Written by Jim Welsh
Macro Tides Weekly Technical Review 10 December 2018
Softer Employment Report Strong Enough for Rate Hike
In the wake of the November jobs report the federal funds futures are now pricing in only a 68% probability that the FOMC will increase the federal funds rate at the December 18-19 meeting. Furthermore, the federal funds futures market is pegging only a 20% chance there will be single rate hike in all of 2019.
Please share this article – Go to very top of page, right hand side, for social media buttons.
Rather than the 180,000 jobs forecast 155,000 jobs were created while October was revised lower as I noted in last week’s WTR:
“The forecast is for 180,000 new jobs in November which would be down from the October increase of 250,000. There is a good chance the October number will be revised lower.”
The October figure was lowered modestly to 238,000 so the average for both months was 196,500. In the tenth year of a recovery with a dwindling supply of workers on the sidelines, job growth of almost 200,000 is remarkable. As I expected Wall Street has interpreted the weaker number as another reason why the Fed may not raise rates at the December meeting:
“While Wall Street will view any number less than 180,000 as good news since it gives the Fed more leeway, the Federal Reserve will see it differently. For the economy to absorb new entrants into the labor market, only 75,000 jobs need to be created. The Fed would view anything above 75,000 jobs as further shrinking slack from the labor market.”
The headline unemployment rate held at 3.7% which is a bit misleading. The actual rate was 3.67% the lowest rate for this expansion. Since the Labor Department rounds the second digit up or down, the reported number was rounded up to 3.7%. Had it been just .03% lower the headline would have read ‘Unemployment Rate Falls to 3.6% from 3.7%’. Average Hourly earnings were up 3.1% which seemed likely given the trend over the past 12 months.
The FOMC is likely to increase the federal funds rate at the December meeting for many of the reasons discussed in the December Macro Tides, and change the language of the post FOMC meeting to covey a greater reliance on incoming data. The FOMC has included the following sentence since at least early 2017:
“The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term.”
To reinforce that the FOMC is data dependent and approaching the neutral federal funds rate, the FOMC will remove the phrase ‘further gradual increases’ from the December 19 statement. Although the discussion at the November meeting didn’t specifically mention December it’s a good bet they will:
“Participants also commented on how the Committee’s communications in its post meeting statement might need to be revised at coming meetings, particularly the language referring to the Committee’s expectations for “further gradual increases” in the target range for the federal funds rate. Many participants indicated that it might be appropriate at some upcoming meetings to begin to transition to statement language that placed greater emphasis on the evaluation of incoming data in assessing the economic and policy outlook; such a change would help to convey the Committee’s flexible approach in responding to changing economic circumstances.”
Although the financial markets are going to seize on the wording change, the reality is it really isn’t a big deal. The FOMC has been increasing the federal funds rate quarterly since December 2017, and March, June, and September 2018. And after each of these increases the FOMC weighed incoming data and decided that another increase was warranted. This pattern indicates that the FOMC wouldn’t consider another increase until the March 2019 and would only act if incoming data supported an additional increase.
The change in wording will result in more volatility as the financial markets attempt to reprice the probability of a hike in March, after every important economic report in January and February. The reality of how the FOMC operates hasn’t changed, but the financial market’s perception has changed and will result in more self inflicted wounds in coming months.
Dollar
The Dollar was one of the key factors in determining how global markets traded in 2018. After the Dollar recorded a trading low in February and March and began the expected rally from 89.00 to 95.00, global equity markets began to decline with the Emerging Markets leading the way.
The Dollar is expected to decline in coming months but rallied today as the British Pound fell by 2% after Prime Minister Theresa May withdrew her negotiated Brexit deal with the EU from being voted on by Parliament on December 11. As the Pound fell it also pulled the Euro lower and pushed the Dollar up.
As noted last week, the first sign that the correction may be starting will be indicated by a close below 96.40 and the rising uptrend line. After closing at 96.51 on December 7 and trading down to 96.36 on December 10, the Dollar jumped to 97.24. This increases the odds that the Dollar will push above the November 12 high of 97.69. This however is still part of the process of a high forming in the Dollar.
Large Speculators continue to hold very big short positions in the Euro, Yen, Australian dollar and the majority of other foreign currencies. These short positions represent a de facto long position in the Dollar since they will profit if the Dollar rises against these currencies.
