Written by Jim Welsh
Macro Tides Weekly Technical Review 08 April 2019
As expected the markets have followed through on the strength generated by the surprise improvement in the Caixin/Markit Manufacturing Purchasing Managers’ Index (PMI) reported on April 1. Equity investors have assumed that this signals an allclear for the global economy.
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While the expected improvement in China will help Germany and the European Union that derives almost half of its GDP from exports, the turnaround may not develop as quickly as presumed. The monthly improvement in the Caixin/Markit Manufacturing PMI was the largest in years, which increases the potential for a modest setback in the next couple of months.
This report suggests a period of stabilization has likely begun, rather than a V-shaped economic rebound. Secondly, even under the best outcome it will be a matter of months before the improvement in China begins to materialize in German data.
The weakness in Germany’s PMI suggests that the recent bout of weakness is likely to persist in the short term. After falling well below 45 signaling a contraction, Germany’s PMI is likely to remain under 50 and still reflect a slowdown. It will take a move above 50 to indicate Germany’s PMI contraction has ended and that a rebound is afoot. World trade represents almost 30% of global GDP.
The leading indicators for World Trade suggest the period of softness may extend. The next few months are likely to contain a mixed bag of reports out of China, Germany, and the EU as the process of stabilization evolves into an actual firming in activity in the third quarter.
Most investors were overly concerned about the global economy in the fourth quarter. My view was that investors were reading way too much into the declines in oil prices, Treasury yields, and FAMANG stocks, which were in large part the result of the unwinding of very crowded trades. The slowdown in the global economy certainly lit the fuse and reinforced what investors thought the markets were telling them.
The willingness to now accept one report from China as evidence that all is well is confirmation that the rally in the S&P 500 has convinced investors that blue skies extend to the horizon. The cover story in this week’s Barron’s “Is The Bull Unstoppable?” has to give any contrarian some pause, since it reflects a high level of complacency which is at least a yellow caution flag.
Markets don’t top and decline just because of a headline. There must be a fundamental reason to induce buy and hold investors like mutual fund managers that it is in their best interest to sell. In the short term there is no big reason, but there are a number of factors that could lead to a modest setback.
I thought the market would follow through based on the strength in response to the good China news:
“The strength of today’s move suggests there should be some follow through in the next few days. Although the Transports did not make a new today they likely will soon, if there is some additional strength. More importantly internal breadth on the NYSE and NASDAQ, as measured by the 21 day net advances minus declines, are well below the levels reached in mid February. These negative divergences may be negated if there is strong follow through in market breadth in the next few days. If the market only pushes modestly higher, (less than 1%), these internal momentum shortfalls will carry a bit more weight.”
The follow through in breadth was decent but not strong. The S&P 500 is almost precisely up 1% and the 21 day Net Advances minus Declines improved but is still well below the mid February highs and now Overbought. The same can be said for the NASDAQ except that the 21 day Net Advances minus Declines weren’t as strong as on the NYSE in mid February and also posted a lower high last week compared to February.
Between the China PMI report last Monday and the better employment report on Friday, the market has been getting good news. Although it has moved up, the move higher has been just OK and maybe not as strong as the data would have warranted.
Click on any chart below for large image.
The divergence between the NYSE Advance / Decline and the NASADAQ Advance / Decline is not a plus. Although breadth on the NASDAQ improved last week it is still well short of the peak in September.
A push to 2910 would complete another 5 wave rally from the low on March 27. This suggests that a short term high could occur as soon as tomorrow. The key is whether an upcoming pullback causes the S&P 500 to drop below a prior low. In this case that would be 2865 the low on April 3 since that is wave 4 of lesser degree.
The month of April has been a model of consistency for the stock market, as it has recorded positive investment returns over the last 10 years, 20 years, and since 1950. That does not mean every April has provided investors a profit. But compared to May, June, August, and September, April is a shining star.
One of the main reasons for the good performance in April is money flows into individual retirement accounts (IRA’s) to capture the tax deduction for contributions. Much of the contributions go to mutual funds that then deploy the inflows into stock purchases lifting the S&P 500.
As discussed last week, a test of supply and demand awaits the market in the second quarter as up to 60 IPO’s offer close to $250 billion worth of supply. Mutual fund cash levels are low and between April 7 and April 21 the majority of companies in the S&P 500 will not be able to buy back their stock due to the quarterly blackout period surrounding earnings reports. This year the headwind coming from a tsunami of Initial public Offerings (IPO’s) could swamp the inflows from IRA contributions. Even if the market is able to hold up during April, the IPO supply issue could pose a problem for May and June, which historically haven’t been great months.
