Written by Jim Welsh
Macro Tides Weekly Technical Review 30 September 2019
As impeachment news soared on September 25 and the stock market slumped, President Trump deftly temporarily shifted the narrative back to the potential of a trade deal with China. After signing a trade deal with Japan in New York, President Trump told reporters that China very badly wants to make a deal and the Chinese were already making big agricultural purchases from the U.S. including beef and pork. The President said a trade deal could happen ‘sooner than you think’. From its low on September 25 the S&P 500 rallied from 2953 to 2990 near the close.
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On Friday September 27 the White House said it was considering restricting capital flows into China and to limit Chinese companies from trading on U.S. exchanges. In 2013 the Obama administration agreed to allow Chinese companies to trade in the U.S. without having to adhere to securities laws which include audits of results. Prior to Friday it should be noted that two bipartisan bills had already been introduced in Congress aimed at pushing U.S. listed Chinese companies to comply with auditing rules in the U.S. If those companies failed to submit to regulatory oversight, they would face de-listing. Up to 200 Chinese companies are trading on US exchanges that could be affected. A further complication is that a number of companies that could be affected are in indexes which would disrupt them going forward. On Saturday the U.S. Treasury denied there was any plan “at this time” to go ahead with investment restrictions.
Click on any chart below for large image.
The details of this issue are secondary to the overall impression one gets from the Trump administration. On Wednesday investors are told a deal could happen sooner than expected and on Friday are told that an escalation within the trade negotiations could develop. Investors cheered the news on Wednesday and then sold on Friday, obviously whipsawed again by the messaging of the President. If the US and China were truly making enough progress to say a trade deal could happen soon, why would the administration poke China in the eye on Friday less than 48 hours after offering such a positive view? No one would antagonize a partner in the later stages of a negotiation like this, if a trade deal were really on track.
On Wednesday September 25 President Trump wanted to give the stock market a lift, just as he did in the wee hours of Monday August 26 , when he Tweeted from Europe that China’s Premier had called not once but twice over the weekend wanting to make a deal. Trump’s Tweet followed his tirade on August 23 which caused stocks to sell off sharply. Investors learned on August 28 that no calls were actually received from China, and that the President had merely co-opted parts of a speech the Premier made in China on August 24 in which he repeated sentiments previously expressed. Only a president could get away with such blatant manipulation of the financial markets. However, as the old expression goes,
“Fool the markets once, shame on us. Fool markets 2, 3, 4 times or more, shame on the Dummies and Algos on Wall Street, who fall for Trump’s messaging without fail.”
The next phase of the Trade negotiations are set to occur on October 10 and 11, which is likely to provide the stock market support. No one wants to be short if a trade deal is announced, and most institutions don’t want to raise cash just in case a trade deal is reached. The lack of selling pressure can help the S&P 500 hold up going into October 10, along with a few Tweets from President Trump telling us China really, really wants to make a deal, just in case anyone has forgotten all the prior reassurances during the past 18 months. Investors want to believe a deal is coming and think President Trump will eventually settle for less, just to get a deal done and move attention away from the impeachment hysteria. This view overlooks that there are two parties to any deal and China can only view the impeachment hoopla as a good reason to drag its feet, and not agree to what the US wants. Why should they? So expect the next round of talks to falter and more Tweets from the President emphasizing how much China wants to make a deal. Where’s Monty Hall!
Repo Market Disruption
I have received a few emails and calls regarding the disruption that occurred in the Repo market on September 16 and the following days. Repo is short for repurchase agreements, which are transactions that amount to collateralized short-term loans, often made overnight. Repo deals let big investors — such as mutual funds — make money by briefly lending cash that might otherwise sit idle, and enable banks and broker-dealers to get needed financing by loaning out securities they hold in return. A healthy repo market helps a wide range of other transactions go more smoothly, including trading in the U.S. Treasury market.
