Written by Jim Welsh
MacroTides Weekly Technical Review 07 May 2018
The April employment report was no too hot or cold. The increase of 164,000 new jobs was less than forecast but not by much and wage growth held steady at 2.6%. In terms of monetary policy this report insures that the Fed will hold to its policy of increasing the federal funds rate at the gradual pace they have projected.
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As noted in the May Macro Tides:
“The FOMC’s preferred inflation measure is the Personal Consumption Expenditure Index (PCE) which reached 2.0% in April and the core PCE rose to 1.9%.”
The Fed didn’t expect the PCE to reach 2.0% until 2019 and projected the core PCE wouldn’t get to 1.9% until the end of 2018. Although the employment report and PCE inflation supports continued rate increases, the ‘just right’ wage growth eliminated concerns that the Fed might fall behind the inflation curve and be forced to become less gradual.
This Goldilocks employment report on Friday goosed the stock market but didn’t have much of an impact on Treasury yields. The 10-year Treasury yield fell from 2.946% to 2.944%, while the 30-year Treasury yield fell to 3.11% from 3.121% on Thursday May 3. Today the yields were 2.95% and 3.12%.
Click on any chart below for large image.
Since peaking on April 25, Treasury yields have dipped but have not eliminated the potential for one more new high. As noted in last week’s WTR:
“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.”
If Treasury yields do exceed the April 25 high, I would want buy Treasury bonds in anticipation of a decline in the 10-year Treasury yield to near 2.72%.
Although wage inflation is likely to rise in coming months and the Fed is likely to raise the federal funds rate at its June meeting, the yield pattern in Treasury bonds suggests that yields are more likely to come down than rise in the next few months. The positioning in the Treasury futures market displays a record short position by Large Speculators, which indicates that the Treasury futures market has already absorbed a lot of selling pressure in anticipation of higher yields. The top half of the CFTC CBOT chart should be 10-year, not 5-year Non-Commercial Net.
In the March 13 2017 WTR I explained why I thought buying bonds and specifically the Treasury bond ETF (TLT) seemed like a good idea:
“The positioning in bond futures suggests the downside is somewhat limited. The Commercials have a large long position, while the trend following Large Specs are short. Since the shorts will have to buy to cover their short positions at some point, bond prices may not fall much. This is what seems to be happening in the face of the coming rate hike in rates on March 15, 2017. The Treasury bond ETF (TLT) has dropped below its mid December low of 116.80 and has made a new price low, so it is possible to count the pattern from the price high last July as a 5 wave decline. This suggests that once a bottom is in, TLT will likely rally to at least wave 4 of lesser degree (122-123). If TLT does post a low at 115.00, it will have declined just over 28.00 points from the high in July. A 38.2% retracement would lead to a rally to 126.00 or so, while a 50% retracement would bring TLT back up to 129.00.”
By June 2017 TLT had rallied up to $128.57 and in September topped at $129.56.
By September 2017 the positioning in the Treasury bond futures had flipped with Large Speculators moving from a big short position to a big long position. This was one of the reasons why I recommended shorting Treasury bonds in September. Although the size of the short position held by Large Speculators is bigger than it was in March 2017, the one missing piece is that TLT has not recorded a clear wave 5 low below the low in March 2018.
If Treasury yields rise above the April 25 high, TLT is likely to drop below the low of wave 3 and complete a 5 wave decline from the price high in September 2017.
It took 3 months from the time TLT made its wave 3 low in December 2016 and the wave 5 low in March 2017. An equal amount of time from the wave 3 low on February 21 would target May 14 – May 21 as a guess of when Treasury yields will exceed their recent high and TLT records a low for wave 5. Establish a 50% position in TLT if it trades under $116.51 in the next few weeks.
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. 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. On May 2 my stop for the remaining 16.6% of the original position for TBT was triggered at $37.90.
Dollar
Two weeks ago I noted that the Dollar had broken out above the congestion of the past two months and the downtrend from its January 2017 high. Last week I noted that the Dollar had become a bit overbought so a pullback is likely. The Dollar has continued to rally after a brief and shallow pullback. 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. On April 23 the Dollar broke out and I recommended adding to the position. On April 24 UUP opened at $23.86.
In the May Macro Tides I recommended selling 1/3 of the position if UUP trades above $24.50. Today May 7, UUP traded up to $24.42 before closing at $24.38. The Dollar (cash) closed at 92.57 on May 7 pennies above the close of 92.51 on May 2, but the RSI posted a slightly lower high. This is an indication that the upside momentum in the Dollar is beginning to run out of steam and why taking a profit on a portion of the position makes sense. The Dollar is also overbought as reflected in its RSI which closed near 75 today.
The Dollar is still expected to rally to 94.50 to 95.00 in coming months. Use a stop of $23.89 on the position.
Euro
On February 16 I established a partial (12.5%) 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, in part because the ECB is likely to extend its QE program beyond September 30. However, in the short run the Euro is oversold and its RSI is near 27 and the price has reached an area of support where a bounce is likely. I reduced my EUO position by half today to 12.5% after selling EUO at $21.79.
Gold
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. In the week ending May 1, Large Speculators lowered their long position from 136,646 contracts to 106,779 and Commercials reduced their short position to -131,872 from -161,800 contracts. This shift in positioning occurred as Gold traded down to $1302 on May 1. The last time positioning was this constructive was on December 11, 2017 when Large Specs were only long 107,068 and the short position held by commercials was down to -128,217.
On December 12, 2017 Gold traded down to $1237 which pushed its RSI down to 32 (black arrow on above chart), and subsequently rallied to $1365 on January 25. In July 2017 Gold rallied from $1205 to $1357 in early September 2017, after its RSI fell to 31. Gold’s RSI finished at 43.24 today. 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 progressively getting more constructive. Buy a 50% position in Gold or the Gold ETF GLD, if Gold trades under $1295. Increase it to 100% if Gold trades under $1275.