Sentiment is also wildly bullish the Dollar. This suggests the Dollar is a crowded long trade and ripe for at least a decent correction. The Dollar may hold up through the end of the year due to global banks wanting to hold dollars.
Technically, the Dollar’s RSI negatively diverged when the Dollar made a new closing high on November 12. The expectation is that the Dollar will fall back to the late September low under 94.00 in coming months. The first sign that the correction may starting will be a close below 96.40 and the rising uptrend line as noted.
Click on any chart below for large image.
Gold
The Dollar appeared on the cusp of closing below 96.40 on December 7 when it closed at 96.51 and last week Gold seemed to benefit from weakness in the US stock market. After the US stock market reversed after its big rally on December 3, Gold rallied from $1230 to $1250. Gold weakened on December 10 as the DJIA recovered from a loss of 500 points and finished up by 34 points. The strong rebound in the Dollar on December 10 also weighed on Gold. In the short term a pullback to the uptrend line near $1220 is possible, especially if the Dollar does manage to make a new high before year end.
Gold is expected to rally above $1300 in the first quarter and could approach $1350. Sentiment toward Gold is remains negative which suggests a rally would surprise most investors.
Gold Stocks
The relative strength of Gold stock weakened significantly in August. This period of extreme weakness was in large part due to the liquidation of $1.2 billion in gold stocks by the Vanguard Precious Metals fund in August and September. After blowing out in August the relative strength rebounded and has stabilized since late October. It would be positive if the relative strength of the Gold stocks was able to drop below the black trend line and fall below the low in late October. This would indicate that the Gold stocks were beginning to outperform Gold and would be a plus for Gold as well.
If Gold rallies above $1300 in the first quarter, the Gold Stock ETF GDX would be expected to test the red horizontal trend line near $21.50. If Gold pushes up to $1350, GDX could rally to $23.00 (green down trend line), especially if its relative strength to Gold improves as Gold rallies.
Treasury Yields
The Treasury bond market has benefited from a flight to quality as stocks have lost more than 10%, a perception that the global slowdown is breaching the shores of the U.S. and a big short squeeze of extremely large short positions in Treasury bond futures.
The RSI on the 10-year Treasury bond fell to 18.1 on December 7 which is the lowest level since February 2016 when it reached 18.4 (red arrows). A similar but less extreme low was formed in April 2017 when the RSI fell to 26.1. The extreme low RSI on December 7 suggests that Treasury bond yields are likely to fall further in coming weeks. A persistent uptrend in bond yields is not likely to begin until there is a negative RSI divergence with the 10-year yield recording a lower low while the RSI is above 25 or higher.
This is what developed after the extreme low in February 2016 and April 2017 as noted by the green trend lines on the RSI. This suggests this process could take two to four months and will require patience. Bond yields are expected to trend higher in 2019 so a good short trade opportunity is coming.
A similar process has unfolded in the 30-year Treasury yield since 2016. Before this process is complete the 30-year yield could test or dip under 3.0%, especially if the S&P 500 experiences a decline below 2532 in the next few months.
Under this scenario the Treasury ETF TLT could rally above $121.00 and could approach the horizontal trend line at $122.50.
Last week I recommended a short position in anticipation of a rise in Treasury yields:
“A 50% position can be established if the 1 to 1 inverse Treasury ETF TBF trades below $23.50, using a close below $23.25 as a stop. TBF looks like it broke out in early September when it moved above the declining black trend line, and is merely ‘testing’ the breakout. Aggressive traders can purchase the 2 to 1 inverse Treasury ETF TBT below $38.40 using a close below $37.88 as a stop.”
On December 4 TBF opened at $23.41 and closed at $23.19 triggering the stop. TBT opened at $38.25 and triggered its stop when it closed at $37.59 on December 4.
Stocks
After the trade truce was announced by President Trump on Saturday December 1, the S&P 500 gapped higher on the open of December 3. As doubts developed about the exact terms of the ‘agreement’, the S&P dropped sharply on December 4, rallied like crazy on December 6, only to fall apart on Friday December 7, and the first 3 hours of trading on December 10. And then a funny thing happened on CNBC as Josh Brown discussed Apple and the potential that a Doji Star might form. Apple, which was trading at $163.84 as Brown was speaking, needed to close at $165.00 which was the priced it opened at. Here’s the definition of a Doji Star:
“The Doji Star signal is composed of one candle. It is formed when the open and the close occur at the same level or very close to the same level in a specific timeframe. In Candlestick charting, this essentially creates a “cross” formation.”
