Written by Jim Welsh
Memorial Day
We have freedom 365 days a year due to millions of brave men and women we have never met going back more than two centuries. It’s a legacy that we remember and celebrate on Memorial Day once a year. We have freedom 365 days a year because there were members of our families willing to risk their lives for the concept of democracy and freedom.
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Today we remember the sacrifices they made and their willingness to put themselves in harm’s way. The sacrifices that provide us freedom are the bond that binds all of us together. The best way to honor all of them is to treat our fellow Americans with respect, even those who hold views different than ours. And remember our shared bond 365 days a year.
Stocks
On April 29 the S&P 500 hit an intra-day high near 2955 and on Friday May 22 closed just above 2955, effectively registering no gain in the past 17 trading sessions. For the past 20 sessions the S&P 500 has remained pinched between the 50 day average near 2730 and the 200 days average, which was 2999 on May 22. This has only occurred 29 times since 1928. In 21 of the 29 times the S&P 500 has subsequently traded below the 50 day average. In the 8 times it pushed above the 200 day average the S&P 500 was on average -12.7% lower six months later.
The Nasdaq 100 is up +7.8% for 2020 through May 22 and is just -3.4% below its’ all time high, but the average Nasdaq stock is down almost -19.0%. The Nasdaq 100 has been pulled up by the ten largest stocks which now sport a P/E ratio of 29 times 2021 earnings compared to 16 for the average Nasdaq stock. The 10 largest Nasdaq stocks comprise 25.4% of the S&P 500 and are the main reason why the S&P 500 is only down -8.5% for the year. The NYSE Composite is -18.5% below its’ December 31 close and the Russell 2000 is off -18.7%, while the Value Line Composite is down -24.4%. Clearly this is the tale of Two Markets.
It appears the S&P 500 is likely to test its 200 day average of 2999 and may briefly climb above it in the next few days. However, the narrowness of the past 20 sessions indicates that the S&P 500 is likely to fall given the record of 29 of 29 times going back to 1928. There is a first time for everything and this may be one of those times given how infatuated investors are with what the Federal Reserve has done and the prospect of more spending by Congress.
There are a number of solid technical reasons why the stock market is likely to correct in coming weeks after one last flourish to the upside. The Nasdaq 100 may make a new all time high but the Advance / Decline line is a mile away from its high in January. The lower peak in the Nasdaq A/D line in February was a sign of weakness and the divergence then was far smaller than now.
The relentless strength in the top 10 Nasdaq stocks has ginned up option trading sentiment, so the Call / Put ratio is signaling too much optimism.
Two weeks ago I recommended establishing a 25% short position in the Russell 2000 at the opening on May 12 through the purchase of the inverse ETF. RWM opened at $40.34 and on May 14 I sent a Special Update advising the sale of half of the position. When the email was sent RWM was trading at $44.67 and subsequently traded as high as $45.32. Last week I suggested using a stop of $39.10 for RWM and 2995 on the 25% short position in the S&P 500. I’m going to cancel those stops and recommend adding 12.5% to the position in RWM if the Russell 2000 trades up to 1395.00.
COVID-19 Vaccine Hype
In the May 4 WTR I discussed the timing of Gilead Science’s announcement of its COVID-19 drug Remdesivir, which was coincidently timed to hit the wires just after a dismal Q1 GDP report:
“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.”
It is said that timing is everything so it was again no coincidence that a report showing scant value in Remdesivir was released at 6pm on Friday May 22 after the whole world had left for the 3 day Memorial Day holiday. According to a pivotal study published in the New England Journal of Medicine, Remdesivir, which was authorized to treat Covid-19 ‘only significantly helped those on supplemental oxygen, and found no marked benefit from remdesivir for those who were healthier and didn’t need oxygen or those who were sicker, requiring a ventilator or a heart-lung bypass machine’. If this ‘great’ news was released just before the opening on May 26 would the market rally much or drop?
Treasury Bonds
If infections increase as the economy is reopened and the stock market reverses lower, and declines into late June or early July, the 10-year Treasury yield has been expected to eventually fall to the near the lows of March 9 (0.398%). Until that happens Treasury yields are likely to chop sideways.
30-year Treasury Yield
As noted last week:
“the 30-year is testing the trend line connecting the two most recent high in yields. Should it close above the black trend it will reinforce the relative weakness in the long Treasury market.”
The trend line held which reinforces the expectation that the 30-year yield is likely to fall under 1.126% and possibly approach the March low of 0.837% if the S&P 500 drops to 2767.
Gold
After spiking up to $1764 on May 17 and reversing lower as expected, Gold is likely to trade down to $1664 at a minimum, which is the low of the triangle formation.
Silver
The Silver stocks ETF SLV left two gaps during the recent spike that are likely to be filled in coming weeks. The lower spike is at $14.83. In the short term, SLV is likely to pop above its recent high of $16.44 to complete 5 waves up, before a correction takes hold. The spike likely eliminates the potential of SLV retesting its March low, and will reach a trading low that is comfortably above the March low. It may also indicate that Silver is about to end its relative underperformance to Gold.
Gold Stocks
GDX finally closed below the rising trend line after its RSI recorded a second lower high relative to its high on April 24. The correction could be deeper than expected if the stock market suffers a correction in June as is the expectation, and Gold falls to $1664 or lower. A decline to $29.75 is the minimal expectation, with the potential GDX could trade under $27.00. GDX’s RSI is expected to drop at least below 40 which will be one of the first signs of an impending trading low.
Dollar
The sideways chop can continue as long as the Dollar doesn’t close below 98.75 (horizontal trend line) or close above 101.00. A close above 101.00 would lead to a test of 103.00, which could also pressure the stock market. A close below 98.75 would open the door to a drop to 96.50.
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 hasn’t improved even as EEM rallied off the March 23 low. As noted last week, the black horizontal trend at $37.90 should represent a wall of over head resistance and is expected to contain any further advance. EEM traded up to $37.91 before reversing lower.
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 Wave (C), and set up a great buying opportunity.
Tensions continue to increase with China in general but the spat with Hong Kong could become a much bigger problem. China has a weighting of 7.5% within EEM but Hong Kong is 32.9%. The chart pattern implies a big drop is coming. Can we infer that the global dispute with China over Hong Kong will provide the back drop?
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. Frequently, after a large decline that drops the MTI below the red horizontal line, the first BMR buy signal is 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.
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 from the BMR buy signal at 2800. The average whipsaw loss was -7.9% suggesting a possible 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 rally buy signal.
As noted two weeks ago:
“A close below the May 4 low of 2796 would likely indicate that a top was in place as that would market the first time the S&P 500 would have broken below a prior low since bottoming on March 23.”
On May 14 the intra-day low for the S&P 500 was 2767 before it rallied strongly into the close. This penetration of 2797 may represent the first crack in the S&P 500’s chart structure. I can’t imagine that infections aren’t going to increase in coming weeks and lead to another correction in the S&P 500. I continue to believe the S&P 500 will fall below 2800 in coming weeks, and ideally provide a better entry point than 2800 where the MTI generated the Bear Market Rally buy signal.
If reopening the economy proves more problematic, the S&P 500 could drop to 2650 – 2730.
The S&P 500 rallied strongly on May 18 after the Moderna news, which may have also been more hype than promise, as I will discuss in the June Macro Tides.
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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