Written by Jim Welsh
Macro Tides Weekly Technical Review 23 April 2018
In the January issue of Macro Tides I discussed why the repatriation of overseas profits of U.S. companies would enable the Dollar to post a trading low in the first quarter and then rally:
“In order to bring non Dollar assets home, companies would first liquidate the investment, sell the currency they are denominated, and then purchase the Dollar with the proceeds.”
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“Potentially several hundred billions of other currencies could be sold and an equal amount of Dollars purchased, which could result in declines in some currencies and a rally in the Dollar. In 2005, the Dollar rose by 13% as money was repatriated, although other influences were certainly a factor. The Dollar has fallen more than 10% since the first few days of 2017 so it is massively oversold and sentiment toward the Dollar is uniformly negative. The Dollar is likely to make a trading low in the first quarter and begin to rally before mid 2018.”
Click on any chart below for large image.
The Dollar made its low on February 16 and has spent the last 8 weeks chopping sideways. Today the Dollar broke out above the congestion of the past two months.
The Euro represents 57.6% of the Dollar Index so any forecast in the direction of the Dollar is highly dependent on the path of the Euro. The sideways trading in the Euro and the Dollar after the February 16 low in the Dollar, allowed for the possibility of one more rally in the Euro to a new high. Even though positioning in the Euro suggested there was more downside potential than upside potential, as noted in the March 19 WTR:
“The positioning in the Euro futures suggests the next big move in the Euro is down, irrespective of any short term squiggles and I don’t want to miss it.”
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, and I recommended adding to the position if UUP traded below $23.15. With today’s breakout in the Dollar Index, adding to the position is warranted. 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.
The breakout in the Dollar Index was confirmed today as the Euro fell below its low of 1.2215 on April 6, which pretty eliminates the potential of one more new high in the Euro. 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. With today’s trading action in the Dollar and Euro I added to EUO today at $20.69. The Euro has the potential to fall to 1.160 – 1.1720 in coming months.
Treasury Yields
As discussed in recent WTR’s and the April issue of Macro Tides:
“The yield pattern for the 10-year Treasury still indicates that its yield should rise above the 2.943% high on February 21.”
On Friday April 20 the 10-year Treasury yield rose above the February 21 high and today pushed as high as 2.990% before buyers stepped up. While 3.0% is viewed as being important since it is a round number, the more important chart level is 3.03%, which was reached in December 2013.
For these reasons it is likely that the increase in the 10-year yield can stall at this level, until news provides the impetus to push through this area of resistance. Last week the increase in Treasury yields accelerated after it was reported that a deal on NAFTA could be finalized within the next three weeks. Concerns about trade have weighed on Treasury yields since a failure to renegotiate NAFTA and tariffs with China would be expected to hurt economic growth in the second half of 2018. A disruption in trade could also cause the Fed to not increase the federal funds rate a fourth time in 2018.
Wages are likely to continue to climb in coming months as the labor market tightens further and small business owners increase pay to retain good workers.
The increase in after tax income should help lift consumer spending, although the rise in gas prices will sap some of the extra income from the tax cuts. According to an estimate by Bank of America, after-tax wages jumped to 7.5% from 5.2% in February. The next employment report is due on May 4 and could rattle the bond market and lift Treasury yields, if Average Hourly Earnings (AHE) rise by 2.9%.
After bottoming in September, the 10-year yield climbed from 2.034% to 2.475% an increase of .441% for wave 1. If wave 5 is equal to wave 1, the 10-year yield would climb to 3.158% from the wave 4 low of 2.717%. If AHE did climb 2.9% in April, the 10-year yield could approach 3.30%. From its low of 1.336% in July 2016, the 10-year Treasury yield rose 1.285% before it topped in March 2017. An equal move up from the September low of 2.034% would target 3.319%. Since wave 5 would mark the end of the rise in yields from last September, a good rally in bond prices and decline in Treasury yields is likely after wave 5 is complete.
Even though Treasury yields across the maturity spectrum – 2-year, 5-year, 10-year have all made new highs, the 30-year Treasury yield has yet to exceed its prior high of 3.221% from February 21. The pattern in the 30-year Treasury yield suggests it’s just a matter of time before it does push above 3.221%. However, it may not exceed it by much since wave 5 only requires is that it exceeds 3.221%.