The opening price is noted on the bar on the left side and the close is marked on the right side. When the opening and closing price are very close, the line formed by the left line and right line make it appear as a cross. The mere mention that Apple might do something positive after weeks of falling was enough to spark a sharp rally in Apple as traders bought in anticipation of a Doji Star! Within 10 minutes Apple rallied to $169.51 and closed at $169.60. The irony is that at the end of the day Apple did not form a Doji Star. 
The rebound in Apple enabled the S&P 500 to catch a bid as well and the S&P 500 jumped from 2696 to 2718 in less than 15 minutes. Clearly the S&P 500 was very oversold on a short term basis after falling from 2700 on Friday morning to 2583 in less than 9 hours of trading. It is also revealing that the S&P 500 was able to rally by more than 2% on something as silly as the potential of a Doji Star in Apple.
The S&P 500 was able to close on December 10 above the intra-day lows formed at 2603, 2631, and 2632, so technically the S&P 500 has the potential to rally in the next few hours/days. The 21 day average of the Net Advances minus Declines has formed a series of higher lows. The first divergence on October 24 and October 29 preceded the S&P 500’s rally to 2815. The second positive divergence developed on November 20 and was followed by the rally to 2800 on December 3. The current positive divergence has the potential to lift the S&P 500 to 2697 and possibly as high as 2740.
The S&P 500 traded under 2600 on December 10 which suggests the support at 2600 has been eroded with each successive test. The next time 2600 is tested a clean break below is likely to follow with a subsequent test of the February low of 2532.
In the November 5 WTR I made the following recommendation:
“A 25% short position in an inverse S&P 500 ETF (SH) can be established if the S&P 500 trades up to 2790 and increased to 50% if the S&P 500 trades up to 2805.”
The S&P 500 traded up to 2815 on November 8 triggering both positions. In the November 19 WTR I recommended covering half of the position if the S&P 500 traded under 2650 which it did on November 20. In the November 26 WTR I recommended:
“Use the 25% that was covered when the S&P 500 traded below 2650 to add to the short position if the S&P 500 rallies above 2730.”
The S&P 500 rallied above 2730 on November 28 after Powell’s speech. Tomorrow December 11 cover the 25% short position established on November 28 at 2730 at the opening. Continue to hold the short position established on November 8 at 2805.
Use the 25% covered at the opening on December 11 to short the S&P 500 if it trades up to 2695. Increase the short position to 75% if the S&P 500 trades above 2740, using a close above 2820 as a stop.
Crude Oil-WTI
Saudi Arabia and Russia were expected to announce a production cut at their meeting on December 6 and they did. The problem is that the oil market isn’t convinced everyone will abide by the cuts. It will take weeks for production numbers to confirm and convince traders that the cuts are being adhered to by the members of OPEC. So far WTI crude oil prices have stabilized and as long as the February contract does not close below $49.50, oil is expected to rebound in coming months.
Three weeks ago I recommended a 33% position in the Alerian Master Limited Partnership ETF (AMLP) if it traded down to $9.56, using a close below $9.38 which is the 78.6% retracement of the rally from $9.30 to $9.85 as a stop. AMLP closed today at $9.31. AMLP yields about 8.5% so I’ll be looking for another entry point.
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. The U.S Sector Rotation Portfolio was moved 33% into cash/money market at 2738.30 on November 6, 66% into cash/money market when the S&P 500 opened at 2774.13 on November 7, and moved 100% into cash/money market fund as the S&P 500 moved above 2800. The average exit 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. Half of the position was covered when the S&P 500 traded under 2650 and SH was trading at $29.97. When 9 the S&P 500 exceeded 2730 on November 28, the 25% that was sold when the S&P 500 traded under 2650 was bought with SH trading at $29.03.
The MTI fell below the blue horizontal trend line last week so the probability of a bear market has increased. This alone does not preclude the potential of the S&P 500 experiencing a bear market rally. But the MTI signal is one reason why I favor looking for the opportunity to go short rather than trying to play a counter trend bounce from the long side.
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.
.
