Written by Jim Welsh
Macro Tides Weekly Technical Review 13 January 2020
As discussed last week tops in the stock market usually follow a progression with sentiment flashing warnings of excessive bullishness representing the first step. In recent weeks numerous sentiment indicators have reached levels that have historically signaled that a top was forming.
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CNN’s Fear & Greed Index has been holding in Excessive Greed territory for an extended time. Through January 13 it has only dipped from 96 to 89, even though the December employment report was less than stellar.
Job growth slowed from 252,000 in November to 145,000. December’s total lowered the average monthly increase in jobs in 2019 to 176,000 the slowest pace of job growth since 2011 and down from 227,000 in 2018. Annual wage growth dropped to 2.9% and below 3.0% for the first time since July 2018. The average workweek for all categories of workers remained unchanged, so no workers were getting paid for more hours.
The softer employment report is consistent with my view that consumer spending is likely to slow a bit in the first quarter as consumers choose to pay down credit card debt and increase savings after enjoying a happy holiday season.
The persistence of the rally has been fueled by the market’s own momentum. The percentage of S&P 500 stocks above their 200 day average has exceeded 80%. Such a high reading is consistent with prior market tops. The upward momentum has pulled in various systemic strategies (volatility control, commodity trading advisors (CTAs) and risk parity) with exposure now at the highest level since January 2018.
Mutual funds and retail investors respond to economic and market events and have upped their exposure to the highest since October 2018. According to Deutsche Bank Consolidated Equity Positioning has reached the 96% percentile and in the past ten years only surpassed in January 2018.
After high levels of exposure to the market in January 2018 the S&P 500 dropped -11.8% and plunged -20.1% after peaking in early October 2018. The rally has chastened those short the S&P 500 ETF (SPY) so some of the strength has come from short covering. It is noteworthy that the size of the short position in the SPY is the lowest since January 2018.
Investors have become very excited about an economic recovery in 2020 and are willing to ignore any data that doesn’t support their thesis. The Deloitte CFO survey of 147 CFO’s with companies with at least $3 billion in annual sales in Canada, Mexico, and the United States was particularly downbeat. In aggregate they see consumer and business spending slowing, and 82% anticipate taking more defensive actions, like reducing discretionary spending and staff.
This outlook doesn’t jibe with investor expectations that the weakest sectors in 2019 – business investment and manufacturing – are getting ready to strengthen.
By just about any measure the stock market is expensive especially after the 30% expansion in the S&P 500’s Forward Price / Earnings ratio in 2019.
Expectations against this economic back drop seem at risk since the consensus forecasts at least a 10% increase in earnings for the S&P 500 by the end of 2020.
As discussed in the January Macro Tides investors are likely to be disappointed if the economy doesn’t confirm that a rebound is taking hold in the first quarter. It’s early but to date recent economic data has failed to support the consensus, as the December employment report indicated.
The second step of the topping progression is a slowing in upside momentum. The NYSE Advance – Decline line continues to make a new high which is positive. Usually the A/D line peaks before the S&P 500 but not always. The A/D line recorded a new high in January 2018 but that didn’t preclude the S&P 500 from falling more than 11% in less than 2 weeks. The only negative is that the A/D line has gotten too far above its moving average.
Momentum Oscillators are displaying the initial loss of upside momentum as the 21 day Advances minus Declines illustrates. The A/D Oscillator actually hit its high on December 26 and registered another lower high on January 13. The S&P 500’s RSI has twice recorded a lower high which indicates that the price momentum of the S&P 500 is slowing. The best analogy is how a baseball behaves after it is thrown up into the air. The ball continues to gain altitude even as its rate of ascent slows. The lower RSI is warning that a price reversal is becoming more likely but has obviously yet to occur.
The third part of the topping progression is the S&P 500 falling below a prior low. The underlying momentum behind the run up in the S&P 500 is still fairly strong since it has yet to violate a prior low. As noted last week the intra-day low on January 3 was 3212 and 3214 on January 6, so 3210 was the first price marker of the S&P 500 forming at least a short term high. The low last week was 3232 before the S&P 500 popped above 3250 which was then retested on January 8.
The first sign that the S&P 500 has made at least a short term high will be given when it falls below and closes below 3250. As long as the S&P 500 continues to make higher highs and higher lows the trend is up.
