Written by Jim Welsh
Macro Tides Weekly Technical Review 19 November 2018
As the U.S. stock market posted new high after new high in 2017 and 2018, President Trump was quick with a Tweet extolling how much the stock market had gained since he became president. While his chest pumping was just another manifestation of the president’s self aggrandizement that is the norm, the stock market’s performance is clearly on his radar.
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With the market more wobbly than at any time since he became president, President Trump and his minions have become adept at tossing a carrot to investors to help prop up the market after a drop. Last week the administration was busy. The DJIA fell by 602 points and the S&P 500 lost 2.0% and closed at 2726 on Nov 12. Before the opening on Nov 13 the administration announced that Treasury Secretary Mnuchin and China were talking! The S&P 500 was up more than 1% in the first 2 hours of trading only to fade and close lower by 3 points.
On November 14 the S&P 500 closed at 2701 and was trading at 2672 on November 15 when a report surfaced that said U.S. Trade Representative Robert Lighthizer had told some industry executives that the next round of tariffs on Chinese imports scheduled for January 1, 2019 had been put on hold as the two nations pursue talks. The S&P 500 roared ahead by more than 2% before closing at 2730, almost 60 points above the trading low of 2671.
Click on any chart below for large image.
This suspension of tariffs report was later denied by Lighthizer. On Friday President Trump told reporters that “China wants to make a deal. We are doing extremely well with respect to China“. In the minutes following this report the S&P 500 jumped from 2720 to 2747.46 before closing at 2737.
On November 17 and 18, Vice-President Pence and Chinese President Xi Jinping met twice during the Asia-Pacific Economic Cooperation summit. For the first time in the Asia-Pacific Economic Cooperation summit’s nearly three-decade history, officials of the 21-member Pacific Rim group ended two days of meetings without issuing a communiqué. The failure to agree on a communiqué was due to the inclusion of one statement: “We agreed to fight protectionism including all unfair trade practices.” China strongly objected believing it amounted to a “singling out” of Chinese trade practices. Other APEC members favored including the language in the final communiqué.
What most investors overlook or ignore is that the trade negotiations with China are not limited to the U.S. trade deficit with China, but include more substantive issues that will require a lot of heavy lifting and negotiating and large concessions by China if a ‘deal’ is going to be realized. Wilbur Ross defined the issues with China quite clearly at the Yahoo Finance All Markets Summit on November 13:
“The issue with China is not just tariffs. If it was just tariffs, I think we could work it out very, very, very quickly. The real issue is intellectual property rights, forced technology transfers, industrial espionage, that kind of thing. We can’t tolerate abuses of that sort”.
To date China has not offered any proposal addressing these issues. As noted in the November Macro Tides:
“Most investors are still clinging to the belief that China will eventually cave in to President Trump. My guess is that after President Trump and President Xi break bread at the G-20 meetings they will emerge and announce they have agreed to talk again! Whoopee!”
On November 13, Chinese Premier Li Keqiang said China and the US could find an arrangement that was acceptable to both sides based on the principle of mutual respect. As I discussed in the August Macro Tides “China, No Trade Pushover”:
“China wants to be treated as an equal to the U.S. and respected, and that’s something China is not willing to trade away.”
The devil in the details is that China will need to compromise on intellectual property rights, forced technology transfers, and curbing industrial espionage for the U.S. to be willing to treat China as an equal. This chasm is not going to be bridged with a dinner at the G-20 meeting on December 1.
Crude Oil-WT
From an intra-day high of $76.90 on October 1 WTI Crude Oil plunged 28.8% to an intra-day low of $54.75 on November 12. The waterfall decline included a 13 day consecutive streak of daily losses, which underscores how intense the selling pressure was. Understandably, some strategists think the oil market is ‘telling’ them that the global economy is slowing more abruptly than they realized. This view has gained some traction since the global economy has already been slowing since the spring. As I discussed in the May Macro Tides and months before global slowing appeared on the radar screen:
“Periods of slower growth during an expansion are not uncommon and in the past 22 years have occurred often without leading to a recession. This is the 13th time global growth has slowed since 1995 but a recession followed only three times. Since the current recovery began in June 2009 this is the sixth time the economy has down shifted.”
What strategists are overlooking is the role that positioning in the oil and natural gas futures markets likely played in accelerating the decline in oil prices and surge in natural gas prices. Hedge funds and Large Speculators expected oil prices to continue to climb on the back of good global growth and sanctions imposed on Iran by the U.S. in early November. To profit from the expected increase in oil prices a record long position in crude oil futures was established in the first half of 2018. In early October the ratio of long positions to short position was 14 to 1. Talk about a crowded trade!
When WTI Crude Oil fell below the August low near $64.00 a barrel, pressure intensified on those still long causing a rout to take hold. When the Trump administration provided exemptions for Iranian oil purchases, the expected decline in supply was restored leading to a 7% drop on November 14.
