Written by Jim Welsh
Macro Tides Weekly Technical Report 09 March 2020
In a Special Weekly Technical Review Report entitled ‘Any Signs Of A Bottom Yet?’ dated February 27, I reviewed what I had told Ike Iossif on Market Views on Tuesday February 25, after Ike asked me what levels could be expected to provide support for the S&P 500:
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“I told Ike in a market like this there are no levels of support (5 min – 6 min).
One can look at the chart of the S&P 500 and identify price levels that previously provided support, but in the middle of a dynamic decline (panic) no one cares.”
That was certainly proven today as the S&P 500 fell -7.60% closed at 2746, after slicing through the February 28 low of 2856 as if it were a mirage of ‘support’.
Last week I discussed how the verbal intervention by Federal Reserve Chair Powell on February 28 may have prevented a potential set up for a steep decline (crash?) on March 2 and a positive reversal on Tuesday March 3, after Powell made the following statement:
“The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook.”
Frequently, a trading low develops after an extended decline carries over from a Friday into a big drop on the following Monday, which sets the market up for a Turnaround Tuesday. It seemed to me that Powell’s verbal intervention
“had changed the flow of the decline that might offer an insight as to when a short term rebound high may develop. Rather than a low being set on Tuesday, it may mark a high.”
In an emergency inter meeting move, the Federal Reserve lowered the federal funds rate to 1.0% -1.25% on March 3, after cutting it by 0.50%. Although the amount of the reduction was understandable, the timing was questionable since it followed a huge rally on March 2. It would have been more effective if the FOMC had waited and let the market find its own level on March 3 after such a big move up. By moving so quickly the FOMC’s emergency rate cut proved unsettling and the S&P 500 lost -2.8% by the end of the day. The FOMC would have gotten more mileage from the rate cut had they waited for the market to resume its decline and acted as the S&P 500 was approaching its February 28 low of 2856.
Last week I discussed possible targets for any rebound:
“The S&P 500 lost 537 points in just 7 trading days. A 50% retracement of the initial drop would allow the S&P 500 to rally to 3125, while 61.8% rebound would target 3250.”
(The correct 61.8% retracement should have read 3188.)
Most of the March 2 WTR was spent reviewing prior high energy declines where the 5-day Advances minus Declines exceeded -1200 in 2011, 2015, 2016, February 2018, and December 2018. As I highlighted after the review:
“The key take away from the review of these prior high energy declines is that the S&P 500 will experience a retest of the low of 2855 possibly before the end of March. With this outlook selling into strength seems appropriate, and using the price targets as an opportunity to go short.”
After the FOMC announced the rate cut on March 3, the S&P 500 rallied to 3136, barely exceeding the 50% retracement level of 3125, before reversing lower. The following quote from the March 2 Macro Tides proved prescient:
“Although the stock market will rally if the Federal Reserve lowers the federal funds rate, the rally may be measured in hours rather than days, since people aren’t going to go out to dinner, movies, sporting events just because the FOMC cut rates. There is a risk that any rally in the stock market that follows a rate reduction will be seen as an opportunity to sell and be followed by a washout that probably creates at least a short term trading low.”
There is one level on the S&P 500 that should provide some element of support and God help us if it doesn’t. The black trend line that connects the bear market low in March 2009, October 2011, February 2016, and December 2018 comes in between 2500 – 2550. This trend line is about 8% below the close of 2746 on March 9, which raises the question of whether the S&P 500 will reach it.
Given the outlook, the odds favor a test of this trend line.
While there is no guarantee that the current decline will stop at this trend line, the S&P 500 could at least experience a strong rally from near this trend line. The path of how the S&P 500 gets to this trend line is murky and will likely occur after at least one vicious rally.
The administration will announce a plan sometime this week that lays out how it will attempt to limit the economic damage that is sure to become a reality soon. Investors will be happy to bid the market up since they want to believe the economic displacement from COVID-19 will be short lived and modest. This news may allow the S&P 500 to rally to 2985 which is the 38.2% retracement of the 659 point decline from the high of 3393.
Until (and if) the S&P 500 approaches 2550, I will suggest that any rally is a selling opportunity.( I told advisors prior to the close on March 9 to expect an announcement from the White House before the opening on March 10, even if details weren’t available. I expected the S&P 500 and the Dollar to rally, while Gold and Treasury bonds were likely to decline.)
The blue trend line below connects the February 2016 low of 1810 and the December 2018 low at 2347 and is currently near 2570. The red horizontal trend line is at 2630 which provided some stability and support during the sharp drop in February and March 2018. The S&P 500 plunged in December 2018 once this support was broken, reinforcing its importance.