If wave 5 is equal to wave 1, the 30-year yield could reach 3.28%. 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. Selling at least 75% of the position when the 30-year Treasury yield climbs above 3.221% is probably prudent since the coming high could reverse quickly since it is wave 5 from the low in September. TBF stop $23.00, TBT stop $37.25.
Emerging Markets
Emerging economies hold nearly $10 trillion in dollar denominated debt. As U.S. interest rates rise, the burden of servicing the debt is a drag on economic growth. This will be compounded if the Dollar rises by 5% or more in coming months as the Dollar and Euro charts suggest. After falling sharply during the late January and early February selloff in U.S. equities, the Emerging Market ETF (EEM) has had a tepid rebound. A decline below $45.00 (black horizontal trend line) is possible in coming months.
Gold
After failing in its third attempt to push and stay above $1360, Gold hovered just under $1360 for a number of days. On April 18, gold traded up to $1354.89 but began to fade as Treasury yields rose and the Dollar firmed. With the Dollar breaking out Gold dipped to $1322 today. As noted last week, my bias was that Gold was not likely to close over $1368 and instead would work its way down to test $1310 in coming weeks.
If the Dollar follows through and moves toward 94.50 in coming weeks, Gold has the potential to close below $1306 and decline to $1275 and potentially $1250. If Gold does breakdown below $1300 it will likely set up a great buying opportunity, since I still expect Gold to rally above $1450 before a more significant top occurs. Go long if Gold does close above $1368.00, with a stop on a close below $1356. The trade can also be executed with the Gold ETF GLD.
Gold Stocks
The Gold stocks ETF (GDX) tried to break out last week on April 18 when GDX traded up to $23.30 and above its resistance of $23.15 before closing at $22.98. If Gold falls below $1300, GDX could trade under $21.50 in coming weeks.
Oil
As discussed last week, WTI oil had reached a potential technical inflection point:
“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 21016 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.”
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. On April 18 two articles provided WTI a big boost. The Saudi’s indicated they would be comfortable with oil trading up to $100 a barrel and a second article suggested oil production from the Permian Basin could be hampered by insufficient pipeline capacity. In response WTI oil quickly traded above $69.00 on April 19, triggering the stop. Trading so far above the price target of $67.67 suggests a different pattern may be at work.
The ideal situation is when technical analysis and fundamental analysis are aligned. As noted last week, 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. There will be another and better opportunity to short oil when the economic fundamentals are suggestive of a slowdown in demand. The positioning in oil futures will then make oil vulnerable to a significant decline as the record Large Speculative long position in oil futures is unwound as economic fundamentals become a reason to sell.
Stocks
After closing at 2606 on April 9, technical analysis suggested the S&P 500 would rally above resistance at 2675, potentially approach 2730 – 2740, with an outside chance of testing 2800. The S&P 500 pushed up to 2717 on April 18 before falling to a low of 2658 today.
(On a side note it is interesting how many markets reversed on April 18 – Dollar firming, Euro weakening, Treasury yields accelerating higher, oil jumping to a new high, gold and gold stocks falling, and the S&P 500 posting a short-term high.)
From its low of 2554 on April 2, the S&P 500 rallied 163 points to its high of 2717. A 50% retracement would allow the S&P 500 to pullback to 2636, which is near a number of intra-day lows on April 10 and April 11. As long as the S&P 500 holds above 2635, the S&P 500 has the potential to exceed last week’s high and reach the secondary target of 2730 – 2740.
Pattern analysis is a big component of my research in attempting to discern any market’s direction and price targets. Invariably there is more than one possible pattern, which requires the use of various momentum indicators to quantify whether a market’s internal strength is improving or getting weaker. This helps identify which pattern is more likely.
Since the low in February the expectation has been for the S&P 500 to rally in an up, down, and up pattern. This pattern analysis helped identify the potential of a high between 2800 and 2806, which the S&P 500 reached on March 13 when it traded up to 2802. The S&P 500 subsequently did not fall to a new low below 2532 as expected, but instead dropped to 2554 on April 2, and then provided indications that it would rally above 2675.
The S&P 500 has thus deviated from the expected pattern so it’s time to review whether the market’s internal strength has been improving while all this bouncing around has taken place.
Last week the NYSE Advance / Decline Line (A-D L) made a new all-time high, which is sign that the market’s internal strength has definitely NOT gotten weaker. Compare the performance of the A-D L since late January to the period from May 2015 through July 2015. In the summer of 2015 it was easy to expect a correction since the A-D line was acting so weak.
