Written by Jim Welsh
Macro Tides Weekly Technical Review 04 February 2019
In speeches and interviews since January 4 FOMC members and Fed Presidents signaled that the FOMC would be patient in coming months and allow incoming data to drive their next decision on interest rates. FOMC members will not only have to be confident that the slowdown in the U.S. economy represents a soft landing followed by enough strength to confirm their forecast of 2.3% GDP growth in 2019, but see evidence that inflation is also firming.
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In the short term inflationary pressures are likely to recede due to the decline in oil prices as they filter through the economy. This was evident in the ISM prices paid index which has tumbled since September.
Although headline CPI inflation is expected to fall in coming months, core inflation is likely to remain resilient, especially since wages are likely to continue to rise. Average hourly earnings have been above 3.0% for the past six months which is the longest stretch since 2008. The Employment Cost Index (ECI) leads changes in wages and salaries by 8 months and indicates that wages will climb further in 2019. This will support core inflation and pose a profit margin problem for corporations as their labor costs rise while the economy slows. This will make it tougher for companies to raise prices to offset higher labor costs.
The global economy is expected to slow more in the first quarter. Germany is the engine of growth for the European Union and has slowed down noticeably as has France, and Italy is officially in a recession.
A resolution on Brexit between Great Britain and the E.U., a compromise in the trade talks with the U.S. and the E.U. (which hasn’t received the attention it deserves), and a clear pathway for trade negotiations between China and the U.S. would remove the high level of uncertainty surrounding each of these issues and lead to an increase in decision making so companies can move forward. Until those minor details are clarified more slowing is coming.
The slowdown in the global economy was seen in the sharp drop in the ISM Manufacturing Export Order Index. The negative feedback into the U.S. economy from the global economy will continue in the first quarter if the global economy slows as expected.
The combination of global slowing, energy sector weakness, higher interest expense, and higher wage costs weighed on earnings growth in the fourth quarter. The Median Earnings Beat in Q4 is the lowest in 7 years according to Factset. In aggregate Q4 earnings are now expected to up less than 1%. As growth slowsin Q1 concerns could increase about the potential for an earnings recession and become a topic of conversation. This could lead to a bout of profit taking after the S&P 500’s nice run from the low in December.
Corporate insiders may already be responding to this potential since Insider selling has increased meaningfully as the S&P 500 has rallied to start the year. Insider selling is back to where it was in early September and just before the market topped on September 21. This is not a timing indicator per se but insiders were aggressive buyers in late December and are now turning more cautious. The Fed hitting the pause button has been priced into the market but may not be sufficient to sustain the rally if concerns about an earnings recession mount.
Stocks
The strength of the rally since the low on December 26 has included a breath and volume thrust in which the ratio of advancing to declining stocks and up and down volume exceeded 9 to 1 on December 26 and January 4. This strength has forced me to alter the expectation of a retest despite the historical data going back decades that indicated that a retest was the most likely outcome after the deeply oversold condition was achieved on December 24.
The challenge and goal has been to identify the high for wave a of Wave B since it will provide guidance as to how much of a correction can be expected to complete wave b of Wave B. From the intra-day low on December 26 the S&P 500 was rallied in a 5 wave pattern to the high on February 4.
Click on any chart below for large image.
Within a of Wave B, wave 4 formed a triangle between January 18 and January 29. Wave 4 triangles frequently are followed by a thrust higher for wave 5 that often carries the width of the triangle above the high in wave 3. The width of the triangle was 2675 – 2614 or 61 points. This suggests wave 5 of wave a of Wave B can reach 2736, which is just above the high on February 4 at 2725. The 200 day average of the S&P 500 is 2741, so the S&P 500 is coming into a range where a reversal lower is likely.
Once wave a of Wave B is complete calculations can be made as to the depth of the coming correction, which would represent wave b of Wave B. A decline below 2675 would increase the odds that wave a of Wave B from December 26 is over. The expectation is that b of Wave B can bring the S&P 500 to 2600 or lower.
Dollar
The expectation remains that the Dollar Index can fall to near 94.00, which is near the low in September in coming months.
Treasury Yields
In the January 28 WTR the expectation was that the next move in 10-Treasury yield would reach the underside of the red trend line connecting the lows in July 2016 and September 2016 at 2.85%.
In the January 28 WTR the expectation was that the 30-year Treasury yield could test of the red trend line from the 2016 low near 3.15%
The CFTC, which publishes the data on positioning in Treasury futures, Dollar, Gold, S&P 500, VIX, and Oil, began to release data on February 1. Unfortunately, the CFTC will take about 3 weeks to catch up since they will publish one week of data on each Friday and Tuesday.
Gold
The expectation has been for Gold to trade above $1300 and potentially tag the trend line near $1340. Last week Gold traded up to $1325 so the upside from is likely to be limited if the triangle pattern is in effect.
As discussed this rally is in the context of a large triangle pattern that began in July 2016 when Gold traded up to $1375. The current rally from the low in August at $1160 would be wave d of the triangle and be followed by a decline representing wave e, which would finish Wave (B). If Gold completes the triangle in coming months, the next move should carry Gold up more than $300 in Wave (C).
Based on extreme positioning in Gold last spring I recommended buying GLD in May and June which proved premature. The average purchase price for GLD was $120.84. In the January 14 WTR I recommended selling 75% of the position at $123.25. GLD traded up to $123.29 on January 28. In the January 28 WTR Sell the remaining 25% if Gold traded above $1330 or GLD trades above $124.60 using $122.00 as a stop. GLD traded up to $125.07 on January 30. The average selling price was $123.58.
Gold Stocks
After dogging it from mid December until January 24, the relative strength of the Gold stocks to Gold caught fire once Gold pushed above $1300. As noted in the January 28 WTR the rally in GDX since the low on January 22 appears to be wave 5 from the low on November 13. If correct, GDX may be completing a larger a-b-c rally from the low in mid August and open the door for a meaningful correction, especially if Gold does pullback in wave e of its triangle. The high from April, May, and June near $22.90 should prove formidable resistance, as noted by the green down trend line.
Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking
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 on November 7. Half of the position was covered when the S&P 500 traded under 2650 and SH was trading at $29.97. When 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. This position was closed at the open on December 11 when SH opened at $29.60. The 16.5% position established on November 7 when SH was trading at $28.35 was closed on December 20 when SH was trading at $31.81.
The U.S Sector Rotation Portfolio established a 16.5% short position in an inverse S&P 500 ETF (SH) at $31.80, when the S&P 500 opened above 2470 on January 2. This position was increased to 33% when the S&P 500 traded above 2520 on January 4 when SH was trading at $31.16, and increased to 50% when the S&P 500 traded above 2575 and SH was $30.46. The average price for the SH position is $31.14. The SH position was stopped out on January 30 at $29.39.
The MTI fell below the blue horizontal trend line on November 21 so the probability of a bear market increased until the MTI climbs above the green horizontal trend line as it did in March 2016. If the S&P 500 does correct to 2600 or lower and technical indicators become strongly bullish (i.e. Call/Put Ratio, 10 and 21 day average of TRIN), it would indicate that wave b of Wave B was completing. Once a low is confirmed a long position would be warranted in anticipation of a rally to at least 2800.
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.
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