Written by Jim Welsh
Macro Tides Weekly Technical Review 03 September 2019
In the September Macro Tides entitled ‘Manufacturing Recession is Close, but No Broad Recession in Sight’, I noted that Export and New Orders in the July ISM PMI report were signaling that the overall PMI was likely to fall below 50 and into a contraction.
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“In July the ISM manufacturing index fell to 51.2 in July from 51.7 in June. The slowdown in Export Orders and New Orders, which are leading indicators, suggest the ISM Manufacturing Index is likely to drop below 50 in coming months. In July Export Orders fell to 48.1 while New Orders barely held above 50 at 50.8.”
The ISM Manufacturing Index for August was released on September 3 and the PMI Index dropped to 49.1. The new export orders component fell to 43.3 its lowest level since April 2009, and new orders dropped to 47.2. With export and new orders so far below 50, the overall PMI can be expected to fall further below 50 in coming months. The U.S. has now joined the manufacturing weakness that has already been apparent in Germany, Japan, South Korea, and the U.K whose PMI’s are already below 50.
The decline in the ISM increases the odds of a rate cut at the September FOMC meeting. Markets have pegged the odds of the FOMC lowering the funds rate at 100%. I think the FOMC is more divided about lowering the funds rate at the September meeting as discussed in the September Macro Tides. This was highlighted on September 3 when St. Louis Fed President James Bullard commented that a 0.50% reduction was warranted, while the Boston Fed President Eric Rosengren said he didn’t see the need for another cut until more signs of slowing in the U.S. were apparent.
This is a great example of why I’m not a big fan of the Fed’s forward guidance effort as noted in the September Macro tides:
“The bifurcation between manufacturing and the service sector in the U.S. is widest in memory and attempting to provide ‘forward guidance’ in such a fluid geopolitical environment is virtually impossible. I’m not a big fan of the Fed’s communication policy and believe that now less is more.”
Offering competing views about the economy’s health and future monetary policy on the same day is counterproductive, and everyone would be better served if nothing was said.
Stocks
The S&P 500 continues to transverse the 3.85% trading range it has been in for 4 weeks, after falling sharply in early August. My guess is (in the current environment guess seems appropriate) the S&P 500 can rally into the FOMC meeting in anticipation of another rate cut. Can Chair Powell in his press conference provide the kind of unambiguous forward guidance the stock market craves? I don’t think so, which suggests the market may be disappointed if it doesn’t receive a near guarantee from Powell that more cuts are coming.
Click on any chart below for large image.
The ECB will meet on September 12 and equity investors are likely to get pumped up about a one-two central bank punch that could briefly lift the S&P 500 above 2943. This could provide the ideal head fake before the S&P 500 reverses lower, and at least retests support at 2820.
Investors love the notion of central bank easing even if won’t do much to offset the uncertainty and impact from the Trade War. Ultimately, investors have to confront the reality that earnings are likely to fall further than currently expected, even if a recession is avoided as seems probable. As more sectors are affected by tariffs, companies will have to either absorb the increase in costs, or try to pass them along to their customers. Since most companies will find it difficult to raise prices enough to cover the cost of tariffs, profit margins are likely to come under pressure.
As firms report Q3 earnings in October, one can only imagine how many companies will cite tariffs and the uncertainty they have created as reasons for why they are guiding future earnings downward.
The expectation is that the S&P 500 can fall to 2730 – 2760 (key support) before a good trading low is established. A break below 2820 will cause an increase in selling pressure, an increase in negative sentiment, and an oversold condition that can support more than a bounce that lasts for just a few days.
If a drop to 2730 -2760 materializes, the Call / Put ratio (below green line) and the Option Premium ratio (above green line) should be at levels that have coincided with trading lows since the January 2018 high.
The 21 day average of Advances minus Declines should drop below the green horizontal line and indicate that the market is truly oversold, as it was in February 2018 and last December.
If the Call / Put ratio, Option Premium ratio, and the 21 day Advances minus Declines oscillator reach levels that indicate a good trading low, the rally may be pretty good. The Trade War has been going on for almost 18 months so it has been weighing on investor sentiment and positioning for quite awhile.
Institutions have sought refuge in the traditionally safe havens of Utilities, Consumer Staples, Real Estate, and other defensive sectors. The crowding into these sectors has almost reach levels that indicate a trading low may be near, as positioning in the ‘safe’ sectors has almost reached the extreme levels in early 2016. The Bank of America Bull & Bear market indicator has also fallen to near the levels it reached in the fall of 2011 and early 2016.
These two intermediate indicators suggest that the S&P 500 might have the potential to rally back to near its all time high after it drops to 2730 -2760.
For months I have presented the Megaphone pattern in the S&P 500 which indicated that the S&P 500 had the potential to fall to the December low of 2347 in coming months. Would a drop to 2750, followed by a rally that approaches the all time high negate the Megaphone pattern?
