Written by Jim Welsh
Macro Tides Weekly Technical review 17 March 2019
New Recovery High for the S&P 500 But Vulnerabilities Appear
As discussed last week there were technical indications that the S&P 500 was expected to finally surmount the heavy resistance zone between 2800 and 2816 in order to potentially complete wave 5 and the rally from December low, or at least wave a of Wave (B).
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From last week:
“The price target for wave 5 of wave c of Wave (B) is 2834 to 2847 and is likely to occur quickly.”
After bottoming on March 8 at 2723, the S&P 500 rallied in 5 of the next 6 trading days and reached 2835 on March 18.
With the S&P 500 closing above such an obvious level of resistance, technicians will be sounding the all clear. In the short termit is a positive for the S&P 500 but a number of the other major market averages have not traded above their February levels. The S&P 500, the Nasdaq 100, and the DJ Utility average have ‘broken out’ (green trend line), but the Dow Jones Industrials, Transports, and Russell 2000 have failed to exceed their February 2019 highs (Red trend line).
This has created a negative inter market divergence. This is bit like one or two cylinders in a 6 cylinder engine not pumping in concert with each other. This type of divergence is evidence of vulnerability and often appears before a modest pullback.
Click on any chart below for large image.
In addition the 21 day average of Net Advances minus Declines for the NYSE and the NASDAQ are well below the levels reached in February. This suggests that market breadth has been narrower since the low on March 8 than during January and February. This indicates that fewer stocks are participating and anothersign that the market has become more vulnerable to a pullback.
Although the S&P 500 has exceeded its high in February, the Equal Weighted S&P 500 has not. Each of the 500 stocks in the Equal Weighted S&P 500 contributes 0.2% to its price, while the S&P 500 is weighted according to each company’s capitalization. As the market rallied off the low on December 26, the Equal Weighted S&P outperformed the S&P 500 until February 20. Since then the relative strength of the Equal Weighted S&P has weakened significantly, which is at least a short term negative for the market.
Last July the relative strength of the Equal Weighted S&P weakened but the Equal Weight S&P simply went sideways. In October and December Weakening led to declines. This highlights an important point – technical indicators suggest the market is vulnerable but the depth of any pullback will be determined by the degree of negative news that appears in coming weeks.
Although the technical indicators cited support the potential for a pullback, the NYSE Advance / Decline line has made a modestly higher high than in February. The 21 day of the percent of stocks making a new 52 week highs has also managed to eke out a new high.
The expectation is that the S&P 500 could experience a pullback to the March 8 low of 2723 or 2685 before rallying again into April or early May. If after a pullback the subsequent rally exhibits more technical deterioration, the S&P 500 will become vulnerable to a deeper correction that could test 2630.
Market breadth needs to be quite negative during that the decline, and the number of new 52 week lows would be expected to expand dramatically.
My guess is that the S&P may experience a correction (2723 – 2685) and then a subsequent rally to a lower high before the market becomes more vulnerable to a large decline. If the S&P 500 is going to fall below the December low in 2019, it will be spurred by negative economic fundamentals (trade deal failure), or a shift by the Federal Reserve to raise rates that convinces long only money managers that it is in their best interest to sell.
British Pound
My expectation has been that there would be no hard Brexit and that Britain would eventually choose to have another referendum. The odds of this outcome have risen in recent weeks which has helped the British Pound to rally. Technically the British Pound appears to have formed an inverted head and shoulders pattern since last July. A close above 129.10 on the British Pound ETF (FXB) would complete the pattern.
The distance from the bottom of the head (121.10 and the neckline at 129.00) is 7.9 points and projects a rally to 135.80 – 137.00 once FXB closes above 129.10. A 50% position is recommended below 129.00 which can be increased to 100% if FXB drops below 126.80. A stop of 125.40 is suggested.
The British Pound has a weighting of 11.9% in the Dollar Index. If the Pound does manage to rally to 136.00 in coming months, it would rise by at least 6.0% and contribute to a loss of about 0.75% in the Dollar Index.
Euro
A resolution to Brexit would be a plus for the Eurozone and the Euro. The biggest risk is a breakdown in the U.S. and E.U trade talks. President Trump has until mid May to make a decision regarding the 25% tariffs on auto and auto parts exports from the E.U. The Euro has been bound within a channel so it does have the potential of recording a lower low.
I would recommend going 50% long the Euro if it does trade below 1.1170. This risk would be reduced if the Euro is able to close above the upper channel line at 1.1380. Irrespective of the short term, the expectation is that the Euro will trade up to 1.17 in 2019.
Dollar
After closing above 97.38 the Dollar has slumped back to 96.51, which makes it appear that the breakout was a head fake out. As long as the Dollar does not close above 97.38, the outlook is that the Dollar will drop to 94.00 or lower in coming months. The chart pattern of the British Pound and Euro suggest those currencies are poised for a rally.