Measures of sentiment and positioning suggest that committing new money is not a good idea since the odds favor an opportunity to buy at lower levels will materialize in coming months. Although the S&P 500 seems destined to breech 3300 in coming days as the trade deal with China is signed, the expectation is that a decline below 3150 down to 3070 is likely. Unless your answer, Do you feel lucky? is Yes.
Treasury Bonds
The 10-year Treasury yield has edged above the red down trend line after failing to close below the green trend line. Until a close below the green trend line develops the trend in the 10-year Treasury yield is up. The 30-year Treasury yield is still below the red trend line and above the green trend line so it remains inside the triangle that has formed. The near term trend will likely be determined by a close above either the red of black trend line.
The 10-year German Bund may be providing a clue as to which direction US rates will move. The December 31 high was above the early November high yield so the trend is clearly up.
Treasury Bond ETF (TLT)
The Treasury bond ETF (TLT) may also be providing a clue as to the next move in Treasury yields. TLT fell about $12.00 from its high of $148.67 to the low at $136.54, and then fell about $12.00 from the subsequent high of $146.03 to the low of $134.45. A similar $12.00 drop from the recent high of $141.77 would suggest a decline to near $130.00 may follow soon. If TLT does fulfill this target the 30- year Treasury yield would like rise to near 2.50%.
If this decline occurs it will set up a buying opportunity, especially if economic data continues to come in soft. The correction that has developed since the high of $148.67 wave (3) may still be wave (4) from the November 2 low of $111.90. If correct, TLT would have the potential to rally above $148.67 in coming months
Dollar
The decline from 99.67 in the Dollar from its high on October 1 to 96.35 on December 31 has dimmed the level of bullishness toward the Dollar and the long positioning. After being titled toward too many longs in the Dollar and shorts in other currencies, the positioning has become more neutral.
This suggests the Dollar may spend more time chopping around before another decline takes hold.
The Dollar is still expected to fall below 96.35 before another rally attempt takes hold. In coming months I expect the Dollar to trend lower and eventually trade below 96.00 and test 94.00.
Gold
The expectation of a rally that would carry Gold above the August high of $1556 was predicated on the price pattern which assumed the August peak was wave 3 from the August 2018 low near $1160. The choppy trading since the August high of $1556 was considered wave 4. Gold rallied to $1579 in response to the Iranian missile attack on January 6 before reversing lower.
As I have noted in recent weeks, positioning in Gold just kept getting more negative with the trend following Large Speculators holding a larger long position, while the Commercials keep increasing their shorts. This suggested that any move above $1556 was not likely to be the start of a sustained move higher. In the near term, Gold is expected to find some support near $1520 which is just above a series of highs around $1515. Gold’s RSI reached 86 on January 6, and such a high RSI reading suggests that the January 6 high in Gold may be wave 3 of wave 5. If sentiment and positioning improve significantly in coming weeks, this pattern leaves open the potential for a rally above $1579 in 2020. We really won’t know until we see quickly the positioning changes. Ideally, Gold will at least test $1450 in coming weeks and cause a decided shift in sentiment and positioning.
Gold Stocks
Last week I noted that the intra-day trading action in GDX had been fairly negative during the last 4 trading days from December 31 through January 6, with GDX opening near the high of the day and then closing not far from the low of the day. This indicated that there was aggressive selling into the rally which had been masked by the enthusiasm surrounding the rally in Gold. The net result is that the relative strength of the Gold stocks weakened noticeably since December 30. GDX has the potential to fall to the late December lows near $27.10, and could drop to $26.00 if Gold falls below $1500.
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.
Until mid January, seasonality and the consensus bullish outlook for 2020 was expected to keep selling pressure muted. If the S&P 500 does pull back in the first quarter, as the measures of investor sentiment suggest, the key technical level will be the red trend line. The January 2018, October 2018, and July 2018 highs are connected by the red trend line. The breakout above this trend line in early November was significant. Often, markets retest a breakout level before either negating the breakout or resuming the uptrend.
The sharp 3 day drop from 3154 on November 27 to 3070 on December 3 was a retest. Given the excessive persistent bullishness though another retest seems plausible. The key will be the form of the pullback and how quickly bullish sentiment dissipates. If the S&P 500 retests 3070 after a down-updown correction, it will likely continue to rally toward 3500 and higher. If the S&P 500 falls in a 5 wave decline as it tests or breaks below 3070, it would suggest the subsequent rally will represent a shorting opportunity.
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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