No.
The S&P 500 was expected to experience a large decline for wave a of wave e within the Megaphone pattern, with wave a tracing out a down, up, down pattern. Since the all time high in July, the drop into early August is the down, the sideways chop since early August is the up, and a decline to 2730 -2760 would complete wave a of wave e. The subsequent rally would represent wave b of wave e, and could approach the all time high. As noted the S&P 500 is expected to rally into the Fed and ECB meeting next week and may push above the rebound high of 2943 before the up portion from the early August low is complete.
The Volatility Index (VIX) broke above its down trend line on July 31 providing a good signal of the impending sell off. If a decline to 2730 – 2760 is to take hold, the VIX should close above 21.
Treasury Bonds
The 10-year Treasury yield fell to a lower low on September 3 continuing the relentless decline in global yields. The trend toward lower yields is intact and wouldn’t indicate the potential for an intermediate low until the 10-year Treasury yield closed above 1.63%. It closed at 1.466% on September 3.
The 30-year Treasury yield didn’t fall to a lower low on September 3. In the very short term this sets up a small divergence between the 10-year and 30-year. However, the trend toward lower yields is intact and wouldn’t change until the 30-year Treasury yield closed above 2.13%.
Dollar As noted last week the Dollar had the potential to rally to a new high which might pressure the stock market:
“A rally above 98.93 is still possible. Dollar strength appears to be playing a role in weakness in the stock market.”
The Dollar did set a new high on September 3 and the stock market fell. The Dollar may pull back as investors expect the FOMC to lower the funds rate, which is expected to lift the S&P 500 going into the meeting. From its low in late June the Dollar rallied by 3.1 points. An equal move up from the low on August 6 at 97.20 suggests the Dollar could reach 100.30 or at least test the rising trend line at 99.65 soon.
Once a high is confirmed, the Dollar is expected to fall as economists lower their GDP estimates for the U.S. in coming months. A drop to 95.85 seems likely.
Gold
Gold rallied sharply on September 3 after the U.S. and China exchanged tariffs blows, but has yet to take out the high of $1552.65 reached over night on August 26. As you may recall President Trump sent out two Tweets on August 26 in the wee hours of the morning saying the Chinese Vice Premier had called not once, but twice wanting to start talks again. Prior to Trump’s Tweets, the S&P 500 futures were down 45 points, and Treasury bonds and Gold were up big. I questioned the veracity of the President Trump’s Tweets last week:
“It appears there were no phone calls made by the Chinese. Instead President Trump ran with the quote from Vice Premier Liu He and simply said Liu He’s comments were made in a phone call. Seems like a wide credibility gap between a speech made in China repeating comments that have been made numerous times in recent months and a direct phone call from China to U.S. trade representatives. The irony is that this misstatement is from the guy who constantly complains about the media and fake news.”
On August 29 CNN confirmed there were no phone calls from China. White House aides
“conceded the phone calls Trump described didn’t happen the way he said they did. Two officials said Trump was eager to project optimism that might boost markets, and conflated comments from China’s vice premier with direct communication from the Chinese.”
I don’t know about you, but I’m counting to ten before I write another word.
On August 29 CNN confirmed there were no phone calls from China. White House aides
“conceded the phone calls Trump described didn’t happen the way he said they did. Two officials said Trump was eager to project optimism that might boost markets, and conflated comments from China’s vice premier with direct communication from the Chinese.”
I don’t know about you, but I’m counting to ten before I write another word.
Gold Stocks
Last week the expectation was that
‘If Gold does rally to a higher high, GDX is likely to exceed $30.00, as long as GDX does not close below $27.22.’
Although Gold has yet to exceed its August 26 high of $1552.65, GDX pushed to a new high on September 3. GDX continues to make higher highs and higher lows, so the trend is still up until that pattern changes.
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 confirming the uptrend. The progressive weakening in the technical structure of the market since late April led me to reduce exposure.
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%. I lowered exposure to 25% in the Tactical U.S. Sector Rotation program on June 11 after the S&P 500 gapped up to 2903 at the open. I lowered exposure to 5% from 25% at the close on Wednesday when the S&P 500 was 2913. I sold the 5% position in Technology ETF (XLK) shortly after the opening on July 1.
I established a 25% short position in the S&P 500 through the purchase of the 1 to 1 inverse ETF SH on July 23, when the S&P 500 traded above 2995 (SH $26.09). The short position was increased to 40% on August 8 when the S&P 500 was trading at 2930 (SH $26.69). The short position was reduced to 20% on August 29 when the S&P 500 was trading at 2920 and SH was $27.09.
If the S&P 500 rallies above 2943 around the FOMC or ECB meeting on September 11 and 12, I will likely increase the short position in SH back to 40%. If the S&P 500 does trade below 2760, I will likely cover the short position in anticipation of another sharp rally since the market will be over sold.
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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