In addition, the positioning in the currency futures indicates that the long Dollar is a crowded trade.
As with all crowded long trades, once price support is broken, the longs in the Dollar will become sellers which will push the Dollar lower. A close below 95.00 would start the liquidation of longs.
Gold
After Gold traded down to $1282 on March 5, a short term bounce was expected that could test $1310 before another decline began. Gold rebounded to $1310.99 on March 13 before falling back. Gold dropped $64.00 after peaking at $1346 on February 20. An equal decline of $64 would allow Gold to test or slightly fall below $1250 which is the expectation in coming weeks. The next low in Gold could provide the last buying opportunity before Gold breaks out above the July 2016 high of $1375 and trades up to $1425 – $1450.
Gold Stocks
The relative strength (Gold GDX Ratio) of the Gold Stocks has been improving since Gold stocks bottomed last September. This is a longer term positive and would be further enhanced if the Gold GDX Ratio is able to close below the green trend on the Ratio. It is interesting that the black relative strength line has twice bounced off the green trend line, before reversing up as the Gold stocks have weakened a bit.
After spiking to $23.70 on February 20, GDX traded down to $21.40 on March 4, before bouncing off the orange uptrend line and the horizontal purple trend line. GDX bounced to $22.97 on March 13. An equal decline of $2.30 would bring GDX down to $20.67. This suggests that the orange and purple trend line will be broken which would likely lead to increased selling pressure. If GDX drops under $21.00, it will likely provide a good buying opportunity. If Gold rallies above $1400.00 in 2019, GDX is likely to rally above $25.00 and test the highs from September 2017 and January 2018. If GDX closes above $26.00, a move up to $31.00 is possible.
Federal Reserve
The Federal Reserve will leave its policy rate unchanged at the March 20 meeting but may finalize details of the unwinding of its balance sheet. The one piece of information that could rattle the markets is the Fed’s dot plot. At the December 2018 meeting the dot plot indicated that the Fed would increase rates 2 times in 2019, rather than the 3 times it had projected at the September meeting. Currently, the markets are pricing in a 33% probability that the Fed will be cutting rates before the end of 2019.
The markets would definitely be shaken if the dot plot reaffirms the outlook for 2 hikes in 2019, and might not like it if one is affirmed given the pricing of a cut before the end of 2019.
The expectation is that global growth has begun the process of bottoming and should exhibit signs of firming by mid-year. The Goldman Sachs Current Activity Index turned up in February so the U.S. economy may begin to show a bit more strength by April.
There are also increasing signs that the liquidity provided by the Peoples Bank of China and cuts in banks Reserve Ratio will be followed by an increase in lending in China.
And the Citi Economic Surprise Index for the Eurozone has turned higher as recent economic reports have been stronger than estimates.
The Fed will remain patient until they have actual proof that the global economy is on the mend and that the risk from trade and tariffs has passed. The FOMC has also indicated that it will be more tolerant if PCE core inflation does rise above 2.0%. However, if all goes well with trade, the markets may be too dovish in expecting the next move to be a cut in rates. At a minimum it will take several months for this to play out, and much can change, especially if the trade talks with China or the E.U turn sour.
Treasury Yields
The expectation was that Treasury yields would rise in the short term and potentially set up a good buying opportunity in anticipation for yields to fall to near the lows recorded in September 2017. In September 2017 the 10-year Treasury yield fell to 2.034%, while the 30-year yield reached a low of 2.651%. Rather than rising Treasury yields have fallen so the pattern may have changed.
Last week I provided the following instructions:
“A 33% position in TLT is recommended if TLT trades down to $120.20 which can be increased to 66% if TLT trades below $118.64.”
For now I’m going rescind these instructions and wait to see if yields are going to climb in coming weeks and provide an entry to buy the Treasury ETF (TLT).
Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking
The MTI generated a Bear Market Rally (BMR) buy signal on January 16, 2019 (green arrow) and climbed above the green horizontal trend line last week, as it did on March 30, 2016. This increases the probability that a bull market has been confirmed. This does not negate the potential of a pullback to 2720 – 2680 in coming weeks. Corrections of 4% to 7% are common in a bull market, which would allow the S&P 500 to fall to 2630.
My guess is that the S&P may experience a correction during the next few weeks (2680 – 2723) and then a subsequent rally to a lower high before the market becomes more vulnerable to a larger decline. If the S&P 500 manages to make a higher high, but the market internals weaken further, a more significant decline that carries the S&P 500 down to 2630 would become more likely. If the S&P 500 is going to fall below the December low, it will be spurred by negative economic fundamentals that convince long only money managers that it is in their best interest to sell.
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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