The percentage of stocks above their 200-day average provides further insight as to the health of the market’s internal strength. The black horizontal line represents the 50% line. In 2015 the percent of stocks above their 200-day average continued to fall below 50% well before the August 2015 sell off. Although the percent has been below 50% since February, it has been holding in the mid 40% range and has not weakened despite the gyrations in the S&P 500.
The expectation has been that the S&P 500 would eventually fall below the February 9 low of 2532 in a Wave (C) decline. The only question was whether Wave (B) ended at 2802 on March 13 or would rally back up to 2800 or 2730 – 2740 before succumbing to Wave (C) and potentially another 340 point decline to match the depth of Wave (A).
The strength of the A-D Line and the percent of stocks above their 200-day average are not supportive of this Wave C pattern, which means the probability of this outcome has decreased. The internal strength of the market suggests the S&P 500 may be tracing out a triangle pattern, which would be labeled wave a for the February 9 low of 2532, wave b at the March 13 high of 2802, and wave c for the April 2 low of 2554.
It would actually increase the odds of a triangle if the S&P 500 pushed above the high of 2717 last week and tag the down trend line connecting the January 26 high and March 13 high near 2750 for wave d. The S&P 500 would then be expected to drop to 2554 to 2575 for wave e. Triangles occur in Wave 4 and are typically followed by a thrust in the direction prior to the onset of the triangle. This means the January high was Wave 3 and the post Wave 4 thrust would be Wave 5 from the February 2016 low.
The triangle pattern would be invalidated if the S&P 500 traded below the April 2 low of 2554.
There are a number of fundamentally driven factors that could derail the market and one big technical issue. The Nasdaq 100 is dominated by the big cap tech names and has been forming an ominous head and shoulders pattern since last December (chart below). This follows an Island Reversal that formed after the Nasdaq 100 completed a 5 wave rally from the February 2016 low. In the March 19 WTR I explained how an Island Reversal is formed and the implication it held for the Nasdaq 100 in coming months:
“An Island Reversal can occur at a low or high and is created when a market average or a stock forms an island above or below the recent trading with a gap on either side. On March 9 the Nasdaq 100 gapped higher and then traded the next 6 days in a tight range. Today the Nasdaq 100 gapped lower leaving the 6 days of trading with no overlapping prices on either side of the gaps. Island reversals are unusual but typically show up at tops and bottoms that accompany an intermediate trend reversal. This increases the odds that the Nasdaq 100 made an important high last week and is likely to test or break below the February 9 low.”
The fact that the right shoulder is lower than the left shoulder is another sign of weakness. A close below the neckline of the head and shoulders pattern at 6386 would project a drop to 5586 since the height of the pattern is 800 points (7186 – 6386 = 800). This would represent of decline of 12.5% and a correction of 22.2% from the mid March high. It must be noted that a head and shoulders pattern represents potential that is not triggered until the neckline is violated.
The Semi-Conductors were one of the strongest sectors within the Technology sector until mid March. The Semi-Conductor Index (SOX) also sports a head and shoulders pattern, and may have closed below its neckline (red trend line) today. The blue trend line extends back to the November 2016 low, and has clearly broken down. The target projected by the head and shoulders pattern is 1045 for the SOX, more than 16% below today’s close and 28% below the mid March high.
If the Nasdaq 100 and the SOX follow through on their respective head and shoulders patterns, it would confirm that the expected rotation out of growth stocks and into value stocks is developing.
The S&P 500 is down for 2018 even though earnings are up 19% for the companies that have reported and 80% of them have beaten their estimates. The majority of company earnings reports are still ahead and may be good enough to provide the market a lift, rather than just holding it up. Higher interest rates could pressure stocks, especially if the April employment report shows that wages grew by 2.9% when it’s released on May 4.
A jump in wage growth could reignite concerns that the Federal Reserve is falling behind the curve and may have to be less gradual in coming months. There could be an instant replay of what occurred on February 2 when the January employment report indicated that AHE grew 2.9%. The jump in AHE sparked a spike in interest rates and decline in stocks.
CNN
Last week I chided CNN for the quality of its news reporting:
“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.”
This chart of the amount of air time devoted to Stormy indicates it was a timely observation.
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.
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.
