Written by Jim Welsh
Macro Tides Weekly Technical Review 09 September 2019
Expectations that the U.S. economy was marching toward a recession were dampened after the ISM Non Manufacturing report and employment report for August were released last week.
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The ISM Non Manufacturing sector rebounded nicely to 56.4 in August recovering almost everything lost after a sharp drop in July. Since services comprise more than 85% of GDP versus 11% for manufacturing, the continued resiliency in services is a good sign. Despite the improvement in the overall Index, the employment component fell, which suggests the slowing in job creation in recent months is likely to continue.
The economy was strong enough in August to create 130,000 jobs, which included 32,000 government jobs. Through the first 8 months of 2019, monthly job growth has averaged 158,000 compared to 223,000 in 2018.
The Unemployment Rate held steady at 3.7% for the third consecutive month and wage growth was firm at 3.2%. It was also encouraging that the average workweek for all private employees increased by 0.1 an hour to 34.4 hours. While the modest uptick in hours worked is a plus, total hours worked are still down from year ago levels.
Overtime hours dropped by 0.1 hour in August from July and are down almost 9% from August 2018, which represents a big hit in pay.
There is no question that the economy has slowed but the strength in services and decent employment growth confirm that concerns about a recession, fanned by the inverted yield curve, have been misplaced. Expectations that the FOMC might cut the funds rate by 0.50% fell after these reports but investors think the FOMC will lower the funds rate by 0.25% on September 18 since the probability is 100%.
The European Central Bank meets on September 11 and is widely expected to lower the policy rate below -0.40%, and announce a resumption of bond buying. It is interesting that a few members of the ECB have expressed doubts about the efficacy of pushing the policy rate further below -0.40% or buying more sovereign and corporate bonds. Mario Draghi’s term as President of the ECB ends on October 31 and a proper send off will likely include the approval of more bond buying and a lower policy rate. Expectations for strong action at the September meeting were raised in mid August after Olli Rehn, who sits on the ECB’s ratesetting committee as governor of Finland’s central bank, suggested the ECB needed to go big Mr. Rehn said:
“When you’re working with financial markets, it’s often better to overshoot than undershoot, and better to have a very strong package of policy measures than to tinker.”
With expectations high there is a chance the ECB underwhelms and European bond yields rise rather than fall. The ECB has also hinted at the possibility of buying equities, so European stock markets may fall if a plan to buy stocks isn’t announced.
The FOMC meets on September 17 and 18 and will announce any changes to the funds rate on the 18th . The announcement that trade discussions will resume in October and the better U.S economic data will lead to a lengthy discussion by members of the FOMC. There is a divergence of opinions on the FOMC with some clearly favoring another cut, and those who would prefer to wait until the U.S. economy shows that it requires stimulus.
At the July 31 meeting two members (Rosengren and George) dissented with the FOMC’s decision to lower the funds rate by 0.25%. The September 18 meeting could prove a repeat. After listening to comments by various FOMC members who are not supportive of another reduction, the probability is a lot less than the 100% the market has it pegged. The FOMC will probably cut the funds rate again so the equity market doesn’t throw a tantrum. As noted last week:
“Investors love the notion of central bank easing even if won’t do much to offset the uncertainty and impact from the Trade War.”
This is why I thought the S&P 500 was likely to trade above 2943, as
“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.”
Stocks
The S&P 500 gapped above 2843 on September 5 after it was announced that Chinese and U.S. trade representatives would meet again in October. Investors want to believe that a trade deal will be consummated, the only question is when not if. There is an old saying that seems applicable now:
“Fool me once, shame on you. Fool me twice shame on me.”
I’m not sure what number we’re on, but it is certainly more than two but the market falls for it every time. The odds of a negative Trade Tweet in the next few weeks is low and the ECB and FOMC are likely to ease policy. The only question is whether expectations are so high that the markets sell on the news.
The S&P 500 is at a fork in the road and as Yogi Berra advised:
“When you come to a fork in the road, take it.”
The 78.6% retracement of the 206 decline from 3028 to 2822 is 2984. The S&P 500 traded up to 2989.43 on September 9 before closing at 2978.43. After the good trade news on September 5 the S&P 500 traded up to 2986. So despite good trade news and economic reports via the ISM Non Manufacturing report and decent employment news, the S&P 500 has made no net progress in three trading days. At the 78.6% retracement, it has reached a price level that could prove significant. The gap higher on September on the Trade News left a gap below the market (2943).
Click on any chart below for large image.
The Trading Index (black 10 day avg.) was oversold and supportive of a rally during August as it recorded a high level. It has plunged to a level that would indicate a short term high. The 40 day average (red) is still well above 1.0 which suggests more upside could follow any short term pullback.
The Call / Put Ratio (10-day average) has moved higher but is not near a level that normally is associated with a high. This indicates that there is still a reservoir of pessimism that could enable the S&P 500 to approach the prior all time high (3028)
The Option Premium Ratio never reached a high level and is dropping quickly but has not fallen to the red horizontal line that would indicate a high in the market .