For most of the last 2 years natural gas prices traded in a range of $2.50 to $3.25 in large part because supply was plentiful. This stability led energy traders to establish a long crude oil position offset by a short position in Natural Gas futures. A perfect storm developed in early November as an unusually long cold spell hit the Northeast driving up demand for Natural Gas just as WTI Oil prices were collapsing. Traders short Natural Gas were forced to cover their short positions which drove the price from $3.20 on October 29 to high of $4.93 on November 14, an increase of 54% in less than 2 weeks. The unwinding of the long oil/short natural gas aligns with the 13 consecutive days of decline in oil prices.
While there may be more unwinding to come that could provide more volatility in WTI Crude Oil and Natural Gas prices, most of the damage is likely done. Near the recent low WTI Crude oil prices tagged the rising trend line connecting the February 2016 low with the secondary low in June 2017, and the horizontal trend line which connects the highs in January and February 2017 near $55.00.
If the unwinding of the long oil/short natural gas was responsible for at least a portion of the $22.15 decline from $76.90 to $54.75, WTI oil could retrace $8.50 (38.2%) and trade up to $63.20 in coming months. If the global economy isn’t quite as weak as some now believe, the rebound could exceed the 38.2%.
The sharp decline in oil prices may have created a buying opportunity in the Alerian Master Limited Partnership ETF (AMLP). Since early August AMLP has fallen by -15.2% and is nearing the trend line connecting the February 2016 low and the low in April 2017. AMLP yields 8.3% and could rally up to $10.75, if oil prices stabilize and then rally. I know almost nothing about the intricacies of MLP’s, so this recommendation is based purely on the chart of oil and AMLP. A 33% position is recommended if AMLP trades below $9.56, which can be increased to 66% if AMLP trades under $9.30. Use a close below $9.10 as a stop.
Stocks – Retest of 2603 Low Coming
From its peak of 2940 the S&P 500 tumbled 337 points to a low of 2603 on October 29. As noted two weeks ago:
“A 61.8% retracement would lift the S&P 500 to 2811.”
The S&P 500 recovered to 2815 on November 7 before falling 144 points to a low of 2671 on November 15. After the Lighthizer rumor on November 15, the S&P quickly rebounded to 2746. The initial rally from the 2603 low recovered 62.8% of the prior decline, while the bounce from 2671 only recaptured 52.1% of the previous decline. This suggests the market is getting weaker and at risk of a washout that drives the S&P 500 below 2603.
As the recent decline has persisted I’ve shown a chart of the Trading Index which continues to indicate the lack of any real fear. The Trading Index (TRIN, ARMS Index) measures the amount of buying and selling pressure (volume) relative to market breadth (advances and declines). Near market highs, or the onset of a consolidation after a large advance, the TRIN will fall well below 1.0, as it did in January 2018 and in late September. When selling pressure becomes overloaded, the TRIN rises above 1.0. At a minimum, the 10-day average (black line) will rise above 1.3, and at intermediate bottoms the 21 day average (red line) will also get above 1.30 (above chart).
The Trading Index is not perfect but does a better job of identifying lows in the market than highs. In August-September 2015, January 2016, April 2017, and March 2018, both the 10 day and 21 day moving average of TRIN rose above 1.30. Here’s the scary part. As of Monday November 19, the 10 day average was 0.977 and the 21 day average was 1.013, so neither is close to signaling that a trading low is in place. Investors may be worried but they have yet to become afraid. Instead institutional investors are gleefully buying the defensive sectors (i.e. Utilities, Consumer Staples, REIT’s) believing these sectors will shield them from the carnage hitting so many other sectors. The hiding in the defensive sectors is contributing to the Trading Index remaining so low despite the decline. (Chart below)
The VIX is also suggesting that investors remain too complacent. The S&P 500 fell to within 10 points of the low on November 15 (2681 vs. 2772) on November 19, but the high on the VIX on November 19 was 20.99 compared to 22.97 on November 15. In most years, there is a strong seasonality factor prior to Thanksgiving, and often going into year end. In years of a mid-term election, the propensity of the S&P 500 to rally significantly is quite high so investors are expecting the market to begin to rally soon.
The post mid-term election rallies since 1950 followed meaningful declines that had nothing to do with the mid-elections. In other words, the rallies were often set up by a large decline which certainly 6 contributed to the spirited rallies that followed the mid-term election. The 1954 increase was coincident with the Federal Reserve slashing the federal funds rate in response to a recession. The big rally in 1962 followed a 25% decline in the S&P 500 after President Kennedy jawboned U.S. Steel for raising steel prices after promising they wouldn’t. The gains in 1970 followed a recession that ended in the summer of 1970, and in 1974 the big bear market recorded its primary low in October 1974.
The nice gain in 1982 was just months after stocks had fallen to their cheapest valuation in a generation and the onset of the huge 1982 bull market. The stock market bottomed in October 1990 after Saddam Hussein invaded Kuwait in July 1990 and a 17% fall by the S&P 500. The terrific gain after the 1994 mid-term election followed a year of flat trading and the launch of the dot.com era bull market. After Long Term Capital Management imploded and Russia defaulted on its debt, the S&P 500 bottomed in October 1998 after falling more than 16%.