The stock market could also experience some selling from those adversely affected by the changes in the tax law which limit state and local tax deductions in high tax states like California, New York, New Jersey, and Connecticut. The increase in taxes shocked many from these states and could force some people to sell stocks to raise cash so they can render to Uncle Sam his due.
The U.S. economy slowed in the first quarter but the slowdown was worse in Europe and in Asia. S&P 500 companies derive more than 40% of their sales and earnings from overseas so internationally exposed companies are not likely to be aggressive in their guidance for the second and third quarters. For many companies the visibility from the first quarter hasn’t improved. Brexit is still undecided and although there is optimism that a trade deal with China will be achieved, few companies will be willing to count their chickens before a deal is hatched. Investors have lowered their expectations but have they lowered them enough? In some cases companies will provide a surprise but my guess the majority will provide guidance that is uninspiring. Certainly not the end of the world but tepid guidance may be enough to unleash some profit taking.
The European Central Bank meets on Thursday and is likely to beat the same drum they did on March 7 when it lowered the 2019 GDP estimate from 1.7% to 1.1%. On March 7, the Euro dropped sharply and a repeat performance seems likely. If it does, the Dollar will get a boost which may cast a pall over the 5 outlook for second quarter earnings for multi-national companies. This could result in some modest selling pressure.
None of these points even combined are enough to cause a meaningful setback in the S&P 500 at this time. The test is whether any pullback holds above 2865 or generates enough selling pressure to suggest additional weakness may be forthcoming.
While the very near term is likely to be boring, there is a cloud forming that will sooner or later rain on the party. The decline in volatility since the low in December, Federal Reserve being on pause, and worst fears about the global economy being put to rest has emboldened hedge funds that like to short the VIX.
The positioning in the VIX futures (Non-Commercial Net) is more aggressive than it was in September and more extreme than in January 2018. The net speculative short position in the VIX as a percent of open interest reached the highest level in history at the end of March 2019. This suggests the tinder for the next sharp increase in volatility in the stock market is already in place just waiting for a spark to ignite it.
Euro
As long as the Euro remains under the down trend line, the trend is down. On Thursday Mario Draghi is likely to emphasize that ECB policy will remain accommodative which may be perceived as a negative for the Euro.
Dollar
The Dollar continues to flirt with the down trend line from the high in December and in March which also occurred at 97.71. The Dollar looks like it is poised for a quick pop that could carry to 100.00, and a selling swoon in the Euro after the ECB meeting on April 11 could provide the fuel.
Gold
Last week Gold tested the range just above $1280 that it first probed in early March. The expectation is that any further strength will hold under $1324 and may not even exceed $1311. Gold is still expected to fall below $1275 which will trigger some stops and potentially lead to a drop to under $1260. The expectation has been that Gold is completing a triangle that began in July 2016 at $1375 and all that remains is one more drop to complete wave e of the triangle. This pattern suggests that the next big move in Gold is up and will likely carry it above the July 2016 high and possibly above $1450.
Gold Stocks
The relative strength of Gold Stocks to Gold continues to improve (bottom panel). This is a long term positive for the Gold Stocks and implies that if Gold does drop below $1260 the Gold Stock ETF (GDX) may not decline below $21.40 (purple horizontal trend line) which has been the expectation. I would recommend a 33% position if GDX falls below $21.60.
Treasury Bonds
Last week the expectation was that TLT would, after completing wave 4 of (C), rally above $126.69:
“TLT rallied to $126.69 which appears to the high for wave 3 of (C). The sharp decline on April 1 after the positive news from China is likely wave 4.”
However, if TLT trades below $122.23 it will overlap wave 1 (in red), which could change the pattern and allow for a decline below $119.00. A buying opportunity would present itself if TLT does drop below $119.00 since the odds still favor a rally above $126.69 and potentially to near $129.00.
British Pound
The British Pound tested the rising black trend line again on April 5 and needs to close above 129.10 to complete an inverted head and shoulders pattern. A close above 129.10 projects a rally to 135.80 – 137.00. A 100% position was recommnded at an average price of 127.79.Use stop on 50% of the position on a close below 126.10 with a stop of 125.70 on the remaining half.
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.
When the S&P 500 closed at 2872 in January 2018 the Weekly RSI was an all-time record high 91.2. In August 2018, as the S&P 500 made a higher closing high, the Weekly RSI had dropped to 69.4 and slipped to 69.2 as it made an even higher closing high in September. With the S&P 500 closing at 2895.77 on April 8 (today), and less than 1.6% from its record closing high of 2941 last September, the RSI is just 62.4.
This is a large negative divergence and a long term negative. With the RSI so far below 70 and so close to the all-time high, it is a sign that upside momentum has been waning since January 2018. This is supportive of the potential for another decline that tests or modestly falls below the December low, or at least brings the S&P 500 down to 2630 in coming months for wave 2 of 5.
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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