A note about investment positioning: One of the keys to investing is having the patience to wait for a high probability trade to develop. Establishing a larger than normal position is warranted, when a good trade does present itself. It’s taken many months but a good intermediate trading opportunity in Gold may finally be setting up. Whatever your ‘normal’ position (5% to 10% allocation) is in Gold or Gold stocks, this is the time to consider doubling your normal position, since Gold has the potential to rally more than 10% from whatever low is established in coming weeks. From the July 2017 low Gold rallied 12.6% in about 6 weeks. Gold rallied 10.3% from its December 2017 low in 8 weeks. With a little luck it may be possible to capture 60% to 70% of whatever Gold rally develops in the next 3 months, which would net a gain of 6% to 8% in a short period of time. From the trading low in July 2017, the Gold stock ETF GDX rose 21.8%, and jumped 16.8% from the December 2017 low. It may be possible to earn 10% to 12% in a short period of time, if one was fortunate to capture 60% of the gain.
This advice is not suitable for the majority of investors who are risk averse since Gold and Gold Stocks are very volatile. At the end of the day, each investor must do what they are comfortable with and nothing more. We live in a crazy world and in reality I have no idea what the future may bring.
Gold Stocks
As noted, the last time the positioning in the Gold futures was this constructive was December 11, 2017. This was my recommendation for the Gold Stocks ETF GDX from the December 11, 2017 WTR:
“A 25% position is recommended if GDX trades under $21.30 which can be increased to 50% if GDX trades under $21.00.”
On December 12, GDX traded down to $21.27 before reversing higher and subsequently rallying to $24.86 on January 25. The RSI for GDX fell to 30 (green arrow) on December 11. GDX’s RSI finished at 53.6 today, and I would expect it to fall under 35 if Gold does trade under $1295 or lower in the next week or so. A 50% position is recommended if GDX trades under $21.75 in coming days.
Stocks
Since peaking on January 26, the S&P 500 has been trading in a contracting triangle, with each high lower than the prior high, while each low is higher than the preceding low. The attention afforded the triangle has become so widespread that CNBC’s Bob Pisani is referencing it often. The focus is understandably on the black trend line connecting the January high and the mid March high. The idea being pushed is that if the S&P 500 is able to rise above the black trend line it will be off to the races again. That is certainly possible but for a number of reasons less likely than a false breakout above the black trend line followed by a decline definitively below the 200-day average. For the seventh time since February 9, the S&P 500 traded down to its 200 day average (red moving average) on Thursday May 3 before reversing higher.
This ‘successful’ test of the 200-day average (again) occurred with far less angst than the test on February 9 or April 2. The 10-day Call/Put Ratio on February 9 was 1.018, meaning in the prior 10 days there were 101.8 calls purchased for each 100 puts. At the low on April 2, the 10-day Call/Put Ratio was 0.996 since more puts had been purchased in the prior 10 days than calls. On May 3 the 10-day Call/Put Ratio was 1.117 which meant 111.7 calls were bought for every 100 puts during the prior 10 days.
At last Thursday’s low the market was not oversold as measured by the 21-day average of net Advances minus Declines. The 21-day average of net Advances minus Declines was below -500 at the February 9 low and below -300 as the S&P 500 was approaching the low on April 2. On Wednesday May 2 it was +2, just -43 on May 3, and today closed at +156. Since the market wasn’t that oversold on May 3, it won’t take much to get the market over bought. In mid March and mid April the 21-day average of net Advances minus Declines topped just above 310, which suggests the upside may be more limited than most investors realize.
While most investors are focused on the black down trend line connecting the January and mid March highs, the blue trend line may be more important. The black trend line has two touch points and is less than 4 months old. The blue trend line has at least 5 touch points, dates back to April 2016 more than two years ago, and contained the S&P 500 for 19 months until it broke out in late November and accelerated in January.
Although the S&P 500 briefly traded above the blue trend line in late February and the first half of March, it gapped below it on March 22. On April 18 the S&P 500 tagged the underside of the blue trend line when it traded up to 2717 before sharply reversing lower. My guess is that the S&P 500 will trade through the black trend line and above the 2717 high on April 18, which is likely to get many people excited and more bullish.
The real test will come if and when the S&P 500 rises to the blue trend line which is between 2740 and 2750. The S&P 500 rallied from 163 points from the April 2 low of 2554 and the April 18 high of 2717. An equal rally from the May 3 low of 2595 would allow the S&P 500 to rally to 2558 and test the blue trend line.
If the S&P 500 fails to rise above 2717 and subsequently closes below 2625, the a, b, c, d, triangle notated in blue on the above chart will be the likely pattern and be followed by a swift decline below the 200-day average. If the S&P 500 rises above 2717, does not close above the blue trend line, then reverses as noted by the black (X), a? and c?, and subsequently closes below 2650 , a swift decline below the 200-day average would likely follow.
As recommended in the May Macro Tides:
“In my Weekly Technical Reviews during March, I recommended that if the S&P 500 traded above 2789 and 2730, “investors should:
- hedge your portfolios,
- do some selling,
- go short using a stop above 2840.
The S&P 500 traded above 2789 on March 13 and 2730 on March 21. The stop should be lowered to 2740 on a closing basis, just in case the S&P 500 breaks out of the triangle to the upside.”
I would raise the stop to a close above 2760. The S&P 500 is nearing the apex of the triangle and volatility is likely to pick up, especially if the S&P 500 reverses and closes definitively below its 200-day average as expected. I apologize if this analysis is a bit confusing, but one must play the cards dealt.
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.