The gain after the mid-term election in 2002 followed a decline of more than 48% in the S&P 500 and the beginning of the 2003 – 2007 bull market. The difference in 2018 is that the S&P 500 made a new all time high a month before the mid-term election, the economy is slowing, and the Fed is not likely to come to the rescue as quickly as investors hope.
When the S&P 500 closed at 2728 on October its RSI was 16.2 (chart above). On November 16 the S&P 500 closed at 2736, up about 0.33% from its close on October 11. However, the S&P 500’s RSI was up to 47.0 versus 16.2 on October 11. The S&P 500 used all of the oversold condition that had developed on October 11, but was only able to a rise by a measly 0.33%. This is another indication of a weak market.
The S&P 500 is expected to test 2603 and potentially fall below 2500 if the decline from 2815 (wave 2 or B) is equal to the 337 point decline from the peak of 2940 (wave 1 or A). If the S&P 500 only manages a weak intra-day rebound if it trades down to 2610 – 2620, a test of the February low of 2532 could follow. The stop on the 50% short position in the inverse S&P 500 ETF (SH) should be lowered to 2765. Cover half if the S&P 500 trades under 2650. If the S&P 500 trades under 2650, lower the stop on the remaining half to 2750, and cover the remaining half if the S&P 500 trades under 2570.
If the TRIN-Arms Index closes above 2.50 on any day, half of the short position should be covered, irrespective of the S&P 500’s price, and the remaining half covered if the TRIN closes above 2.5 after the S&P 500 has traded under 2650.
Dollar
Sentiment is lopsidedly bearish toward Gold and positioning continues to be supportive of a major move to above $1300 and possibly above $1400 in 2019.
Gold
Sentiment is lopsidedly bearish toward Gold and positioning continues to be supportive of a major move to above $1300 and possibly above $1400 in 2019.
Gold Stocks
The Gold stock ETF (GDX) rallied in 3 waves from the low in mid August (wave A), and then fell in 3 waves from the high on October 23 (wave B). This leaves open the potential for an equal rally of $3.23 from the low of $18.26 on November 13 which would be wave C and potentially allow for a rally in GDX to near $21.50. Sell the remaining 66% of the GDX position if GDX trades above $21.25.
Emerging Markets
The relative strength of the Emerging Markets ETF EEM to the S&P 500 continues to improve compared to the weakness it displayed since March. I thought EEM could trade down to $38.00 as noted in the October Macro Tides:
“In coming months EEM has the potential to test $38.00 which suggests patience.”
EEM fell from $42.50 in early October to $37.57 on October 29. I would recommend adding to the position if EEM trades below $38.50, or taking a 33% position if EEM wasn’t bought when it traded down to $38.00.
Treasury Yields
Last week I thought that if the S&P 500 declined sharply in coming days, the 10-year Treasury yield could dip under 3.08% before resuming the upward trend to 3.28% or higher. The 10-year Treasury yield dipped to 3.052% on November 19 and could approach 3.03%. After the upcoming low in the 10-year yield, I expect yields to make a new high. From the low of 1.32% in July 2016, the 10-year Treasury yield increased to 2.62% in March 2017, an increase of 1.30%. From the September 2017 low of 2.037%, an equal rise of 1.30% suggests the potential for the 10-year Treasury yield to climb to 3.33% before the potential of another trading low is possible.
If the S&P 500 declines sharply in coming days, the 30-year Treasury yield could dip under 3.32% before resuming the upward trend to 3.48% or higher. The 30-year yield fell to 3.316% on November 19 and could dip to 3.30% before reversing higher. If wave 1 from 2.925% and wave 5 are equal, the 30-year Treasury yield can rise to 3.52%, slightly above the green trend line connecting the May high (3.247%) and the early October high at 3.424%.
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 which is still in effect.
Past performance may not be indicative of future results.
The MTI has weakened significantly since early October. At the opening on November 6, the U.S Sector Rotation Portfolio was moved 33% into cash/money market, 66% into cash/money market if the S&P 500 rallied above 2760, and moved 100% into cash/money market fund if the S&P 500 moved above 2800. The S&P 500 opened at 2738.30 on November 6 and opened at 2774.13 on November 7 and traded above 2800 on November 7. The average price was 2770.81. The U.S Sector Rotation Portfolio established a 33% short position in an inverse S&P 500 ETF (SH) at $28.35, when the S&P 500 traded above 2800. The probability of a bear market will rise if the MTI falls below the blue horizontal trend line.
Money is flowing into sectors perceived as being defensive which is why Health Care, Utilities and Consumer Staples have been performing well on a relative basis to the S&P 500. One sign that a trading bottom has been reached is when these sectors are sold and institutional investors stop hiding in them. This would indicate that sentiment has truly become too bearish.
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.
