Written by Jim Welsh
Macro Tides Weekly Technical Review 28 October 2019
New High for the S&P, Topping Process Unfolding
This week 30% of the companies in the S&P 500 will report earnings, the Federal Reserve meets on Wednesday and may announce a ‘hawkish’ rate cut, and on Friday the ISM Manufacturing and October Employment report will be released. Other than that not much is going on. The GM strike and hiring for the Census will make the October employment report noisy.
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The S&P 500 recorded a new intra-day and closing high as expected on October 28. From a low of 2822 on August 5 the S&P 500 rose to 2922 on September 19. If the S&P 500 rallies an equal amount from its low of 2856 on October 3 the S&P 500 can push up to 3056. This suggests that the S&P 500 could have a bit more to run before a top is completed. If the S&P 500 rallies to 3056 it will tag the red trend line that connects the January 2018 high, the peak in September 2018, and the high on July 26.
Click on any chart below for large image.
The financial news will trumpet that the ‘stock market’ made a new all time high but that isn’t entirely accurate since the majority of market averages are comfortably below their all time highs. While the S&P 500 and NASDAQ Composite and NASDAQ 100 were at a new high, the DJIA is -1.1% short of its high, the New York Composite is -3.3% below its high, the Russell 2000 is off -9.75%, Transports -6.6%, and the Value Line Geometric is -11.0% under its all time high.
It would be far less negative if the shortfall in all these market averages was less than -2.0%, since the gap below the high could be overcome with a bit more strength. But the gaps and negative divergences are so big, a warning message seems appropriate. It seems more likely that the S&P 500 is nearing a peak rather than preparing for a meaningful breakout.
The upside momentum in the rally since the low on October 3 is lackluster. The 21 day Advance – Decline oscillator is below the red horizontal trend line so it isn’t overbought. It would become overbought with a further push which suggests the upside is limited. The fact that the Oscillator is not overbought despite the new high indicates the rally hasn’t been great.
The CBOE Equity Call/Put Ratio was 1.78 on October 28 indicating that 178 calls were bought for each 100 puts. The Call/Put Ratio I use incorporates all the options traded on all the exchanges and includes the CBOE equity data, and isn’t available until 9pm pst. The extremely high level of equity call buying suggests the overall Call/Put Ratio will be higher than the moving average and lift it closer to the red trend line. If the S&P 500 does manage to move up to 3056 over the next week or so, the Call/Put Ratio will probably rise above the red trend line and indicate the high level of optimism is confirming a top.
The divergences among the major market averages indicates there is a crack in the market’s foundation but that won’t lead to a decline unless investors are given a reason to sell or are disappointed. The Fed may let investors down a bit if the FOMC lowers the funds rate but indicates it is hitting the pause button unless economic data comes in weaker than expected. This could be a case of the FOMC’s decision to lower the funds rate tastes great but the messaging is less filling.
The decision to cut rates for the third time is not a slam dunk but 95% of investors expect the Fed will give them what is expected. After the two ‘insurance’ cuts the FOMC has already implemented, the economy doesn’t need another. This is why there will be at least two dissents against doing a third (Rosengren, George, and possibly Evans).
Chair Powell has referenced the mid-cycle cuts in 1995 and 1998 and in both instances the FOMC lowered the funds rate 3 times. Powell has given the impression that symmetry almost compels the FOMC to complete the pattern.
Bullard and other FOMC members will point out that the funds rate is above the 90-day T-bill rate (1.93% vs. 1.66%), which suggests policy is still slightly tighter than it needs to be.
As noted last week, 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.”
The markets are pricing in a 95% probability the FOMC will lower the funds rate on October 30, and a 20% probability the FOMC will follow with another cut at the December 11 meeting. Although 20% is not that high, Powell will endeavor to communicate that additional rate cuts will have to be earned, since FOMC members anticipate the previous reductions will help the economy in coming months. As a result the FOMC will need to see more definitive signs of weakness to warrant additional cuts.
The stock market is likely to do its usual dance after an FOMC announcement by falling and coming back more than once. When the dust settles the S&P 500 is likely to pull back for a few days before attempting to test 3056 by mid November.
When the S&P 500 traded up to 3040 on October 28, I purchased a 20% position in SH for my managed accounts at $25.59. SH is the 1 to 1 short S&P 500 ETF that gains in value when the S&P 500 declines. My expectation is the S&P 500 has the potential to drop to 2830 and possibly as low as 2740 in coming months.
Dollar
Since peaking at 99.67 on October 11 the Dollar Index dropped in 3 waves to 97.15 on October 21 before bouncing. The modest rally since October 21 is likely wave 4 and will be followed by another drop below 97.15 to complete the initial decline from the high. A lower low in the Dollar will effectively confirm that the Dollar has indeed set a top that could last for a number of months.
Once the Dollar has completed a 5 wave decline from 99.67 it is likely to bounce again and retrace 50% or more of the total decline from 99.67. The upcoming bounce will provide another opportunity to short the Dollar or buy sectors that benefit from a weaker Dollar.
The positioning in Dollar futures suggests a multi-week decline is likely.
Emerging Market Local Currency Bonds
The Emerging Market Local Currency Bond ETF (EMLC) was expected to benefit from a weaker Dollar, and their high yield (6.5%) was expected to help them weather a higher rate environment since the expectation was that Treasury yields would rise. The Dollar has fallen, Treasury yields have gone up, and EMLC has been able to grind higher. EMLC was expected to retest the July high of $35.00, and, if it is able to breakout above that resistance, a move up to the early 2018 high above $39.00 may follow. I have a 20% position in EMLC from $32.92 for my managed accounts.
Treasury Bonds
The ongoing assumption has been that the decline in global bond yields and Treasury yields remains intact. If this outlook is correct, 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 6 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 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%.
On October 28 the 10-year Treasury yield rose to 1.86% so the move above 1.903% is within sight. If this pattern unfolds, the 10-year Treasury yield would subsequently fall below the low of 1.429% on September 3 sometime in the first half of 2020 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%. On October 28 the 30-year yield reached 2.35%, and is poised to move above 2.378% soon. 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. On October 28 TLT traded down to $136.99.
Gold
In the September 23 WTR I recommended shorting Gold if it traded above $1531. Gold traded up to $1534 on September 24 and September 25 before reversing lower. Last week I noted that Gold was retesting a rising trend line connecting the lows in July, August, and the October 1 low, so it was possible that Gold could rebound back above $1516 to complete an a-b-c rally from the October 1 low. If Gold did manage to rally above $1516, a subsequent decline of $100 would likely follow.
Gold did rally to $1516.65 on October 25 before selling off again. If Gold is about to drop under $1420, it should not rally back to $1516 anytime soon. A stop on the short position should be $1513, and cover the short if Gold falls below $1425. If the FOMC does sound more hawkish than expected Gold could get hit quickly.
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.
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.
Gold Stocks
GDX has now bounced off support near $26.50 five times since last July and since the high on September 4 the last three bounces have posted a lower high. The expectation is that sooner or later GDX will convincingly fall below $26.50 before an intermediate trading low is established. If Gold falls below its recent low of $1456, a trap door under GDX may open:
“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.
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 9 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.
When the S&P 500 traded up to 3040 on October 28 I purchased a 20% position in SH for my managed accounts at $25.59. SH is the 1 to 1 short S&P 500 ETF that gains in value when the S&P 500 declines. My expectation is the S&P 500 has the potential to drop to 2830 and possibly as low as 2740 in coming months.
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The Major Trend Indicator has now made a third 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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