60.1 and GDX is still almost 2.0% from breaking out above $23.15. If Gold breaks out above $1368.00, GDX has the potential to rally above $23.15. However, given the level of GDX’s RSI I’m not confident that GDX has the legs to reach $24.75 – $25.50, even if the relative strength really improves. If Gold breaks out above $1368, I would buy the Gold ETF (GLD) rather than GDX. The risk of a whip saw can be better managed with GLD.
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 fell below the green horizontal line on March 29 which indicates that the bull market is in jeopardy. In the March 5 and March 12 Weekly Technical Reviews 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.
Past performance may not be indicative of future results.
The MTI has weakened significantly since peaking in late January. If the S&P closes rallies to 2730 – 2740, and subsequently closes below 2670, I would suggest getting very defensive or going short. This type of chart failure would suggest the S&P 500 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.
