Written by Jim Welsh
Macro Tides Weekly Technical Review 04 May 2020
In last week’s WTR I discussed reasons why the S&P 500 was expected to rally to 2934, after expecting the S&P 500 to rally to 2896 based on its price pattern:
“The S&P 500 reached 2888 on April 27 so the rally may be near an end. However, there are a number of reasons why the S&P 500 may be able to rally to 2934.”
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“On April 27 the Nasdaq 100 only gained +0.80% but the broad market averages did far better with the S&P 500 +1.47%, NYSE +2.24%, Value Line Composite +3.77%, and the Russell 2000 +3.96%. The weakest sectors were the strongest as investors bought the areas of the market that have lagged which is a classic sign that the market is approaching a high.
However in the short term the breakouts by the Russell 2000 and Value Line are likely to lead to some follow through buying. The 50% retracement of the drop from 1705 to 966 on the Russell 2000 targets 1341, which is just below the high of 1351 on March 10. This suggests the Russell 2000 could rally another 4% or so and also help lift the S&P 500 to its 61.8% retracement of 2934.”
On April 29 the S&P 500 pushed up to 2954 as the Russell 2000 spiked to 1373. After hitting those price targets the S&P 500 quickly dropped -5.3% to a low of 2798 on May 4, while the Russell 2000 plunged -10.1% to 1234.
At the high on April 29 the 21 day average of Advances minus Declines hit an overbought level of +542, and by reaching a higher high confirmed the new price high. The expectation is the Oscillator will record a lower high prior to when the next shoe drops in the market. This is what has occurred prior to every pullback in the past year. A high in the S&P 500 will likely be confirmed if the S&P 500 closes below the April 21 low of 2727, or the green 5-day average (2860) falls below the blue 13-day average at 2830.
Valuation is a very poor timing tool, but there are times, like now, when ignoring what investors are expecting could be a big mistake. On Friday the Labor Department will report how many jobs were lost in March and the number will set an all-time record. It is estimated that more than 22 million workers are now out of work and that the unemployment rate could reach 16.0%, the highest level since records began in 1948.
These disheartening figures will add to a string of economic data showing that the U.S. entered a deep recession in March. No amount of Federal Reserve liquidity or spending by Congress can replace the lost demand caused by the COVID-19 Pandemic. Investors have been mesmerized by the Fed and Congress and have priced the S&P 500 at its highest valuation since 2000.
On April 9 the Labor Department reported that 6.6 million people had filed for Unemployment Insurance, after 10 million filed in the week ending on April 2. Within seconds of the report the Federal Reserve announced it would begin buying corporate bonds, including high yield bonds via ETFs, and provide $500 billion of support for the municipal bond market. This news – a historic and controversial decision by the Fed – dominated the financial news headlines and completely drowned out the dreadful unemployment news. On April 29 the Bureau of Economic Analysis (BEA) announced that GDP contracted by -4.8% in the first quarter and far more than forecast.
Within seconds Gilead Sciences announced that its Phase 3 trial had shown promise which more than offset the terrible economic news. What makes the timing of Gilead’s announcement interesting was that it was originally scheduled for late May. It was announced on April 29 since the results were not expected change materially in coming weeks. The net result was the ugly GDP report was completely buried by the wonderful news about Remdesivir. Just another coincidence, right?
The Fed’s and Gilead’s announcements were masterfully choreographed to support the stock market. Knowing this one has to wonder what ‘unexpectedly positive’ news will come out on Friday to overshadow what promises to be a completely dismal jobs report.
Last week I showed the performance divergence between the mega cap stocks in the FANG ETF (FNGS), Nasdaq 100, S&P 500, and the broad market averages NYSE Composite, Russell 2000, and the Value Line. Not much has changed.
Another way to look how the majority of stocks have performed since the S&P 500 bottomed on March 23 is to look at the percent of stocks that are above their 200 day average.
Despite the amazing rally in the mega cap stocks and S&P 500, only 12% of stocks traded on the NYSE were trading about their 200 day average as of May 1. The red horizontal line is at 20%. Compare how the overall market performed after the S&P 500 bottomed on December 26, 2018 to now. In early January 2019 the percent of stocks quickly jumped above 20% and continued to climb steadily. The lack of participation suggests that the market is far more vulnerable to another shoe to drop, if and when the mega cap stocks falter.
Two weeks ago I advised that
“If the S&P 500 climbs above 2879 traders can take a 25% short position in the S&P 500 using a stop of 2950 on a closing basis:”
The S&P 500 triggered this position when it rallied up to 2888 on April 27. After topping at 2954 the S&P 500 quickly fell to 2798. The 61.8% retracement of this 156 point drop would target a move back up to 2894. Increase the short to 50% if the S&P 500 trades up to 2885, using 2955 as a stop on the entire position. Cover 50% of the position if the S&P 500 drops below 2700.
Coronavirus-19 Projections
As discussed in the March Macro Tides the number of infections and deaths are likely to increase as numerous states open their economies, even though they do not have enough testing capability or ability to perform effective contact tracing. The Federal Emergency Management Agency (FEMA) updated its projection through May 1 and it included projections that were concerning. The New York Times had access to a copy of the report and you can view it using the link behind the image below.
