Written by Jim Welsh
Macro Tides Weekly Technical Review 14 October 2019
Stay of Execution
Since January 2018 the global economy and financial markets have been in a Trade Jail after President Trump announced his first round of tariffs on Chinese imports of solar panels and washing machines. Since then financial markets have been buffeted as the U.S. and China traded tariff escalation punches that weighed on global growth and slowed the U.S. and Chinese economy.
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On Friday President Trump stated the U.S. and China had agreed to a ‘very substantial phase one deal’. After the 13th round of negotiations, China agreed to purchase $40 to $50 billion of agricultural products, and the U.S. announced it wouldn’t increase the tariffs on $250 billion of Chinese imports from 25% to 30% on October 15. China will provide more transparency on how it manages its currency and some additional provisions on intellectual property, although no details were provided. President Trump said it will take 3 to 5 weeks for the ‘deal’ to be written.
Click on any chart below for large image.
In August 2019 President Trump officially labeled China as a ‘Currency manipulator’. During his campaign he had promised to do so soon after taking office since he had repeatedly called China:
“The single greatest manipulator that’s ever been on this planet.”
In the January 2017 Macro Tides I reviewed this claim and found, no surprise, that it was exaggerated. Since January 2007 through October 11, 2019 the Chinese Yuan (CNY) has actually appreciated +10.2% versus the Dollar. However, it has fallen -15.1% since December 2013. By comparison the Euro is down -15.4% against the Dollar since January 2007 and has lost -19.1% since December 2013. No matter which time frame is used the Euro has been a ‘currency manipulator’, if using the value of the currency is the benchmark. For the Yuan the conclusion is less clear depending on which time frame one uses, but since 2007 China has clearly not been “The single greatest manipulator that’s ever been on this planet.” In comparing China and the European Union one would conclude that the EU has earned that distinction in terms of depreciating its currency.
President Trump stated over the weekend that the deal announced on October 11 was
“The greatest and biggest deal ever made for our Great Patriot Farmers in the history of our Country.”
Previously China was buying about $20 billion annually of U.S. agriculture products so this is a significant increase, if China follows through. Is this the greatest deal ever in the history of our country for farmers? I think Jefferson’s Louisiana Purchase of 827,000 square miles for $15 million in 1803 was far more significant, since it provided much of the land farmers’ use today to grow the crops that will hopefully be exported to China.
While the increase in tariffs slated for October 15 was postponed, none of the existing tariffs have been removed. The existing tariffs are estimated to depress GDP growth by 0.7% with the postponement of the October 15 increase accounting for only 0.1% of GDP.
A slowing in business investment has been one of the primary contributors to the deceleration in the global and U.S. economy over the past year. Even if all goes well and the deal announced on Friday is signed in mid November it will do little to lift the lack of clarity that has depressed CEO confidence and investment.
The one thing that can be said, and it is an important point, is that trade tensions didn’t increase. In recent weeks the U.S. had openly flaunted the idea of restricting capital flows to China and enforcing auditing guidelines on more than 100 Chinese companies trading on exchanges in the U.S. This new escalation was likely what prompted China to move forward, as Michael Pillsbury, a noted expert on China, discussed on CNBC on October 14.
The progress announced on Friday was a positive, but much of the heavy lifting remains. Unless solutions to the unresolved issues are achieved in the Phase Two negotiations, Friday will be seen in hindsight as merely a Stay in the Execution of the Trade War, with the December tariffs looming on the horizon.
Dollar
The Dollar fell in anticipation and announcement of the trade deal with China, and finally closed below the trend line from the July low. This is the first concrete sign that the Dollar has topped. A close below the horizontal trend line at 98.15 will provide further confirmation. A close below 98.15 should lead to a decline to 96.00. The Dollar found support slightly below 96.00 in February, March, and June so a test of this level is likely in the next few months.
The positioning in the Dollar is still showing too many longs, which can provide selling pressure once the Dollar closes below 98.15.
Emerging Market Local Currency Bonds
A decline in the Dollar should be a tailwind for non U.S. assets. Four weeks ago I recommended buying the Emerging Market Local Currency Bond ETF (EMLC) in anticipation of a Dollar decline.
On October 4 EMLC rallied to $33.58 and retested the prior short term high of $33.59 on September 12, before reversing lower on October 7. As noted last week a close above $33.60 may open the door for a move higher and a possible test of $35.00.
EMLC did close above $33.60 on October 11 as the Dollar fell, which increases the odds of a rally to $35.00 or higher. EMLC yields 6.5% and on October 7 paid out $.1846 which effectively lowered the cost basis to $32.915.
Treasury Bonds
The ongoing assumption is that the low yield of 1.429% in the 10-year Treasury bond was 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 (a) of wave 4, since the rebound in yields last week overlapped the low of 1.635%. The overlap suggests the recent 3 wave drop in yields (a, b, c in blue) was wave (b) of wave 4. This suggests that the 10-year year could rise to 1.903% to complete wave (c) of wave 4. If this pattern unfolds, the 10-year Treasury yield would subsequently fall below the low of 1.429% on September 3.
The pattern in the 30-year Treasury bond yield is the same as the 10-year.
The pattern suggests the 30-year Treasury yield will rise above 2.378% to complete wave 4 from the high last November. The pattern would then allow the 30-year Treasury yield to fall below 1.905% in coming months.
