Written by Jim Welsh
Soybean Exports Could Lift Q2 GDP Above 4%
In the third quarter of 2016 GDP grew 2.9% aided by a surge in soybean exports that added 0.83%. A poor crop in South America allowed U.S. famers to dramatically expand their exports of soybeans. Soybean exports have exploded in the second quarter of 2018, as global consumers ramped up their imports of U.S. soybeans ahead of imposed tariffs by China. (Soybeans picture from Wikipedia.)
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Although the current spike isn’t quite as big as in 2016, second quarter GDP could be boosted by 0.6% or more when the first estimate for Q2 is announced on Friday July 27. GDP growth will be lifted by solid consumer spending, business investment, and maybe 0.5% of inventory growth. Soybean exports are a one-off event which will not be repeated in the second half of 2018. A large increase in inventory growth in the second quarter could borrow some growth from Q3 as companies maintain inventory levels rather than add to them.
As of July 18 the Atlanta Fed GDPNow estimates Q2 GDP grew by 4.5%, while the Federal Reserve of New York’s Nowcast is forecasting growth of 2.69% as of July 20. Normally splitting the difference between these estimates would be in the ballpark, but the surge in soybean exports introduces a wild card that could result in a GDP estimate that is above 4.0%. It is important to remember that this will be the first of 3 estimates and will not include trade data for June. However, if GDP growth does come in above 4.0% President Trump will launch a tweet storm. The key point is that the second quarter is likely to be the high water mark for GDP growth in 2018.
Last week the Trump administration revised its estimates of the budget deficit in coming years by $100 billion due to more government spending and higher interest rates. If accurate the budget deficit will top $1 trillion in 2019 despite good economic growth. The deficit has never risen during a period of economic growth. The growth in federal debt as a percent of GDP is projected to climb at a steep rate during the next decade, even though the Congressional Budget Office assumes there will be no recession prior to 2026. If a recession does materialize before 2026, government spending will increase faster than projected, tax revenue will be less, and the deficit will be larger and the mountain of debt will become even more daunting.
Dollar
Most investors were surprised by the 8% rally in the Dollar from its low in February 2018 to its high in June, but in the March issue of Macro Tides I expected the Dollar to rally from 88.25 to near 95.00 in coming months:
“The recent low was 88.25 (cash) and could be retested amid trade discussions that include retaliatory actions by other countries in response to U.S. steel and aluminum tariffs. The Dollar chart suggests a rally to near 95.00 is possible in coming months. This would represent an increase of almost 8.0% from its low at 88.25.”
As I discussed in the July 9 Macro Tides Weekly Technical Review, bullish sentiment toward the Dollar exceeded 90% on a number of days prior to its high of 95.53 on June 28 and its chart pattern suggested a top:
“Based on the price pattern in the Dollar it has completed a 5 wave rally from the February low and is now set up for a meaningful decline.”
I also stated that President Trump might weigh in with a tweet about the Dollar’s strength:
“I wouldn’t be surprised if President Trump doesn’t send a message via Twitter that he favors a lower Dollar.”
Trade negotiations don’t seem to be progressing as smoothly as President Trump expected when he said “Trade wars are easy to win.” On Friday July 20 President Trump tweeted the following:
“China, the European Union and others have been manipulating their currencies and interest rates lower, while the U.S. is raising rates while the dollars gets stronger and stronger with each passing day – taking away our big competitive edge”.
This tweet followed comments in a CNBC interview in which President Trump criticized the Federal Reserve for raising rates. The Dollar quickly fell -1.3% after the president’s comments and tweet.
This isn’t the first time excessive bullish sentiment and chart pattern analysis indicated the Dollar was topping prior to comments by then President elect Trump. As I discussed in the January 9, 2017 issue of Macro Tides:
“The Dollar has rallied strongly in the wake of the election, the Federal Reserve’s decision to increase the Fed funds rate, and the Fed’s forecast of an additional three rate increases during 2017. The consensus of strategists is that the Dollar will continue to rally in coming months. Surveys of currency traders have recently indicated that more than 90% of traders are bullish the Dollar, which means they have already bought the Dollar. The last two times bullish sentiment toward the Dollar exceeded 90% was in March 2015 and January 2016. The Dollar subsequently declined by more than 7% in the months following these two periods of ebullience. Chart pattern analysis and the excessive level of bullishness suggest the Dollar could experience a multi-week / month correction.”
In the January 9, 2017 issue of Macro Tides, I also discussed Trump’s view of the Dollar and suggested that Trump might not hesitate to talk the Dollar down sometime in 2017:
“Sometime in 2017, I expect Trump to convey (via a tweet?) to currency traders that the Dollar is too strong and that he will tolerate a weaker Dollar.”
In an interview with the Wall Street Journal published on January 17, 2017 he described the Dollar as “too strong“, and said the U.S. might need to “get the Dollar down“, if a change in tax policy pushes it up:
“Having a strong Dollar has certain advantages, but it has a lot of disadvantages.”
The Dollar subsequently fell by more than 8% by early September 2017.