Click on image.FEMA is projecting a marked increase in the number of infection Cases and Deaths per day by the end of May. The Reported Cases (blue dots) have been hovering just below the Modeled Cases, but the Modeling indicates the number of cases might increase 50% before the end of May.
Of greater concern is that Reported Deaths have consistently exceeded the Modeled Deaths, and Modeled Deaths are projected to almost double rising from 1,500 per day to near 3,000 by the end of May.
It must be noted that these projections are based on assumptions including adherence to social distancing as states reopen. If the Model is using a low social distancing rate than what actually develops, these projections may prove too negative.
Treasury Bonds
After a surge of volatility between March 9 and March 18, the Treasury bond market has become comatose with yields barely moving. Despite the rally in the S&P 500, economic data has been so weak Treasury yields have chopped lower with the 10-year yield falling from 0.764% on March 23 and 0.637% on May 4. If the stock market reverses lower and infections increase as sections of the economy are opened, the 10-year Treasury yield has been expected to eventually fall to the near the lows of March 9.
The 30-year Treasury yield closed at 1.344% on March 23 and 1.297% on May 4, and has been a little more volatile than the 10-year Treasury. The 30-year yield is likely to fall under 1.0% and possibly approach the March low of 0.837% if the S&P 500 drops under 2500.
Gold
The flow of money into Gold ETFs (green bar) indicates that investors are confident that Gold is going to keep rallying.
I don’t actually disagree with that outlook longer term, but in the short run such widespread optimism is rarely rewarded without testing investor’s nerves first. This is one reason why a shakeout in coming weeks could develop.
The positioning in Gold Futures paints much the same picture with Large Speculators and Managed Money hold large long positions, while the Commercials continue to hold a large short position.
The net result is that Gold is a very stretched Long. If Gold does pullback it could trigger some liquidation as Large Specs and Managed Money positions are pared.
If Gold (cash) rises above $1715, traders can short the Gold ETF (IAU) using $16.59 as a stop, and cover the short if IAU trades under $15.25.
Silver
Silver has been far weaker than Gold. If the stock market has another swoon as infections rise and expectations for GDP growth in the second half fall, Silver could decline more than Gold. Silver’s relative weakness to Gold is why the Gold/Silver ratio continues to hover near record highs.
Traders can short the Silver ETF (SLV) at $14.10 using $14.42 as a stop. Cover half of the position if SLV drops to $12.44. It appears the SLV has only 3 waves down from the high in February and the bounce since mid March could be a wave 4. If correct, SLV has the potential of falling below $11.00 before a more significant trading low forms.
Gold Stocks
After bottoming in mid March, the Gold stocks continue to exhibit better relative strength compared to Gold. The expectation is that GDX will trade below the rising trend line before the next meaningful advance takes hold. A decline to $29.75 is the minimal expectation and with the potential GDX could trade under $27.00.
Dollar
As long as the Dollar doesn’t close below 98.75 the trend is up, as noted last week. The intra-day low on May 1 was 98.78 before the Dollar closed at 99.07. A close above 101.00 would lead to a test of 103.00. The Chinese Yuan is hovering just below 7.10, which has been resistance in the past. If President Trump continues to blame China for the Pandemic, China may decide to let the Yuan trade above 7.17894. That low was reached at the height of the trade dispute with China in August 2019.
Emerging Market
Since the peak in January 2018 at $51.76 EEM has persistently underperformed the S&P 500, which is why the Relative Strength moving averages have trended lower. EEM’s relative strength weakened further even as EEM rallied off the March 23 low. EEM is expected to trade down to $30.10, which was the intra-day low on March 23. This would complete its Wave 5 decline from the high of 46.32, and set up a great buying opportunity.
Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking
The MTI generated a Bear Market Rally (BMR) buy signal when it crossed above the red moving average on April 16 when the S&P 500 closed at 2800. A new bull market would not be confirmed unless the MTI is able to get above the green horizontal line.
If the past is any guide the BMR may prove to be a whip saw trade as the table below the chart illustrates. It is common after a large decline that drops the MTI below the red horizontal line, for the first BMR buy signal to be followed by a retracement that is deep enough to cause the MTI to cross back below the red moving average. In the current environment this outcome seems likely, unless the U.S. is able to reopen without a meaningful increase in infections.
The update from FEMA certainly casts doubt on that outcome and instead suggests we may be on the cusp of a significant increase in Reported Cases and Deaths.
A crossover below the moving average is considered a sell signal. The expectation is that the S&P 500 will decline enough to cause the MTI to fall below the red moving average, even if a full retest of the March 23 low does not develop. Since 1962 the smallest whip saw loss was -4.0%, which would bring the S&P 500 down to 2688. The average whipsaw loss was -7.9% suggesting a drop to 2580.
In 1987 there was only a single crossover, but there was also a full retest of the initial low prior to the bear market 9 rally buy signal.
The S&P 500 closed below the close on April 14 on May 4, so it has made no upside progress in the past 14 trading sessions. That is why the MTI has begun to flatten out.
As discussed in the April 27 WTR, the minimum expectation is that the S&P 500 will experience a wave 2 correction if the March 23 low stands. At a minimum that is likely to bring the S&P 500 below 2800 in coming months and provide a better entry point, since that is where the MTI gave its Bear Market Rally buy signal. Obviously, if reopening the economy proves more problematic, the S&P 500 could drop to 2650 – 2700.
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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