Written by Jim Welsh
Macro Tides Weekly Technical Review 28 May 2019
Support at 2800 for the S&P 500 Is Not Likely to Hold
Based on speeches and Tweets by President Trump, the initial trade negotiations with China seemed focused on narrowing the annual $500 billion trade surplus with the U.S. As the talks intensified and evolved it became clear that the U.S.’s strategic aim was addressing China’s failure to fulfill the responsibilities it assumed when China became a member of the World Trade Organization in 2001.
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Also in focus were the promises China has made in recent years to the U.S. to curtail its cyber espionage and corporate theft of intellectual property. For the U.S. these issues outweigh the annual trade deficit with China since they require fundamental changes in how China has manufactured its growth since the financial crisis.
President Trump has effectively drawn a red line and told China that it must alter the way it has be doing business not just with the U.S. but with the European Union, Japan, and the rest of the world, since China has used the same tactics against every industrial power.
The hardliners within China have a different perspective. The hardliners set a course for China years ago to reestablish China as the dominant nation in the world by 2049 which holds great symbolism for China. The hardliners believe China has become large and integrated enough within the global economy to successfully resist any pressure to change, and that no country has the right to tell China what it can or can’t do. This is why the trade negotiations broke down and why there has been an increase in state sponsored nationalism against the U.S. The hardliners within China are laying the groundwork for an extended impasse that could include the targeting of individual U.S. companies like Apple.
After China communicated its unwillingness to base future discussions on these strategic issues, President Trump threatened and then imposed additional tariffs on May 10. Rather than accepting a scaled down trade deal centered on narrowing the trade deficit with China, President Trump has conveyed his willingness to hold fast and accept the short term negative impact on GDP growth and the stock market to achieve the more important long term goal of reining in China’s penchant for operating outside of signed agreements.
Neither China or President Trump seem willing to blink, which suggests there will be a further escalation before talks are likely to resume.
The financial markets appear to be coming to grips with the new reality: no trade deal around the corner and the potential that more tariffs from the U.S. and China are coming, which will further weigh on global growth. In the first quarter GDP in the US was a stout 3.2% but that number is misleading. It was goosed 1.7% by a large increase in inventories, which is unlikely to be repeated, and a surge in exports and drop in imports.
In addition the GDP deflator in the first quarter fell from 1.5% to 0.6% in Q4, so inflation only subtracted 0.6% from nominal GDP in Q1 rather than 1.5% in the fourth quarter.
The economy is slowing in the second quarter and when the factors that lifted GDP in Q1 are reversed, second quarter GDP may be less than 2.0%. Growth in the first quarter was not as strong as estimated and the weakness in the second quarter is likely to be overstated as well. Investors are likely to attribute the weakness to the increase in trade frictions and drive the S&P 500 below 2800 and possibly below 2650 in the third quarter.
One cannot rule out an effort to dampen the increase in negativity before the G20 talks in late June. However, it is becoming clear that the trade negotiations are just part of a larger realignment of power between the US and China, as both countries wrestle with non trade issues that have the potential to shape which country dominates the world in coming decades. With so much at state a quick resumption of talks seems unlikely.
Stocks
After a long holiday weekend the S&P 500 jumped 0.5% at the opening on May 28 only to fade throughout the day closing barely above the low. As noted in the May 20 WTR:
“Based on the technical deterioration I’ve discussed in recent weeks, and the poor prospects for a quick resumption of trade talks, the downside risks in the market have increased. Sooner or later the S&P 500 is expected to fall below 2780 and test 2650.”
The S&P 500 closed at 2802 so a test of the intra-day low of 2785 on March 25 could come on May 29.
Click on any chart below for large image.
While the S&P 500 is trying to hold Key Support, the Russell 2000 has already broken below its Key Support and the NASDAQ 100 (QQQ) closed right near its Key Support on May 28. The market is not oversold as measured by the 21 day Advances minus Declines oscillator. As of the close on May 28 the oscillator was only at -112, which is nowhere near the -400 level that usually coincides with a short term low. This suggests the market can break below support before a more sustained oversold bounce takes hold.
Just as the S&P 500 bounced off its Key Support at 2600 – 2630 last October and November 3 times before plunging below it, the S&P 500 may experience another bounce in the next few days. There is a gap in the S&P 500 at 2851 so a rebound to that level is possible. Selling into a rally to 2850 if it develops seems appropriate.