The financial press was quick to remind investors that a similar disruption occurred just before Lehman Brothers blew up in September 2008. The circumstances are very different now than in September 2008. In fact the first signs that the financial system was in trouble occurred in August 2007 more than a year before Lehman failed. I discussed this in the September 24, 2007 Macro Tides:
“Throughout the Pacific Ocean there are sounding buoys to determine if a 100 foot tsunami traveling 500 miles per hour, or a 2 foot wading wave has developed after a large earthquake. The disruption that swept through credit markets worldwide in August was equivalent to an 8.4 magnitude earthquake. While seismologists know if a tsunami was created within a couple of hours, we won’t know for a number of months the full economic impact. But the displacements that took place leave no doubt that a significant seismic event occurred. In just seven days, T-bill yields plunged from 4.9% to 2.5%. In a month, the $2.2 trillion commercial paper market has contracted by more than 15%. Even as the ECB pushed well over $250 billion of liquidity into their banking system, the 90-day LIBOR rate jumped from 5.36% to 5.73%. In August, the issuance of junk bonds dropped by 93%, as the appetite for risk disappeared. This caused the spread between Treasury bonds and junk bonds to surge from 2.6% in June to 4.6% in less than six weeks.”
Prior to the recent turbulence, the Repo rate traded less than 10 basis points above the federal funds rate, and on September 13 was trading near 2.13%. On September 17 the spread between the Repo rate and the federal funds rate widened from 0.10% to 3.51%.
Even as the Repo rate spiked from 2.2% on September 15 to almost 10% on September 17, the rest of the credit market remained subdued. T-Bill rates didn’t plunge and spreads between Treasury bond and corporate bonds didn’t widen. Symptoms of a real liquidity event didn’t materialize in the rest of the credit market as they did in August 2007.
This is not to say there wasn’t a problem that needed to be addressed. On September 17 and every day since the Federal Reserve Bank of New York has injected liquidity into the banking system to make sure there is ample liquidity. The Fed has been criticized for not anticipating the liquidity needs prior to the surge in the repo rate, which seems fair. The Fed has said that a confluence of events came together to create a drop in liquidity, i.e. corporate quarterly tax payments, a surge in Treasury bond issuance which drained liquidity as dealers paid for the bonds, and an unwillingness of banks to lend to other banks once the Repo rate rose. I’m willing to give the Fed the benefit of the doubt since there was a surge in Treasury bond sales after the debt ceiling was increased, and the Repo market has quickly stabilized.
Since mid August Treasury balances at the Federal Reserve increased by more than $220 billion, which meant that $220 billion was removed from the banking system as dealers and investors paid for the Treasury bonds they purchased.
In his Press conference after the September 18 FOMC meeting, Chair Powell said the funding issues and the Fed’s operations “have no implications for the economy or the stance of monetary policy.” The New York Fed said it plans to keep injecting funds through Oct. 10 and has increased the size of these injections in recent days to $100 billion from the initial level of $75 billion. So far the injections have had the intended effect of calming the Repo market down. The New York Fed will face another test going into yearend as demand for liquidity increases. In the short term, as long as the repo remains stable it is not likely an issue to be concerned about.
Stocks
The S&P 500 closed on September 30 less than 2 points from where it was on September 9, which was the expectation. As noted in the September 9 WTR:
“The problem in the short term is that it is difficult to identify a reason why institutional investors would sell and raise cash.”
The economy is OK, most investors expect there will be a trade deal when they meet in October, and institutional investors want to show their clients they are fully invested on September 30. No one wants to be short if a trade deal is announced, and most institutions don’t want to raise cash just in case a trade deal is reached. The lack of selling pressure can help the S&P 500 hold up going into October 10. In the short term a few of the technical indicators have improved modestly.
The Call/Put Ratio has dipped from a relatively high level two weeks ago, and the Trading Index has moved higher as selling pressure increased last week. The Trin-Sentiment indicator that combines the Call/Put Ratio and Trading Index has dropped to a level that is supportive of additional upside. However, it is not as extreme as it has been at other decent trading lows, nor is the Trading Index or C/P Ratio.
Although the Advance / Decline Line has basically flat lined since September 11, it is still holding above its 50 day average so it remains positive. Prior to the deep decline in the fourth quarter, the A/D line fell below its 50 day average on October 2. The odds of a breakdown would increase if the S&P 500 closed below 2945, which was the intra-day low on Friday September 27, and especially if it closed below the green trend line near 2910.
The Investor Intelligence Weekly survey provides an intermediate assessment of investor sentiment. The Bulls minus Bears percent last week lifted the net to just below 40%, which indicates that most investors are fairly complacent.
