Written by Jim Welsh
Macro Tides Weekly Technical Review 16 December 2019
In the six trading days from December 6 through December 13 the financial markets were given a heavy dose of good news.
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The list:
- The November U.S. employment report far exceeded expectations on December 6;
- The Democrats indicated on December 11 they would support the passage of the USMCA Trade Pact between the U.S., Mexico, and Canada;
- Moments after the market opened on December 12 President Trump Tweeted that a Big Trade Deal was near;
- Great Britain appeared to resolve the Brexit issue with a resounding election of Boris Johnson after 3.5 years of struggle on December 12; and
- On Friday December 13 the U.S. and China announced a trade deal had apparently been achieved.
I can’t remember a week with so much diverse economic news that uniformly was the best possible outcome the markets could have hoped for.
It has been suggested that the only reason the Democrats agreed to passing the USMCA trade deal was to prove they could actually do something, other than pursuing the impeachment of President Trump. So what! The bottom line is something did get done that should be a plus for economic growth in coming years irrespective of the motivation.
Nancy Pelosi said the deal, after revisions pursued by the Dems, was infinitely better than the deal Trump’s team had negotiated. Even in today’s hyper environment of political grand standing, that assessment may be seen as an exaggeration.
Even though Great Britain’s election last week removes some doubt about the ultimate outcome, it doesn’t provide any clarity on whether Brexit will be smooth or a destabilizing divorce by the end of 2020. This means the threat from a disorderly Brexit and a high level of uncertainty will return and hang over the markets especially after mid-year. Despite the election nothing was truly resolved.
I didn’t expect the U.S. and China to agree to a Phase 1 deal so I was wrong and surprised. Taken at face value the agreement appears to be good for the U.S., and if China lives up to its promises, it will be good. That of course is the rub with any deal involving China given China’s history. All one needs to do is look at how China has not abided by the World Trade Organization rules it agreed to when China was allowed to join the WTO in 2001. So a clear understanding and evaluation of the Phase 1 deal will not be possible for a long time.
Markets rallied on December 12 after The WSJ reported that the U.S. would not impose the December 15 tariffs and would lower existing tariffs by 50% on $370 billion of Chinese imports. While the U.S. did agree to suspend the December 15 tariffs, China will continue to pay a 25% tariff on $250 billion of imports. The only tariff roll back will be a reduction from 15% to 7.5% on $120 billion of imports saving U.S. businesses $9 billion a year. As of September 30 Nominal U.S. GDP was $21.5 trillion so a tariff savings of $9 billion is a wisp.
Overall, the level of uncertainty should be lower in the first half of 2020, but the official deal won’t be signed until sometime in January so the cloud of uncertainty will remain until its official and the details are known and understood.
The addition to production capacity in 2017 and 2018 after Trump was elected, and the economic slowing from the imposition of tariffs in 2018 and 2019 has resulted in a significant drop in Capacity Utilization, which has fallen -3.6% from 79.6 in November 2018 to 76.7 in October 2019. Business investment is not likely to pick up until some of the increase in spare capacity is absorbed. This suggests that there could be a meaningful time lag between a successful resolution to the Trade War and an increase in business investment. CEO’s and small business owners will need to see an actual increase in demand and reduction in spare capacity to have the confidence necessary to spend more money.
This time lag could prove important since a consensus has developed in recent weeks that U.S. and global growth is set to rebound in 2020 in response to central bank easing, a bottom forming in manufacturing, and the prospect of a trade deal. With the seeming resolution of both the USMCA and China trade deals, expectations of a stronger rebound are likely to take hold. If business investment does not respond as quickly as strategists are estimating, the rebound may be delayed or weaker than projected.
The other major factor that is expected to remain strong is U.S. consumer spending, which in Q2 and Q3 accounted for more than 70% of GDP growth. So the consensus expects any improvement in manufacturing will add to GDP growth.
However, Retail Sales for November were weak and unchanged from October and have been losing ground Y-O-Y for months.
This suggests Consumer spending may not remain as strong as it has been and may undermine the assumption that the U.S. economy will strengthen nicely in coming months. The trade deal is not likely to directly boost consumer spending.
On December 16 weak economic news out of Europe was simply ignored since it didn’t jive with the consensus outlook, and because expectations for improvement are so strong. IHS Markit’s Eurozone Manufacturing PMI Output index fell to 45.9 in December from a 47.4 in November and the lowest level in 86 months. The assessment by IHS Markit was decidedly downbeat:
“The Eurozone economy closes out 2019 mired in its worst spell since 2013, with businesses struggling against the headwinds of nearstagnant demand and gloomy prospects for the year ahead. The economy has been stuck in crawler gear for fourth straight months, with the PMI indicative of GDP growing at a quarterly rate of just 0.1%. There are scant signs of any imminent improvement. New order growth remains largely stalled and job creation has almost ground to a halt, down to its lowest for over five years as companies seek to reduce overheads in the weak trading environment and uncertain outlook.”