In addition to becoming more defensive should the S&P 500 rally to 2850 aggressive investors can establish a 33% short position in the S&P 500. Although the odds of a rally above 2892 have diminished, aggressive investors can increase the short position to 66% if the S&P 500 rallies above 2880.
Gold
The expectation has been that Gold will drop below $1250 before a significant rally develops. However, if the S&P 500 closes below 2785, it could fall to 2725 quickly and potentially 2650. A sharp decline in the stock market could provide Gold the opportunity for a quick bounce to above $1301, which may complete an a-b-c rally from the low of $1266. Unless Gold is able to rally above $1325, a decline below $1250 is likely to follow.
Gold Stocks
Last week I recommended selling half of the 66% position in GDX if it traded up to $21.00 and the remaining half if GDX trades at $21.17, and to use a stop of $20.40 on half of the position if GDX failed to rally to $21.00. GDX traded up to $20.88 on May 23 and then triggered the stop at $20.40. If Gold pops over $1301, GDX may try again to push above $21.00. Sell the remaining half if GDX trades at $21.00.
Treasury Bonds
As noted in recent weeks the expectation was for TLT to rally above $126.69 which TLT accomplished on May 23.
As noted previously, the weekly chart suggests TLT may rally above the September 2017 high of $129.56. From the November low of $111.90 TLT moved up $11.96 and an equal rally from the February low of $118.64 would target $130.60. TLT rallied $8.05 from the low in February and an equal rally from the April low of $122.11 would target $130.16.
If TLT retraces 61.8% of the 27.13 decline from its high in July 2016 to the March 2017 low, TLT could extend the current rally up to 133.25. Once the current rally is complete TLT may have finished the corrective rally from the low in March 2017 for Wave (B) in red. This corrective rally would have taken the form of an a, b, c in green. If this pattern analysis is correct, TLT has the potential to decline below $105.00 by early 2020 for Wave (C), if Wave (C) is equal to Wave (A) (143.62-116.49 = 27.13)
The expectation has been that the 10-year Treasury yield was likely to drop under 2.30% and could breach 2.20%. On May 28 the 10-year Treasury yield fell to 2.264%.The 30-year Treasury yield was expected to drop under 2.77% and could breach 2.60%. On May 28 the 30-year Treasury yield fell to 2.698%.
A decline below 2780 by the S&P 500 in coming weeks could provide the motivation for Treasury yields to fall to these targets. From the momentum low in December 2016, TLT rallied until early September 2017 or just over 8 months. A comparable rally in time from the low in Treasury bond prices on October 5 would target June for the next high in Treasury bond prices and low in yields.
Dollar
The choppy trading in the Dollar continues. After making a new multi-month high on May 23 when the Dollar traded up to 98.37, barely above the prior high at 93.32, the Dollar quickly fell to 97.55 on May 24. Despite the choppy trading pattern since last November, the Dollar has continue to make higher highs and higher lows since it bottomed at 95.03 on January 10.
Although the Dollar could still push up to 100.00, sentiment and positioning argue strongly that an intermediate high in the Dollar is near. Although the Dollar and Gold often don’t trade inversely a push higher in the Dollar may be one of the factors that contribute to Gold dropping below $1250.
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 confirming the uptrend.
In the April 29 WTR I noted that there was an important negative divergence between the S&P 500 and the NASDAQ 100, and the majority of the other major market averages, as well as a loss of internal momentum:
“The S&P 500 pushed to a new closing high and a new intra-day all time high on April 29, along with the NASDAQ Composite and NASDAQ 100. The New York Composite Index is -1.7% below its September 2018 high and -4.4% under its January 2018 all time high. The Russell 2000 is -7.9% below its all time high while the DJ Industrial average is -1.2% short and the Transports are -4.1%. The fragmentation between the major market averages is not a sign of strength. Despite the new high by the S&P 500, internal strength as measured by the 21 day average of Advances minus Declines has continued to weaken (blue arrows). This confirms what the divergences between the market averages indicate: Fewer and fewer stocks are lifting the S&P 500 higher, while the majority of stocks tread water or fade.”
In the May 6 WTR I noted that the MTI had flattened out as the ascent in the S&P 500 had slowed which provided another warning that the S&P 500 was at risk for a pullback. The key is the S&P 500 holding above important support at 2780.
The progressive weakening in the technical structure of the market led me to reduce exposure from 100% to 50%. When the S&P 500 was trading at 2877 at 7am on May 16 I lowered the exposure in the Tactical U.S. Sector Rotation Model Portfolio from 100% to 50%.
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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