If the S&P 500 immediately drops into the range of 2570 – 2630, traders can establish a small position in the S&P 500 ETF SPY in anticipation of an oversold rally. If this trade is triggered, sell half of the position above 2835 and the remaining half above 2885. If the S&P 500 rallies above 2800, before it drops to 2570 – 2630, do not make this trade.
U.S. GDP could easily contract in the second quarter and may be negative in the third quarter if the virus persists into June or July. Two consecutive quarters with negative GDP defines the official definition of a recession. Irrespective of whether an official recession develops, S&P 500 earnings may fall from last year’s level of $165.00, rather than rising to $175.00 – $180.00 as has been forecast.
Last week some strategists suggested that the decline in the 10-year Treasury yield would justify a higher multiple for the S&P 500. Following this logic one could say that German stocks could have an infinite P/E since the 10-year German Bund yields -0.83%. The other minor detail is that earnings may actually decline in 2020, so it seems a bit silly to suggest a higher multiple might be appropriate. As I pointed out previously, if the multiple falls to 14 and earnings are flat at $165.00, the S&P 500 could briefly dip to 2310, which is just below the December 2018 low of 2347.
Fiscal Stimulus
Consumer spending comprises almost 70% of GDP and will soften as more consumers choose to avoid going out into public places. Importantly, roughly 40% of the total spent by consumers is done in social settings. Anyone who has a job that interacts with the public is at risk of losing their job, as infections rise in many parts of the U.S. The most obvious examples are workers in restaurants, travel industry workers including hotels, airlines, tourist destinations, retail stores, and the majority of service industries, who are not able to work from home.
Many businesses could experience a 20% drop in business virtually overnight. This could cause the majority of small businesses to lay off workers, further weakening consumer spending, or go out of business if the slowdown persists for a number of months. Italy’s experience could be repeated in many large cities in the U.S.
The spread of COVID-19 has led Italy to impose a travel quarantine for the whole country as of March 10. Business activity could grind to a halt through March in much of Italy after the quarantine takes effect. Here are some details:
Italian Prime Minister Giuseppe Conte said all of the quarantine measures imposed in the north of Italy in recent days will apply to the whole country, with effect from Tuesday morning. That means Italian authorities will allow travel to, from and within Italy only if it is demonstrably necessary for work or health reasons. The nationwide quarantine also means employees are urged to take vacation and stay home, bars and restaurants must close at 6 p.m., and virtually all public gatherings are banned. In shops, churches and all public places, people must keep a distance between themselves of a meter, or just over 3 feet.
Treasury yields have fallen to historic lows and the Treasury should take advantage of this opportunity to issue $2 trillion of 10-year Treasury bonds immediately. In order to limit any spike in the 10-year Treasury yield the Federal Reserve should stand ready to buy 10-year Treasury bonds if the yield rises to 1.30%. This ceiling is just below the low in yields in July 2012 and July 2016. The proceeds can be used to address a number of economic weaknesses that are likely to appear soon.
- As consumers change their behavior to limit exposure to COVID-19, small businesses are especially at risk if the economy experiences a sharp contraction. Short term loans must be made available to small business so they can survive if sales fall meaningfully.
- Making credit available to small businesses might help employers avoid laying off their workers if small businesses are provided a funding life line.
- Accelerated enrollment and enhanced unemployment benefits that replaces 90% of weekly wages for workers who lose their job due to the dislocation from COVID-19.
- Funding for employers to pay sick workers, even if they don’t work. This will encourage nonsalaried workers who don’t have sick leave compensation to stay home if they are ill.
- Funds for infra-structure projects will provide the economy a lift 6 to 12 months from now to sustain the recovery after the short term impact has passed.
- An increase in the supply of 10-year Treasury bonds will cause the yield curve to steepen which would be good for the banking system and a better cure than another rate cut by the FOMC.
- A modest increase in Treasury yields would calm investors and take some of the pressure off the stock market.
- Issuing new 10-year Treasury bonds will save the government interest costs by replacing higher yielding Treasury bonds with new 10-year bonds with a lower yield, and extend the duration of Treasury debt.
During World War II the Federal Reserve helped fund the war effort by purchasing government debt at low rates. From July 1942 through June 1947 the Federal Reserve bought Treasury bills at 0.375%, one-year bills at 0.875%, 7-year to 9-year bonds at 2.0%, and long term Treasury bonds at 2.5%.
This precedent can be repeated to address this national emergency and implemented at much lower rates than during World War II.
Treasury Bonds
Last week’s assessment was spot on:
“If the S&P 500 retests or makes a new low, the 10-year Treasury yield will probably make a lower low before a more serious uptick in yields takes hold.”