The rally since the low of 2822 on August 5 is clearly a corrective rebound given the choppiness that consumed most of August. This implies that once this rally is complete a decline back to 2822 is possible. If the S&P 500 does fall to 2822 the odds favor this important level of support will not hold, which would set up a drop to 2730 -2760. The expectation is that should the S&P 500 fall to 2730 – 2760 (key support) a good trading low will develop that can support a more sustained rally.
The problem in the short term is that it is difficult to identify a reason why institutional investors would sell and raise cash. The rally on September 9 was a huge rotation out of the sectors that have performed well so far in 2019 (technology, REIT’s, utilities, staples) into the sectors that have performed the worst (financials, energy, industrials). The question is whether these down and out sectors can truly provide leadership over an extended period of time or was today’s big bounce a flash in the pan.
According to Bespoke, the 50 stocks that have performed the best in 2019 were down – 1.45%, while the worst performing rose a whopping +3.37%. On the day the S&P 500 fell -0.28 points. The trigger for the rotation was an increase in Treasury yields, was seen as a sign the economy wasn’t going into recession. Many traders had interpreted the yield curve inversion as a recession signal, so the widening in the yield.
If the prior leaders continue to correct, it could be an upward slog for the S&P 500 since Technology, Real Estate, Utilities, and Consumer Staples represent 35.11% of the S&P 500. The weighting of Financials, Energy, and Industrials is 27.50%. So far in 2019 Health Care (14.2%) has been neutral, while Consumer Discretionary (10.19%) has done well so it could be a swing factor.
Unless Technology and the interest sensitive sectors can move up during a rally led by the prior laggards, it is hard to see the S&P 500 pushing much above the prior high, and may not even retest it. My guess is that the S&P 500 can hold up until the FOMC meeting on September 18, and could press near the prior high of 3028 if it closes above 2989 in coming days.
Treasury Bonds
As noted last week, the trend toward lower yields is intact and wouldn’t indicate the potential for an intermediate low in yields, until the 10-year Treasury yield closed above 1.63%. After dropping to a new low of 1.429% on September 3, the 10-year Treasury yield jumped to 1.635% before closing at 1.622% on September 9. This reinforces the importance of 1.63%.
For months the 10-year Treasury yield traded within a channel until it crashed below the lower channel line in early August after President Trump increased tariffs. That lower channel trend line is currently at 1.68%. A rise into the channel would further solidify the technical evidence that Treasury yields had made an important low.
As noted last week the 30-year Treasury yield didn’t fall to a lower low on September 3, as the yield on the 10-year Treasury yield did. In the very short term this set up a small negative divergence between the 10-year and 30-year. This type of inter market divergence is often present at short term trend changes.
The trend toward lower yields wouldn’t change until the 30-year Treasury yield closed above 2.13%, as noted last week. The intra-day high on September 9 was 2.116% and it finished the day at 2.098%. The lower channel line for the 30-year yield is 2.29%. On September 9 the 10-year yield made a higher intra-day higher yield of 1.635% versus 1.623% on August 22, while the 30-year held below its prior intra-day high of 2.123% on August 23. This is a short term positive divergence so the next few days in the Treasury market and stock market are important.
Dollar
Last week I thought the Dollar would pull back as investors expect the FOMC to lower the funds rate, which I expected would lift the S&P 500 above 2943 going into the meeting. The Dollar hit its high of 99.37 on September 3 and has pulled back. However, until the Dollar Index drops below 98.00 it still has the potential to move to another modest new high.
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 100.10 – 100.30, or at least test the rising trend line at 99.65. 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.
Sooner or later President Trump will talk the Dollar down to offset the economic weakness from the Trade War. The negotiations with the European Union will come to a head in November. If a no trade deal is achieved, President Trump will want the Dollar to fall against the Euro.
Gold
For weeks I have noted that optimism toward Gold had become extreme with more than 90% of traders bullish. I have also noted that positioning in Gold was more lopsided than at any time since July 2016. From the July 2016 high of $1375, Gold dropped to $1126 in December 2016.
Although a correction that deep is not likely, Gold could fall more than expected just to shake out the trend followers who joined the party late in recent weeks. Gold rallied from a low of $1266 in early May to a high of $1556 on September 4 a gain of $290. A 38.2% retracement of the $290 rally would bring Gold down to $1445, while a 50% retracement would target $1411. Gold traded in a range between $1410 and $1430 from June 25 until the end of July, so there is a fair amount of support in this price range
Gold Stocks
After peaking on September 4 at $30.96, GDX has quickly fallen -10.75% to an intra-day low of $27.63 on September 9, before closing at $27.73. The Gold stocks have enjoyed a monster rally that carried GDX from a low of $20.14 to $30.96. A 50% retracement would bring GDX down to $25.55 which is just 2% lower than the spike low of $26.04 on August 1.
After such a sharp break in just 4 trading days, GDX is probably close to a short term low. A bounce that carries GDX up to near $29.00 is certainly possible. The high of any bounce will offer the opportunity to measure a potential downside target that may provide a more precise target.
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 28 when the S&P 500 was trading at 2882 and SH was sold at $27.09.
I will likely increase the short position in SH if the S&P 500 rallies into the FOMC meeting on September 18. 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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