Written by Jim Welsh
Macro Tides Weekly Technical Report 30 April 2018
More than half of the companies in the S&P 500 have reported earnings and overall they have been stellar, along with strong growth in revenue. To date 80% of companies that have reported first quarter earnings have beaten their estimate, the highest rate dating back to 1999. The average is 64%. Despite great earnings many stocks have initially rallied only to quickly succumb to selling pressure.
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Sometimes it is more important how a stock or the stock market responds to good or bad news than the news itself. If a stock rallies on good news or declines after missing earnings, there’s not much to be learned from the obvious. But when a stock doesn’t fall after bad news, it usually indicates that all the sellers have already sold and the stock is primed for a rally. The reverse is also true. The inability of individual stocks and the market as a whole to rally after companies have met or exceeded earnings expectations is not a good sign. If stocks can’t rally on good news, what would they do if presented with bad news? This suggests that the stock market could vulnerable to a quick sharp decline if some bad news materializes, since a number of major market averages and sectors are holding just above important support.
As discussed last week, the Nasdaq 100 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. Since peaking in mid March, the Nasdaq 100 has posted two lower highs which merely reinforces that the trend is down. The fact that the right shoulder is lower than the left shoulder is another sign of weakness. It must be noted that a head and shoulders pattern represents potential that is not triggered until the neckline is violated.
Click on any chart below for large image.
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. The lower highs and the neckline are forming a descending triangle. The down trend line from the March high and the neckline converge before the end of May, so the Nasdaq 100 will breakout to the upside or close below the neckline soon, which seems more likely given the recent poor trading action in technology stocks.
The Semi-Conductor Index (SOX) represents a key technology sector and could provide an early warning signal that the Nasdaq 100 is in the process of breaking down. The chart pattern is very similar to the Nasdaq 100 but the SOX looks weaker and more vulnerable. The target projected by the head and shoulders pattern is 1045 for the SOX, more than 15% below today’s close and 28% below the mid March high. After Intel reported earnings on April 26, Intel’s stock rose 5.1% from the prior close only to reverse and end down –0.6% on Friday April 27. Lucky Intel didn’t disappoint!
The S&P 500 briefly fell below the support I discussed last week before rebounding:
“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.”
The S&P 500 fell below 2635 on April 24 and April 25 when the yield on the 10-year Treasury bond push up to and through 3.0%, before falling below 3.0%. After the 10-year yield fell below 3.0%, the S&P 500 quickly jumped above 2635, which reinforces its near term importance. As long as the S&P 500 holds above 2635, it has the potential to rally above 2677 and approach 2700. A close below 2635 would open the door for a drop to 2570 – 2580.
In March I recommended investors should:
“1) hedge your portfolios, 2) do some selling, or 3) go short using a stop above 2840”
when the S&P 500 traded above 2789 on March 13 and 2730 on March 21. The stop should be lowered to 2750 just in case the S&P 500 breaks out of the triangle to the upside.
Federal Reserve
The Federal Reserve meets on Wednesday and will announce that it is leaving the target range for the federal funds rate unchanged. This is what the financial markets are expecting so it is not the focus. Investors will be focused on whether the FOMC reaffirms its plan to increase rates twice more in 2018, and its assessment of the economy.
The FOMC is likely to express confidence in the economy’s prospects for the remainder of 2018 and their expectation that inflation will trend toward its 2.0% target. None of this should be news so the financial markets are likely to bounce around after the statement is released but not make a major move.
Treasury Yields
The most important economic news this week will come on Friday when the April employment report is released. The forecast is for 187,500 new jobs in April and that the unemployment rate will dip to 4.0%, after holding at 4.1% for five months. The more important data point will be Average Hourly Earnings which spooked markets on February 2 when it rose to 2.9% in January. It then fell back to 2.6% in February and rose to 2.7% in March. Wage growth is headed higher. The only question is whether it ticks up to 2.9% in April or waits for another month. Small businesses have been increasing wages and plan to raise them more in coming months.
The 10-year Treasury yield rose to 3.035% on April 24 and then reversed as I thought likely:
“On Friday April 20 the 10-year Treasury yield rose pushed as high as 2.990%on April 23, 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.”
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. On Tuesday April 24 the 30-year Treasury yield rose to an intra-day high of 3.219%, before closing at 3.209%.
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. On April 2 I wrote:
“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.”
When the 30-year yield rose to 3.219% the risk reward indicated it was time not to get greedy for another 0.2%. I reduced my short position to 16.6% on April 24 after selling TBT at an average price of $39.22, when the 30-year yield was above 3.21%. At that time TBF was trading between $23.62 and $23.65.
I have a weekly conference call with a number of advisory groups and use the calls to review the economy and the majority of markets – from U.S. stocks, bonds, currencies, gold and gold stocks, and European and Emerging Markets. When a market has reached a good buying opportunity or a time to sell an existing position, I call these groups to let them know what I’m doing. On Tuesday these groups sold their position in TBF during the trading day and the Rydex short Treasury bond fund RYJUX. If you are an advisor and would like to learn more about this additional service, give me a call.
Since its intra-day high of 3.219%, the 30-year yield has quickly dropped to 3.096%, while the 10-year Treasury yield has fallen to 2.935% from 3.035% on April 24. It is possible that this pullback in yields is wave 4 of wave 5 from the low on April 2. If so yields could briefly rise above the highs reached on April 24. Given how quickly yields have dropped since April 24, it is possible the high is in for awhile and wave 5 from the low in early September is complete.
The stop should be raised from $23.00 to $23.18 for TBF, and to $37.65 for TBT. Selling half of TBF at $23.40 and $38.45 for TBT is advised. These are the 50% retracement levels of the decline from the high on April 24 to today’s low. The remaining half should be sold if TBF and TBT trade above last week’s high. The red arrows indicate where I recommended shorting bonds and the green arrows are where the shorts were covered.
Dollar
Last week I noted that the Dollar had broken out above the congestion of the past two months and the downtrend from its January 2017 high. The Dollar has become a bit overbought so a pullback is likely.
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. Last week the breakout in the Dollar Index warranted adding to the position in UUP. On April 24 UUP opened at $23.86. 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
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 EUO position on March 8 at $20.25. The breakout in the Dollar Index was confirmed on April 23 as the Euro fell below its low of 1.2215 on April 6. With the breakdown in the Euro on April 23, I added to EUO at $20.69. The Euro has the potential to fall to 1.160 – 1.1720 in coming months.
Gold
My bias was has been that Gold was not likely to break out to the upside with a close over $1368 and instead would work its way down to test $1310. Today Gold traded down to $1310.28. If the Dollar does pullback in coming days, Gold may try to bounce again but is unlikely to trade above $1350.00. If the Dollar moves toward 94.50 in coming weeks/months, 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.
If Gold closes below $1300 and its RSI gets near 30, I will probably look to establish a long position since positioning in the futures market is gradually getting more constructive. The sideways chop of recent months is wearing Large Speculators out (green line middle panel) and causing them to progressively sell their long positions in gold. If Gold drops below $1300 they will give up and dump their longs. Conversely, the Commercials are getting less short and would likely aggressively cover their shorts on a decline below $1300. It’s taken many months but a good intermediate trading opportunity in Gold may finally be setting up.
Gold Stocks
The Gold Stock ETF (GDX) broke below the rising trend line from the March low today, which should be followed by a decline to below $21.50. It is encouraging that the relative strength of GDX to Gold is beginning to show modest signs of improvement.
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.
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.