Treasury Bond ETF (TLT)
If the 30-year Treasury yield does rise above 1.905%, a good trade in TLT may develop if TLT drops below the low of wave (a) and $136.45
Gold
Last week I thought Gold could rally above last week’s high of $1516 to complete the bounce from the low at $1456 last week.
Gold rallied up to $1515.58 on October 10, before falling below $1475 after the trade deal was announced on October 11. In the short term Gold can still briefly pop above $1516. Longer term Gold can fall to $1410 – $1430 as previously discussed. Positioning in Gold continues to indicate that too many traders remain bullish (stretched long).
The next intermediate low is not likely until a good number of those currently long become cautious and sell Gold.
Gold Stocks
Since last July GDX has bounced off support near $26.50 four times. What is noteworthy is the last two bounces have been weaker, meaning GDX has bounced to successively lower highs. This suggest that the next time GDX falls to $26.50 it is likely to break below that support which should trigger additional selling. The expectation has been that GDX has the potential to correct more in coming weeks before a trading low is established:
“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.”
GDX looks to have formed a head-and-shoulders top pattern with the neckline at $26.50. From the neckline to the top of the head at $30.96, GDX could drop $4.40 or so to $22.00 to $22.50 once it closes below the neckline.
Stocks
Third quarter earnings will be somewhat in focus in coming weeks with investors tuning into corporate calls for clues about the outlook for the fourth quarter and early 2020. What is interesting is that expectations going into the results for Q1 and Q2 were fairly downbeat, which made it possible for companies to modestly beat estimates. In the second quarter estimates as of June 30 were for S&P 500 earnings to fall by -2.7% (in grey). When all the numbers were reported S&P 500 earnings were down only -0.1% (in green) and 75% of companies beat their estimate.
Every quarter companies guide analysts to lower their estimates so they can beat the number, and every quarter CNBC’s Bob Pisani gushes that more than 70% of companies beat their bogey. According to FactSet the hole is a bit deeper this quarter as S&P 500 earnings are projected to be down -4.5% from last year.
Analysts usually don’t sharpen their pencils for next year’s earnings until the fourth quarter of the preceding year. With earnings growth virtually nil for 2019, analysts will rely heavily on the guidance they receive during the third quarter calls. The tone and guidance could be make-or-break for whether estimates for 2020 continue to hold at a gain of 10%. I will be surprised if estimates don’t come down.
The Financial ETF XLF is dominated by a four large banks which comprise more than 30% of the ETF (JP Morgan 11.8%, Bank of America 7.7%, Wells Fargo 6.25%, Citigroup 5.0%), with 3 of the 4 reporting their earnings this week. In December 2017 XLF traded near $28.00 and 22 months later it is trading below $28.00 (October 14, $27.69), as its relative strength to the S&P 500 has remained weak.
The Financials have the third largest weighting within the S&P 500 at 13.1% just behind Health Care 14.2%, and Technology 21.5%. The red trend line on XLF is at $28.67 and a breakout above it is unlikely, which will hamper any attempt by the S&P 500 to breakout.
Measures of sentiment move quickly when the news is obviously bullish or bearish and the market reacts strongly. When the ISM Manufacturing and Non-Manufacturing reports were released on October 1 and October 3, the S&P 500 declined and investors bought a bunch of puts, which pushed the Call/Put Ratio down to 1.0.
With the expectation that a trade deal was coming and then announced on Friday, investors cheered and bought a lot of calls, which drove the C/P Ratio higher.
CNN’s Fear& Greed Index is still pretty low. The C/P Ratio is not yet high enough to suggest a top, and neither is CNN’s Fear & Greed Index. So sentiment appears supportive of more upside before a meaningful top is formed. As noted last week:
“In the short term the C/P Ratio indicates that sentiment became too negative and in the very short term the C/P Ratio suggests the market is likely to hold up and may be able to retest the July high.”
The NYSE Advance – Decline line continues to hold above its 50 day average and is not far from making a new high. However, the percent of stocks above their 200 day average is just 50%, so many stocks are not participating even though the S&P 500 is less than 2% from a new high.
The NASDAQ Advance – Decline line indicates a much different picture than the NYSE A/D Line. The NASDAQ A/D line peaked more than a year ago and is well below that peak, which is a long term negative.
Although the NYSE A/D line is not far from a new high, the percent of stocks making a new high on the NYSE is comfortably below the high in late July, and lower than it was in September
As the S&P 500 was forming a top in September, it fell to 2957 three times before cracking below 2957 on October 1, after the ISM Manufacturing report disappointed. After the ISM Non-Manufacturing report was far weaker than expected on October 3, the S&P 500 spiked down to 2856 before reversing higher. It rallied up to 2959 on October 7 and responded as if it had hit a wall, as it quickly dropped to 2893 on October 8.
The S&P 500 gapped above 2959 on October 11 as investors were thrilled by the prospect of a trade deal. A drop below 2959 will make the rally from 2856 appear to be 3 waves, which is not positive in the short term.
As long as the S&P 500 holds above 2856 the potential for a rally to test the July high or make a new high is possible. I do not think the S&P 500 will break out above the red trend line near 3050 and is more likely to test 2825 in coming months, which is the expectation. A break below 2820 would open the door for lower prices with a decline to 2650 possible.
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.
The Major Trend Indicator has now made a second lower high since late April, which suggests the market is vulnerable unless the S&P 500 is able to close above the top trend line forming the Megaphone. Until that occurs, the risk is skewed to the downside.
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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