Written by Jim Welsh
Macro Tides Weekly Technical Review 27 January 2020
When the coronavirus started making headlines last week, investors shrugged and used any weakness in the S&P 500 as a buy-the-dip opportunity. Investors were told that every prior instance of a global health scare always proved to be temporary. Comparisons to the SARS epidemic (severe acute respiratory syndrome) were widespread on CNBC and investors were told the current version of coronavirus was likely to be less virulent.
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Between November 2002 and July 2003 SARS inflected 8,098 people in 17 countries resulting in 774 deaths with a fatality rate of 9.6%. SARS originated in China which bore the brunt of the economic fallout of $50 billion in lost GDP. In the U.S. the Centers for Disease Control and Prevention (CDC) has reported that there have been at least 15 million Americans who have experienced the flu illness during the 2019-2020 season, 140,000 people of them have been hospitalized and 8,200 have died. Dr. William Schaffner, professor of preventive medicine and health policy at Vanderbilt University Medical Center, told Kaiser Health News:
“When we think about the relative danger of this new coronavirus and influenza, there’s just no comparison. Coronavirus will be a blip on the horizon in comparison. The risk is trivial.”
So far the current variation of coronavirus has been reported to have infected more than 2,700 worldwide and killed 81 people. Compared to the flu the coronavirus looks like a paper tiger. However, after learning over the weekend that the coronavirus was continuing to spread in China and there were 5 reported cases in the U.S., investors expressed their anxiety on January 27. The S&P 500 fell -1.57% today snapping the streak of 71 days without a 1% move up or down that began on October 11, 2019 and the sixth longest stretch since 1969.
Despite the decline commentators on CNBC were universally of the opinion that any additional weakness in the S&P 500 from coronavirus was an opportunity, since the U.S. economy remains in good shape and the global economy has turned the corner after a weak 2019.
Those who contracted the SARS version of coronavirus were not infectious until after they exhibited symptoms. This made it possible to quarantine those exposed to SARS and isolate those with the SARS virus quickly and before they infected other people.
In contrast, the current version of coronavirus is infectious before symptoms appear, meaning it can be transmitted to many people before the initial person can be quarantined. It is believed that the incubation period, during which a person has the disease but no identifiable symptoms, ranges from between one and 14 days. A person may not know they have the coronavirus, but can spread it to dozens of other people who would then be capable to infect many others before any of them know they are sick.
This is a huge difference since it makes it infinitely more difficult to contain this version of coronavirus as compared to SARS.
The number of additional people who become infected is known as the reproductive number. An outbreak with a reproductive number of below 1 will peter out, since there is no multiplier effect. On average those who contracted SARS only infected 0.49 other people, or less than 1 other person. A number of scientific groups have calculated the reproductive rate for this current outbreak based on available data. The scientific calculation is known by the term R-naught or R0. As noted, SARS had a R0 of 0.49.
The current coronavirus has a R0 in the range of 2 to 3 and possibly as high as 7 by one estimate. This means each person who gets infected infects at least another 2 or 3 people.
Since this version of coronavirus can’t be isolated until after additional people become infected, containing it will be very difficult. Trevor Bedford, a computational biologist at the Fred Hutchinson Cancer Research Center in Seattle, suggested the estimates are sobering and point to continued spread:
“If it’s not contained shortly, I think we are looking at a pandemic.”
Bedford cautioned that it’s impossible to know at this point how severe that type of event would be. Dr. Tom Inglesby, director of the Center for Health Security at Johns Hopkins School of Public Health, urged countries to start planning to deal with global spread of the new virus. Such plans need to include far more aggressive efforts to develop a vaccine than have already been announced. Inglesby noted the mathematical modeling, the statements from Chinese authorities, and the sharply rising infection numbers make a case for this possible outcome:
“I’m not making a prediction that it’s going to happen. I think just based on those pieces of limited information, it’s important for us to begin some planning around the possibility that this won’t be contained.”
The World Health Organization stopped short of calling the outbreak a global health emergency, although there are questions regarding China’s ability to contain the epidemic. There is no cure for 2019-CoV as it is now described and it will many months before a vaccine can be brought to market in the volume needed.
Hopefully the calendar will help as most versions of the flu spread during the winter but disappear in the summer. If 2019-CoV behaves in a similar fashion it will buy researchers time to find a cure before the next flu season begins in late 2020. Based on the dynamics in place the number of people who become infected by 2019-CoV could rise significantly in the next 2 weeks which could continue to rattle global equity markets.
S&P 500
The title of last week’s Weekly Technical Review was ‘Will 3336 Prove a Pivot for a Top?’ This price target was calculated based on how the S&P 500 had traded after reaching a low of 2347 on December 26, 2018:
“From its low of 2347 on December 26, 2018 the S&P 500 rallied to a high of 2954 on May 1 (Wave 1) a gain of 607 points. From the S&P 500’s Wave (2) low of 2729 on June 3, an equal rally of 607 points targets a high of 3336 as the potential high of wave (3) from the December 2018 low.”
