Written by Jim Welsh
Macro Tides Weekly Technical Review 15 April 2015
Two weeks ago global equity markets were heartened after China’s Caixin/Markit Manufacturing PMI recorded the largest increase in years. As noted last week the quick assumption that this indicates that a V-shaped economic rebound will follow may have been overdone in the short term:
“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.”
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This view was reinforced by a new estimate of global growth for 2019 by the International Monetary Fund (IMF). On April 10 the IM F lowered its estimate for global GDP in 2019 to 3.3%, which is the lowest rate of growth since the financial crisis.
As recently as October 2018, the IMF thought GDP growth would be 3.7%, which was then lowered to 3.5% in January. The rapid deceleration is setting off alarm bells as is the low estimate of growth. This is resonating with investors since U.S. GDP growth has also slowed from 4.2% in the second quarter of 2018 to 3.4% in Q3 and 2.2% in the fourth quarter. Most estimates of GDP for the first quarter of 2019 are around 1.5% so the slowing has carried into 2019.
Most investors drive their car by looking through the rear view mirror so they expect the slowing in the global and U.S. to persist and cause the Federal Reserve to lower its federal funds policy rate in December or January 2020. One can drive a car by looking through the rear view mirror as long as the road remains in a straight line. As we all know the economy does not proceed in a straight line, which often causes investors heart burn. Rather than looking backwards you need to be looking forward for signs that the current slowing may change, especially since the current expectation of a rate cut is so widespread.
The improvement in China’s economy is good news for Germany and the EU, but it will take months for this to develop. This suggests that a pick-up in EU data can realistically be expected to show up probably early in the third quarter. Once economic activity improves in the EU, the perception of the global economy will change from expecting more weakness to acknowledging things are getting better. A turn in perception will also cause the 10-year German Bund yield to move higher, after dipping below 0% for most of March and early April.
This has certainly been one of the factors pulling down Treasury yields. A reversal in the German Bund yield would likewise allow Treasury yields to find less resistance in rising as I expect in the second half of 2019.
The vast majority of investors expect the Federal Reserve to lower the federal funds rate before the end of 2019. The real surprise for the bond and stock market would be if Treasury yields rose by more than 1.0% by early 2020. 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. This stabilization window may allow Treasury yields to form a bottom while the S&P 500 completes a top near Memorial Day on May 27.
Stocks
As referenced last week, the cover story in the April 8 edition of Barron’s was “Is The Bull Unstoppable?” This has to give any contrarian some pause, since it reflects a high level of complacency which is at least a yellow caution flag. The weekly Investors Intelligence survey found last week that the percent of Bulls rose to 53.9% while the Bears were just 19.2%. The Bull-Bear spread was 34.7% and the highest since August 3, 2018. The spread can get wider as it did in September 2018 and at the end of 2017. But one thing is clear. The deeply negative sentiment that prevailed in December has been replaced by a growing surge in optimism.
Click on any chart below for large image.
After breaking hard in the fourth quarter, the S&P 500 has returned to the underside of the blue trend line (chart above), which connects a number of lows since February 2016. This is a common pattern in which a market average or individual stock falls below an important trend line of support or resistance, and then checks back to test the trend line before reversing. In this case the reversal would be down.
On Friday the total Call/Put Ratio (C/P Ratio) rose to 1.487 which means that investors bought 148.7 calls for every 100 puts purchased. As the table reflects this is one of the highest daily numbers in the past 15 months.
In January 2018 there were two high readings before the S&P topped on January 26, and 3 before the S&P 500 recorded its high on September 21, 2018. High C/P Ratios more often appear near the end of an extended rally so this is another caution sign. The S&P 500 completed a streak of moving higher for 8 consecutive days on April 8, a feat that doesn’t happen that often. As might be expected long streaks usually occur as the S&P 500 is coming off an important low, or near the end of a multi-month rally.
Measures of sentiment suggest that the S&P 500 is nearing a top but probably not quite there. That’s why one must use technical indicators to measure upside momentum to quantify whether momentum is getting stronger, rolling over, or weaker as the S&P 500 grinds higher. Let’s look at some trend lines. The black trend line connects the secondary low on January 3 with the intra-day low on March 8 and closing lows on March 25, 27, and 28. The green trend line dates back to the low in February 2016, November 2016 and lows in March and April 2018. The S&P 500 is nearing the apex of these two trend lines so it is approaching a possible inflection point.