The Dollar is not likely to suffer an equivalent decline in the next few months as it did after the January 2017 top, but a 50% retracement of the 8.0% rally would result in a pullback of 4%. Sentiment has become quite bullish with recent surveys showing more than 90% of traders being bullish. Positioning has also become extreme with traders already long according to the latest IMM data. Now that everyone knows why the Dollar has rallied 8% since February, it will take something new to push it appreciably higher.
Although the Dollar is near a short term high, it has yet to confirm that a top is in place. In the short term, the Dollar may push above its high of 95.65 on July 19 which was recorded before President Trump’s comments about the Federal Reserve and his tweet about other countries manipulating their currencies on July 20. The Dollar has tested and held the trend line connecting the lows in May, June, July, and today at 94.207. A close below 94.20 would increase the odds that the high is in place, while a close above 94.75 would likely be followed a brief move above 95.65.
Click on any chart below for large image.
Euro
Since the Euro comprises 57.6% of the Dollar index, a meaningful move in the Euro translates into a big move in the Dollar. In early February Large Speculators were holding an all time record long position of 140,823 contracts (green line middle panel). My expectation in February was that selling pressure would pressure those long the Euro to sell and cause the Euro to decline and the Dollar to rally.
After being forced to sell by the sharp decline from 1.24 to 1.16 in the Euro, Large Speculators are now long just 21,407 contracts. This is the smallest long position since May 2, 2017 and just before the Euro rallied from 1.10 to 1.20 by the end of August. The price pattern in the Euro allows for some additional choppy trading in the next 1-2 weeks, followed by a quick thrust to a new low. If this develops it would potentially complete a 5 wave decline from the high in February and set the stage for a rally in the Euro and decline in the Dollar. Establish a 50% long position in FXE if it declines below $110.55.
Gold
As noted in the July 9 WTR:
“Sentiment remains lopsidedly bearish toward Gold and the positioning in the futures market is supportive of a decent rally. What’s missing is better price action.”
After Gold fell below the December 2017 low of $1236.00 on July 17, the positioning in Gold futures became the most positive since the major low in December 2015 when Gold bottomed at 1046.
Large Speculators have the smallest long position (green line middle panel), Commercials (red line middle panel) have the smallest short position since January 2016, and Managed Money (blue line bottom panel) has the largest short position since December 2015. By falling below the December 2017 low of $1236 the intermediate term technical outlook is not as positive.
Gold is less likely to breakout above $1370 before the end of 2018 which had been the expectation. Instead, Gold is likely to rally up to $1300 – $1315, possibly as high as $1350 before falling and recording a higher low than the expected low in the next 2 weeks. If the Dollar pushes to a higher high above 95.65, Gold could briefly dip under $1200 before reversing higher.
To say that Gold is oversold doesn’t really capture how relentless the selling has been during the last 30 days. Gold has managed to close up on just 7 days of the past 30 trading days which is the lowest since December 2, 2015.
Over a multi-decade period Gold and M2 money supply have tended to move together with the ratio tending to revert to a long-term equilibrium of 1.0. When the ratio is 0.25 above the 1.0 equilibrium, the 12-month median return has been -6%. The 12-month median return has been over +12%, when the ratio is .25 below the 1.0 equilibrium. On July 12, the ratio was 0.73 or 0.27 below the 1.0 equilibrium and the lowest since December 2016. The ratio is probably lower today since Gold is down -1.5% from its close on July 12.
Since mid May I have recommended scaling into Gold as it fell below a number of trend lines, which was expected to turn sentiment more bearish and allow positioning to become more constructive. I thought the Gold ETF GLD might trade under the July 2017 low of $115.00. On July 19 GLD dipped to $115.12 before reversing higher. It is not a coincidence that the Dollar reached its high of 95.65 on July 19 and suggests Gold may wait until the Dollar has confirmed a peak before mounting a sustained rally.
Normally, I would suggest a stop above recent lows, but sentiment and positioning suggest that Gold and Silver could spike lower and then pop like a volley ball submerged under water. That would make it difficult to execute a tight stop and a repurchase price that wasn’t higher than the stop. The weekly RSI for GLD closed today at 30.7 the most over sold since December 2016. My guess is that GLD is likely to bottom above the black horizontal trend line at $114.00 and within the next two weeks
Gold Stocks
The relative strength of Gold stocks to Gold weakened late last week as Gold fell below $1236. The positive is that the RSI for the Gold Stock ETF (GDX) finally fell to 35 today July 23, an event I’ve been waiting for months to develop.
A 50% position was recommended if GDX traded under $21.80 and a 100% position if GDX fell below $21.56. On July 17 GDX opened at $21.73 and opened at $21.50 on July 19, so the average cost is $21.62. There is a decent chance that GDX may spike under $21.00 especially if Gold dips under $1200. I’m going to suspend the instruction to sell GDX if it closes under $21.16 since its RSI would be close to 30 if it does. I’m not entirely comfortable doing this, but Gold and GDX are likely to be higher once the selling pressure abates. Just as Gold has resistance at $1300 – $1315, GDX is likely to run into over head supply above $22.50. The rally above the September high may have to wait until 2019.