IHS Markit’s Composite Purchasing Managers index combines Manufacturing and Services, and the Composite fell to 50.6 in December leaving it barely above 50.0, which denotes contraction or expansion.
In the short term the glow from all the good news is likely to continue. With no reason to sell most institutional investors will look to hang onto winners with those under invested feeling pressure to increase exposure. At times like this I’m always reminded of a Grateful Dead lyric,
“When life looks like easy street, there’s danger at your door.”
Stocks
The Call/Put Ratio jumped on December 13 to the highest reading on an individual day in many years boosting the 10-day average significantly. Sentiment has been overly bullish for a number of weeks but the news last week put the cherry on top. Excessive bullishness is a warning that much of the good news has already been acted upon. With the end of the year approaching, the bias is up.
In late July the S&P 500 recorded a new high but its RSI was weaker which foreshadowed the quick sharp correction in early August. That selloff was triggered by an escalation in the Trade War. A similar negative divergence is present today so the S&P 500 is vulnerable to a shallow pullback.
The S&P 500 has been lifted by a string of good news and it is difficult to see what additional good news could occur before the end of the year. This suggests the upside from here may be limited but so is the downside. Short term support is 3135 which was the low last week before the trade news broke.
Treasury Bonds
Despite all the good news Treasury yields remain below their November 7 high. The high for the 10-year Treasury bond last week was 1.924% compared to 1.971% on November 7.
The 30-year Treasury yield reached 2.350% on December 12 compared to 2.443% on November 7.
There is a risk that the U.S. and global economy may not accelerate as currently forecast in 2020, and with the trade deals in place forecasts are likely to be increased. The pattern in the 10-year and 30-year Treasury bond yields suggest that yields are going to fall, and potentially to the low of 1.429% in the 10- year and 1.905% for the 30-year Treasury bond in 2020.
Treasury Bond ETF (TLT)
Two weeks ago I recommended establishing a 65% position if TLT traded down to $137.90. After the strong employment report on December 6, Treasury yields spiked higher and TLT dropped to $137.86. On December 12 TLT fell to $136.61 after President Trump Tweeted a trade deal was close.
The economic news has been so bullish it is hard to believe Treasury yields haven’t gone up more than they have. Maybe that’s what’s coming next. But for now the expectation is for yields to fall in coming months. Use a close under $136.16 as a stop. If TLT trades above $141.77 raise the stop to $137.20. If Treasury yields fall as expected in coming months, TLT has the potential of trading above the August high of $148.67.
Dollar
The Dollar has been expected to fall to 96.00 or lower in coming weeks. Last week it traded down to 96.72 and should continue down toward 96.00 before a bounce takes hold.
Gold
Gold could still jump above $1500 in the short term. A rally to a higher high above $1556 is not likely until Gold drops below $1446 and ideally under $1420. The expectation of a rally that does carry Gold above the August high of $1556 is predicated on the price pattern and assumes the August peak was wave 3 from the August 2018 low near $1160. The choppy trading since then is wave 4. This is why aggressive traders can buy Gold (GLD or IAU) if it trades under $1420, using a 1.5% stop on a closing basis.
Gold Stocks
If Gold does drop below $1420 and GDX trades under $25.85, traders can establish a 50% position using $25.10 as a stop.
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.
Becoming cautious in late April and July was prescient as the S&P 500 subsequently corrected by more than 5%. What I didn’t anticipate was how quickly the market would rebound after any positive Tweet from President Trump, nor how the market would rise so persistently after October 7 even though no concrete signs of a trade deal appeared.
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. The short position in the S&P 500 was increased from 20% to 40% on the opening of November 19 when SH opened at $24.87, and sold on November 22 when SH trading at $25.03 or higher.
My expectation has been that the S&P 500 had the potential to drop to at least 2950 in coming weeks, especially if there was no trade deal. The announcement of the trade deal does not eliminate the potential for a drop to 2950 but it certainly delays when it may occur. If the economy doesn’t rebound as expected in the first quarter, profit taking will set in.
My guess is that consumers will splurge a bit on Christmas but then use the first quarter to pay down credit cards and replenish savings which could put a dent in first quarter GDP. And if any improvement in business investment doesn’t materialize in the first quarter, the notion that manufacturing has bottomed will be questioned.
Between now and mid January seasonality and the consensus bullish outlook for 2020 is likely to keep selling pressure muted. Of course, any hiccup before a Trade Agreement is actually signed will cause a flurry.
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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