On January 22 the S&P 500 traded up to 3337.77 before reversing lower. As noted last week,
“A short term high will be signaled if the S&P 500 closes below 3280, and a stronger confirmation will be provided when the S&P 500 closes below 3250 (30 minute chart below). These two levels are the support levels the 3 S&P 500 has traded at since the beginning of the year.”
On January 24 the S&P 500 dropped to 3281 before closing at 3295. On January 27 the S&P 500 gapped well below 3280 trading down to 3234 before closing at 3243. It is likely the S&P 500 will close the gap created with today’s decline and will rally back up to 3281 – 3300.
The VIX closed at 18.23 on January 27 and well above the levels cited in last week’s WTR:
“A VIX close above 16.5 would exceed the intra-day high of 16.39 on January 6 and break above the downtrend line from the December 2018 high of 36.20 in the VIX.”
As long as the VIX holds above the down trend line currently 15.60 (which is expected), volatility is likely to trend higher.
As discussed last week, a shallow correction (.238%) of the 607 point rally since June 3 would bring the S&P 500 down 145 points, while a 38.2% pullback would retrace 230 points. These modest retracements suggest the S&P 500 can fall to 3200 and possibly 3100:
“Given how extended the S&P 500 was above its 4 20-day moving average last week, and the large short position in VIX futures, a correction down to these levels could be quick and sharp as the initial declines were following the highs in January 2018 and October 2018. The S&P 500 lost -11.4% after the high on October 3, 2018 before striking a low in 18 trading days on October 29, and lost -11.8% in 9 trading days post the January 26, 2018 high. An 11% correction would bring the S&P 500 down to 2969.”
A decline to 3100 (red trend line) would retest the breakout level which is quite common. A drop below the breakout level of 3100 would alter the outlook. The expectation is that the current decline will hold above 3100 and be followed by a rally to a new high.
No one knows with any certainty how severe the coronavirus will become or whether it will follow the historic pattern. The differences with the SARS epidemic suggest it could have a pronounced negative impact on global growth if it is not contained quickly.
Fed Chair Powell will be asked on Wednesday how the FOMC will respond to this threat to global growth. Powell will say the FOMC will respond if it does weigh on growth by lowering rates, especially if the yield curve inverts. The 10-year Treasury yield closed at 1.605% on January 27 barely above the federal funds rate of 1.55%. If the coronavirus becomes a pandemic, lowering the funds rate won’t make much of a difference.
Based on the analysis that indicated the S&P 500 might top at 3336, I recommended establishing a 20% short position in the S&P 500 via the ETF (SH) as long as the S&P 500 was trading above 3320, using a stop of 3370. The S&P 500 traded above 3320 on January 21, 22, 23 and 24 topping at 3337 on January 22. SH could have been purchased at $23.35 or lower. The stop should be reduced to 3337.
Treasury Bonds
In the January 13 WTR I noted that the 10-year Treasury yield had 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 10-year Treasury yield closed at 1.788% January 15 and below the green trend line and has continued to fall. It closed at 1.605% on January 27.
In the January 13 WTR I noted that the 30-year Treasury yield was 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 trend line or below the green trend line. The 30- year Treasury yield closed below the green trend line on January 15 when it closed at 2.242%. On January 27 it closed at 2.055%. The expectation has been that the 30-year will test the low of 1.905% by mid-year
Treasury Bond ETF (TLT)
I thought the Treasury bond ETF (TLT) might repeat the pattern of $12.00 declines that began after it peaked at $148.67 and fall to near $130.00 after hitting a high of $141.77. TLT negated this pattern when it closed above the declining black trend line on January 14. The longer term expectation was that TLT was likely to rise above the high of $148.67 to complete a 5 wave rally from the low of $111.90 on 6 November 2, 2018. As discussed previously,
“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.”
Gold
In a conference call on January 23 with a group of financial advisors, I told them I expected Gold to bounce to $1573 – $1580 before a decline below $1520 followed. Gold rallied to $1585 on January 27 as the stock market sold off sharply. Positioning in Gold remains quite negative which suggests that after any near term strength Gold will subsequently be vulnerable to a sharp decline.
Gold Stocks
In the January 23 conference call I told the financial advisors tuning in that I expected GDX to fall below $27.68 and possibly fall to the late December lows near $27.10. After opening near the high of the day on January 27, GDX sold off sharply, much as it did from December 31 through January 6.
Dollar
As noted in the January 13 WTR, the positioning in the Dollar and other currencies had become more neutral. This suggested the Dollar might 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.
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, 2019 confirming the uptrend.
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 so evident in January 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 3100 after a down-up-down 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 3100, 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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