A breakout above the green line should lead to a test and likely new high above 2940. A close below the black line would suggest that the S&P 500 is beginning the process of rolling over, while a close below the blue trend line would be further confirmation. Since the S&P 500 has not traded below a prior low, a decline below the recent of low of 2785 would indicate that it was setting the stage to enter the getting weaker phase.
A subsequent rally that takes the S&P 500 to a lower high, or a higher high on far less upside momentum, would prepare the S&P 500 for a decline. This is what happened in September prior to the fourth quarter plunge.
The analysis of the trend lines suggests that the prerequisites for a meaningful decline are not yet in place, although measures of sentiment indicate that a top could form within the next 6 weeks.
The 21 day Net Advances minus Declines is still below the mid February highs and Overbought. The loss of upside momentum in this internal measure of market breadth increases the probabilities that the S&P 500 won’t break out above the green trend in the previous chart. Instead, the odds are increasing that the S&P 500 will soon break below the black trend line and test the blue trend line.
As expected the S&P 500 rallied to 2910 which was identified as a potential high last week:
“A push to 2910 would complete another 5 wave rally from the low on March 27.”
This 2910 target was calculated by adding the 45 point rally for wave 1 to the low of wave a within wave 4 at 2865. The width of the triangle formed between April 3 and the wave b high on April 8 at 2895 is 30 points (2895-2865). The low for wave e of the triangle on April 11 was 2882 which produced another target of 2912. (2882+30= 2912)
The S&P 500 rose to 2910 on April 12 and has at least stopped rising which suggests the 2910 area has the potential of being an inflection point. However, the S&P 500 has yet to decline in a 5 wave pattern to confirm at least a short term high.
Finally, there is the element of time. The S&P 500 peaked on January 26, 2018 and recorded the trading low on April 2, so the decline lasted just over 3 months. After peaking on September 21, the S&P dropped until December 26 or just over 3 months. It could be argued that the rally off the April 2, 2018 low lasted until October 3, since it was just 1.05 points beneath the high on September 21. If the rally off the December 26 low also lasts about six months a top would be expected near Memorial Day May 27.
Dollar
As long as the Dollar holds above the March 20 low of 95.74, the potential for a quick pop that could carry to 100.00 can’t be eliminated. However, positioning in the Dollar has become a crowded long trade, so the next really big move is more likely to be down than up
I think the Fed may be forced to consider raising rates again before the end of 2019. Most investors would expect the Dollar to rally. They assume higher rates in the U.S. would attract global money flows and push the Dollar higher. They are forgetting what happened between January 2017 and March 2018. The Fed increased the federal funds rates 4 times by a total of 1.0%, but the Dollar fell from 103.80 to 88.25 a loss of 15.0% despite the allure of higher interest rates. So much for logic!
Euro
The positioning in the Euro suggests that an upside reversal is coming. Positioning is not quite as extreme as it was in early 2017, but it shows that the Euro is becoming a crowded short.
As long as the Euro remains under the down trend line, the trend is down. However, once the Euro breaks out above the down trend line a rally to 1.17 could follow within a few months.
Gold
Irrespective of any short term squiggles, Gold is still expected to close below $1275 and then fall below $1260.
Gold Stocks
The Gold stock ETF (GDX) bounced off the short term orange trend line on April 15, which would allow GDX to rally above $22.93 before another short term high is recorded. If Gold falls below $1260 GDX retains the potential to drop below $21.50 and possibly as low as $20.50. The depth of any decline will be determined by the relative strength of the Gold stocks to Gold. The relative strength of GDX to Gold has been improving since the early September low in GDX (bottom panel).
Treasury Bonds
TLT has yet to trade below $122.23 and overlap wave 1 (in red), which could change the pattern and allow for a decline below $119.00. Until TLT rallies above $126.68 or below $122.23, it is in no man’s land.
British Pound
The British Pound is nearing the apex of a triangle so it nearing an inflection point. The EU hs agreed to given Britain until October 31 to decide the fate of Brexit. The British Pound will make a decision long before the British government resovles the Brexit issue. The expectation is that the Pound will breakout to the upside. 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 on February 26, as it did on March 30, 2016. This increases the probability that a bull market has been confirmed. Prior to a decline the MTI would be expected to at least flatten out as it did in September. However, the reversal in January 2018 was so quick the MTI effectively topped as the S&P 500 peaked.
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 2907.41 on April 12, and less than 0.8% from its record closing high of 2930 last September, the RSI is just 63.1. 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 closing 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.
