Written by Jim Welsh
Macro Tides Weekly Technical Review 21 October 2019
In recent weeks the expectation was that the Dollar would fall, Treasury yields would move higher, as Gold and Gold stocks stumbled, and the S&P 500 would move toward a new high. The markets that benefited from rising concerns about the global and US economy and the escalation in the Trade War are now under pressure. The partial unwinding of trade tensions and realization the U.S. economy was not headed for a recession has provided the S&P 500 a bid. As discussed last week, earnings expectations were lowered so much (which happens every quarter) that the results reported to date have not been as bad as feared.
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Dollar
The Dollar finally closed below the trend line from the July low on October 11, which provided the first real indication that the Dollar topped when it traded up to 99.67 on October 1. The reversal at 99.67 confirmed analysis that was provided in the September 16, 2019 WTR:
“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.”
Click on any chart below for large image.
The Dollar found support on a number of days during September near 98.15 (horizontal trend line), which indicated that this was another important area of support. Last week I wrote:
“A close below the horizontal trend line at 98.15 will provide further confirmation and 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 Dollar closed below 98.15 on October 16 and quickly peeled off 1% falling to 97.16 on October 21. The Dollar’s RSI has dropped to 30 so a bounce is likely before the decline resumes.
The positioning in the Dollar suggests there is more selling yet to come as those long sell. This increase in selling pressure is one of the reasons why a drop to 96.00 is likely in coming months.
Emerging Market Local Currency Bonds
Since I was anticipating a decline in the Dollar I recommended buying the Emerging Market Local Currency Bond ETF (EMLC) ($32.92). EMLC yields 6.5% and if the Dollar corrects as expected, EMLC should rally to retest the July high of $35.00. If it is able to breakout above that resistance a move up to the early 2018 high above $39.00 is possible.
Treasury Bonds
The ongoing assumption is that the decline in Treasury yields and global bond yields remains intact, and that Treasury yields will drop and make another lower low in coming months. Within that context 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 above 3 1.903% to complete wave (c) of wave 4. If wave (c) of 4 is equal to wave (a) (1.903-1.429 – .474), the 10- year Treasury yield could reach 1.98%.
If this pattern unfolds, the 10-year Treasury yield would subsequently fall below the low of 1.429% on September 3 in wave 5 from the high of 3.248% last November.
The pattern in the 30-year Treasury bond yield is the same as the 10-year. If wave (c) is equal is wave (a), the 30-year Treasury yield could push up to 2.48%. The pattern would then allow the 30-year Treasury yield to fall below 1.905% in coming months to complete wave 5 from the high last November.
Treasury Bond ETF (TLT)
If wave (c) is equal is wave (a), TLT could drop to $133.90 as it completes wave 4, which may provide a good trading opportunity. If the pattern analysis is correct, TLT would then rally above $148.67 as the 30-year Treasury yield drops below 1.905% in coming months.
Gold
In the September 23 WTR I recommended shorting Gold if it bounced above $1530:
“The 61.8% and 78.6% retracement of the $71 drop in Gold from $1556 to $1485 allows for a bounce to $1529 (61.8) and $1540 (78.6%). 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 on September 24 and September 25 before reversing lower. In the September 30 WTR I noted the initial target for this decline was $1463:
“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.”
Gold spiked down to $1456 on October 1 and then bounced to $1516. Gold is retesting a rising trend line connecting the lows in July, August, and the October 1 low, so it is possible that Gold could rebound back above $1516 to complete an a-b-c rally from the October 1 low.
If Gold does manage to rally above $1516, a subsequent decline of $100 would likely follow. The alternative is that Gold is on the cusp of a sharp drop soon.
A 38.2% retracement of the $290 rally ($1556 – $1266) would bring Gold down to $1445, while a 50% retracement would target $1411. My guess is that Gold can drop to near $1411 and possibly as low as low as $1377, which is the 61.8% retracement of the $290 rally.
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
Last week I noted that GDX had bounced off support near $26.50 four times since last July and that the last two bounces had been successively lower highs. My conclusion was:
“The next time GDX falls to $26.50 it is likely to break below that support which should trigger additional selling.”
GDX traded down to $26.18 before rebounding to $27.35 in an attempt to hold above $26.50. GDX closed at $26.58 on October 21 after posting an intra-day low of $26.50. GDX’s RSI is 42 so it is not yet oversold enough to generate a sustainable rally. 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 headand-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
As expected third quarter earnings estimates were lowered so much that most companies have managed to beat their estimates. The Federal Reserve is expected (88.3%) to lower the funds rate for the third time in 2019 when the FOMC meets on October 30. In all likelihood the FOMC will decide to cut the funds rate again after a long discussion and at least two dissents against doing so (Rosengren, George, and possibly Evans).
However, the message Chair Powell communicates in the post meeting press conference may not be as direct as equity investors expect. The minutes of the September meeting indicated that some of the FOMC members wanted to reset markets expectations regarding future rate cuts:
“Committee members in September worried that markets were currently suggesting greater provision of accommodation at coming meetings than [members] saw as appropriate.”
Chair Powell will have to do a balancing act of letting markets know that the third cut will likely be the last for awhile, unless incoming data comes in weaker than expected. Stocks may respond positively to another rate reduction but not be happy that another cut at the December meeting won’t be automatic.
Stocks may hold up until mid November as investors expect the Phase One trade deal with China will be signed. The Wild Card may not be China, but a Second Front in the Trade War launched against the European Union on November 14. After the World Trade Organization ruled in favor of the U.S. against Airbus and the EU, the U.S. didn’t hesitate to implement a 25% tariff on $7.5 billion of European imports. The tariffs took effect on October 18 and cover a myriad of products. The amount of the products covered is not much, but moving so quickly suggests that very little progress has been made with the EU since they received a 6 month extension (temporary stay) from President Trump in May.
The EU is one of America’s largest trading partners, accounting for $806.5 billion worth of trade in 2018. The U.S. exported $318.6 billion worth of goods to the EU, and imported $487.9 billion for a deficit of $169.2 billion, according to the Census Bureau. In 2018 the U.S exported $120 billion of goods to China and imported $540 billion from China.
The EU theoretically has more leverage with the U.S. than China since exports to the EU are $318 billion versus just $120 billion to China. If a second front in the Trade War develops with the EU, it could be more problematic than what has occurred with China. And no one seems to be paying attention to this risk.
With the FOMC about to lower rates again, trade tensions with China receding, and earnings not disappointing, the short position in the S&P 500 ETF (SPY) has dropped to 2.6%. The S&P 500 has topped within a few weeks after the short ratio has fallen below 3.0%, with the exception of March 2019. Bullish sentiment is more widespread than in March since 7 that was just 3 months after the 20% drubbing the S&P 500 had taken in December.
Another symptom of complacency is evident in the large short position in the VIX futures. The current position is almost as big as it was in September 2018 and is larger than in January 2018 and April 2019. A large VIX short position is like kindling for a fire.
But like any fire someone has to strike a match to get the blaze going. Whatever lights the match is secondary to the scramble to cover the short position, once the VIX starts to soar. The market is approaching another top but is expected to make a new high before the high is recorded.
I do not think the S&P 500 will break out above the red trend line near 3050 and it is more likely to test 2825 in coming months, which is the expectation. If the S&P 500 fails to breakout and then reverses lower, a good shorting opportunity may set up. 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 8 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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