The S&P 500 did make a new low and the 10-year Treasury yield plunged to 0.398% before rising to 0.499%.
It appears that lower Treasury bond yields are contributing to more weakness in the stock market as noted last week:
“Until the S&P 500 bottoms, the pressure on yields to fall further will remain.”
German 10-Year Bund
I thought Treasury yields would fall to historic lows based on their chart pattern, but also because the pattern in the 10-year German Bund sported the same chart pattern. This suggested that the 10-year Bund yield would fall below the low of -0.71% it reached last summer for its wave 5 from the high in yield 6 in January 2018. The German 10-year Bund has fallen below -0.71%, as its yield fell to -0.83% on March 9.
The fallout from COVID-19 could easily last into this summer and keep sovereign bond yields low, even if they don’t continue to make lower lows. However, now that Treasury yields and the German Bund have potentially completed a 5 wave decline from their highs in the fourth quarter of 2018, the risk of a reversal higher in global bond yields in coming months must be monitored.
If COVID-19 infections cause more economic damage in the next few months, the probability of a global fiscal response will rise significantly. This could set the stage for a sharp increase in global bond yields, once there is a meaningful drop in COVID-19 infections.
Treasury bond ETF (TLT)
TLT opened at $179.10 on March 9 and rallied to an intra-day high of $179.70, before reversing lower and closing at $171.29. This type of reversal usually indicates that a short term high has been made. After the close the Trump administration said it would ask Congress to pass a tax cut and take other steps to help the economy.
After an enormous rally TLT could quickly fall to $160.00 – $164.00 before a bounce kicks in. If the S&P 500 does drop to 2500, Treasury yields could approach their lows reached over night on March 9, and TLT could push above $175.00.
Gold
Gold didn’t rally on March 9, even as the S&P 500 broke below its prior low of 2856 on February 28. Investors are told they should always have a portion of their portfolio in Gold to protect them from big declines in the stock market.
The ‘experts’ forget to acknowledge that Gold declined during the 2008 financial crisis, and always having an allocation to Gold doesn’t make sense.
Gold rallied to $1920 in 2011, only to fall to $1050 in 2015. Riding a volatile asset up and down seems counter productive. If the stock market experiences a strong rally in coming days, Gold could quickly fall to $1550. The next Gold buying opportunity may not materialize until Gold is below $1475.
Gold Stocks
In the February 24 WTR I thought it was time to reduce exposure to Gold stocks since GDX had rallied beyond its price target of $30.50. On February 25 GDX opened at $30.48 and then plunged -16.5% to $25.43 on February 28. On March 9 GDX closed at $27.31. A drop below $25.43 might provide a buying opportunity. Until that develops GDX is still stuck in the broad trading range it’s been in since August.
Dollar
Two weeks ago I thought the Dollar was near a high and might weaken as expectations for rate cuts by the Fed increased. The Dollar had been expected to fall below 96.36 in coming months. After the FOMC’s emergency rate cut and expectations of another cut at the March 18 meeting, the Dollar fell out of bed and traded down to 94.65 on March 9. The Dollar has become oversold as measured by its RSI at just 18.6. A bounce to 96.35 to 96.70 is likely before a retest of 94.65 occurs.
Emerging Market
As discussed in the February 24 WTR, EEM was expected to decline below $40.50 at a minimum. EEM recorded an intra-day low of $39.28 on February 28 and a lower low was expected, especially if the S&P 500 retested its February 28 low. On March 9 EEM fell to an intra-day low of $36.60.
Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking
The Major Trend Indicator (MTI0 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.
Once the S&P 500 closed beneath 3214 (the intra-day low on January 31 and February 24), which was the expectation discussed in the February 24 WTR, an intermediate peak was confirmed. The unrelenting decline that has followed has caused the MTI to drop sharply. It is likely the MTI will fall below the blue horizontal line by the end of this week, and signal that the probability of a bear market has increased significantly.
After breaking below the red trend line that connects the January 2018, October 2018, and July 2018 highs near 3100, the S&P 500 rallied back to the underside of this trend line on March 2. The S&P 500 rallied up to 3136 on March 3, just above the 50% retracement of the prior 537 point decline. As discussed the S&P 500 is likely to fall to 2500 – 2550 and test the green rising trend line from the March 2009 bear market low.
WBBM Chicago – After The Bell: Wall Street’s Wild Ride 3-6
In this short interview Andy Giersher and I discuss why a large government stimulus program is needed to fund support for small businesses, unemployment benefits for those who will lose their job in coming weeks, and fund infrastructure programs.
Source: https://wbbm780.radio.com/articles/after-the-bell-wall-streets-wild-ride
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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