GDX was down over 2.0% today in part due to weakness in Barrick Gold whose CEO left to run another gold company. Barrick Gold is 7.1% of GDX and its plunge of 4.52% accounted for more than 15% of the decline in GDX and likely cast a pall over other Gold stocks.
Stocks
Most people believe that markets are a discounting mechanism. When I hear strategists on CNBC say:
“Since the stock market hasn’t declined even as President Trump has expanded tariffs, the market is telling me the trade stuff will work out and the market is going higher.”
It may work out that way but it sounds like those strategists are practicing circular logic. The market didn’t provide the right guidance in October 2007 when the S&P made a new all time high just before the financial crisis or at the March 2009 low. The market is always wrong at tops and bottoms and it usually catches most investors off guard. A 5% – 7% decline before mid September would catch complacent investors by surprise.
As discussed last week there are a number of reasons why the market could be vulnerable to a correction. By rising above the March 13 intra-day high of 2801.90, the S&P 500 may have completed wave c from the April 2 low, and an a-b-c countertrend rally from the February 9 low which also completes wave (B). Since the April 2 low at 2554 is 22 points higher than the February 9 low at 2532, the S&P 500 could push up to 2824 which would make the rallies equal in length. If this pattern analysis is correct, the S&P 500 may be vulnerable to a wave (C) decline that has the potential of bringing the S&P 500 below the February 9 low of 2532.
In July 2017 67% of stocks were above their 200 day average and in October and January it was 68%. At those highs, the ratio of stocks above their 200 day average was better than 2 to 1. On July 18, the S&P 500 closed at 2816 and the ratio was 1.04 to 1.0. This is more a sign of weakness than strength. Although the S&P 500 has closed above its mid March high, the NYSE Composite has not.
The Option Premium Ratio is a sentiment indicator that helps identify tops and bottoms in the market. A high ratio develops near a market low, and a top occurs if the OPR falls to an extremely low level below or near 0.50.
I initially presented the table above in the June 11 WTR and noted:
“In 8.5 years the OPR has only fallen to near 0.50 on five other occasions which were each followed by a correction of some magnitude.”
The S&P 500 fell -3.1% over the next two weeks. The OPR fell below 0.50 on July 19 when the S&P 500 closed at 2804. The internal strength of the market is weaker now than it was in mid June so the market is vulnerable to a larger decline if selling pressure increases.
The percent of stocks that have made a new 52 week high during the past 21 trading days is also revealing. On October 13, 2017 5.92% of NYSE stocks had posted a new high during the prior 52 weeks (Chart below). On January 24 that rose to 6.92%. When the S&P 500 closed at 2787 on June 12 just 2.61% of NYSE had made a new 52 week high. On July 18 it was down to 1.29% even though the S&P 500 closed at 2815.62 about 1.0% higher than on June 12. The divergence with June 12 is striking since it wasn’t that long ago.
In the March 12 WTR 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″.
The S&P 500 traded up to 2802 on March 13 and then lost -8.4% in the next 14 trading days, although the S&P did not fall to 2533. The S&P 500 is about where it was in mid March but the NYSE Composite is -1.65% lower. The majority of stocks are below where they were in mid March with the exception of the FAANMG stocks. Once again it’s time to 1) hedge your portfolios, 2) do some selling, or 3) go 25% short above 2805 and 50% short above 2820, using a stop above 2840. The S&P 500 rose above 2805 on July 17. A number of big name tech stocks report earnings this week which may lift the S&P 500 above 2820.
Treasury Yields
Federal Reserve Chair Powell testified before Congress on July 17 and July 18 and reiterated that the Fed is on the path of raising interest rates in response to economic growth and the expectation that inflation will remain at or above the Fed’s target of 2.0% in coming months. During and after Powell’s testimony the bond market yawned and yields barely moved. The real action didn’t begin until President Trump chided the Federal Reserve for increasing rates on July 19.
From their low on July 19, Treasury yields jumped from 2.834% to 2.895% at Friday’s close for the 10-year Treasury bond and to 3.031% from 2.952% on the 30-year Treasury bond.
After speculation mounted on Sunday July 22 that the Bank of Japan may be adjusting its monetary policy and bond buying program, the 10-year Treasury yield rose to 2.965% on July 23 while the 30-year Treasury yield hit 3.104%. An increase of 0.131% on the 10-year yield and 0.152% for the 30- year yield in two days are big moves.
As I have noted in recent weeks, Large Speculators are still holding a large short position in the 10-year futures market that is larger than in January 2017 when bond yields were topping near 2.60%. This large short position is likely to put a floor under prices and keep yields from rising too far. If correct, the 10- year Treasury will hold under the high of 3.115% in coming weeks.
The 30-year Treasury yield is not likely to exceed its high of 3.247% in coming weeks. If I’m wrong and bond yield rise above their mid May highs, the stock market might actually notice.
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 remains well below its high from January and barely above its level on June 13 when the S&P 500 it traded up to 2792. A close below 2690 would suggest a meaningful top has been completed.
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.