The S&P 500 could test the black trend line connecting the January 2018 high, September 2018 high, and July 2019 high near 3047. A breakout above the black trend line is not expected. Investors are optimistic about the prospects for a trade deal. I don’t share that view and do not expect a trade deal to develop anytime soon.
The S&P 500 appears to be working its way into the apex of a rising wedge, which suggests a pickup in volatility may be right around the corner, once the S&P 500 closes below the rising black trend line. (Chart below) A close above 18.0 on the VIX would likely signal a breakout and usher in a bout of volatility. Large Speculators (green line middle panel) are holding a big short position in the VIX that is comparable to late April and September of 2018, which both preceded a sharp decline.
Dollar
In the short term the Dollar still has the potential to exceed its September 3 high of 99.37, as discussed last week:
“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.”
The Dollar traded up to 99.46 on September 30 but its RSI has diverged for the second time and was 64.7 on September 30. This is obviously well below 70. I have found that RSI divergences that occur with the RSI below 70 are more significant. The table is set for the Dollar to reverse lower and confirm a top. Once a high is confirmed, the Dollar is expected to fall since positioning is negative. Asset managers are holding a larger long position than in January 2017 as the Dollar Index topped at 103.82. The Dollar Index fell from 103.82 in January 2017 to 88.25 in February 2018.
The large long position was unwound as the Dollar fell, which contributed to the decline. The long term chart of the Dollar suggests the Dollar could be on the cusp of a significant decline that could equal the 15.6 point decline after the January 2017 top. President Trump may provide the impetus for the kickoff of the move lower, if he decides to talk the Dollar down after mid November when the EU trade extension expires.
Emerging Market Local Currency Bonds
Two weeks ago I recommended buying the Emerging Market Local Currency Bond ETF (EMLC) in anticipation of a Dollar decline in coming months. On September 17 EMLC opened at $33.10. A rally to above $35.00 is possible and EMLC yields 6.5%.In the face of the Dollar trading at its highest level in 28 months, EMLC is holding up well. It closed at $33.00 on September 30.
Treasury Bonds
Not much has changed. As the labels on the chart illustrate the low yield of 1.429% may have been wave 3 down from the high of 3.248% last November. The rebound since the low of 1.429% to 1.903% would be wave 4, and implies that another drop below 1.429% is possible to complete 5 waves down from last November. The obvious cause for another drop to a new low would be a break down in trade talks with China.
The same pattern is evident in the 30 minute chart of TLT. As long as TLT does not drop below the low of $136.54 on September 13, the pattern suggests TLT could rally to a higher high. If TLT declines to under $139.50 in three waves, (i.e. a down, up, down pattern), it might offer the opportunity to buy TLT in anticipation for a rally above $148.90, using $136.54 as a stop. From the recent high of $143.84, TLT has dropped, and bounced up, so another dip below $139.50 may set this trade up.
Gold
Last week I thought the rebound in Gold from its low of $1484 was a selling opportunity for those long Gold, and a shorting opportunity for traders:
“This rebound is another opportunity to reduce exposure to Gold. Traders can short Gold (or an inverse ETF) if it trades up to $1531 (cash) using $1548 as a stop.”
Gold traded up to $1534.64 on September 24 and dropped to $1465.83 on September 30. From its high, Gold fell from $1556 to $1485 or $71. An equal drop from the rebound high of $1534 targets the potential for a short term low near $1463.
Gold is oversold in the short term and came within $2 of its first downside target, so another rebound is likely.
Longer term Gold can fall to $1410 – $1430 as previously discussed:
“A 38.2% retracement of the $290 rally ($1556 – $1266) 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.”
Positioning in Gold is very negative so patience is warranted since the downside targets have a good chance of being reached in coming weeks.
Gold Stocks
Last week I noted that the rally in GDX since the low at $27.45 looked corrective and could reach $29.61, which was the 61.8% retracement of the $3.51 drop from $30.96. I thought that this rally was “another opportunity to reduce exposure to Gold stocks since a drop to $26.04 or lower is likely in coming weeks.”
GDX traded up to $29.58 before reversing and traded down to $26.54 on September 30. As detailed in the September 16 WTR:
“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.”
Despite the sharp selloff, GDX’s RSI is 39.7 so it isn’t yet oversold, which suggests it can fall to the $25.55 target in coming weeks before it is truly oversold.
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. The remainder of SH was sold on September 25 at $26.03.
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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