Written by Jim Welsh
Macro Tides Weekly Technical Review 01 June 2020
The S&P 500 was expected to breakout above its 200 day average last week as discussed in the May 25 WTR:
“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.”
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After briefly besting the 200 day average (purple line) on May 26 on an intra-day basis, the S&P 500 convincingly closed above it on May 27. The intra-day low on May 27 was 2969 and it would be negative if the S&P 500 closed below it, and confirm the expectation that the foray above the 200 day average would be brief.
The S&P 500 is approaching what is likely to be significant resistance after moving up so aggressively off the March low. The red trend line in the chart below connects the price high in January 2018 with the subsequent highs in September 2018 and July 2019, and is currently at 3107.
As reported in the May 18 WTR the stock market zoomed higher after Moderna reported promising news about their potential vaccine for COVID-19:
“The stock market’s rally on May 18 was quite strong with 2647 stocks rising and just 332 falling, a ratio of almost 8 to 1. It was also of interest that the Mega Cap stocks actually lagged when compared to the broader market. The Nasdaq 100 was up 1.86% and the S&P 500 jumped 3.15%, while the New York Composite gained 4.16%, the Equal Weight S&P 500 was up 5.47%, and the Russell 2000 soared 6.1%.”
“Despite this one wonder day boost the broad market averages failed to exceed their late April high even as the Nasdaq 100 and S&P 500 did. It will be important to see if this one day phenomenon is able to carry forward.”
On May 26 the averages I reviewed in the May 18 WTR did indeed follow through and did exceed their April 29 highs.
These breakouts certainly removed a negative that was overhanging the market in the short term, and significantly increase the odds that a retest of the March lows aren’t likely until 2022, when the 20 year cycle is due to bottom.
Near the end of a large rally it is common for the sectors that have not fully participated to get a bid. Traders and investors aren’t comfortable buying the stocks that are already up a lot, so they buy what is still down. The Transports, the Russell 2000, and the Financials were 3 sectors that were still down -15.0% to -20.0%, prior to the big bounce since the close on May 22.
While the breakout above the April 29 high in these averages is a positive for the market longer term, in the short term it actually leaves the market vulnerable to a pullback. These sectors were not overbought, but now they are. These sectors are far more exposed to the economy than the FAMANG stocks, so they may be profit taking targets, if the number of COVID-19 infections increase in coming weeks. The Russell 2000 is approaching what should be significant resistance near 1450, since this price level has been touched at least 7 times starting with a high in July 2017 and 6 trading lows in 2018 and 2019.
As discussed in the June Macro Tides, COVID-19 infections are likely to rise into mid June, just as Swine Flu infections rose into mid June 2009. This seasonal aspect, and likely increase in infections after all 50 states opened up their economy, could raise doubts about the risk of roll backs in some hot spot cities, and overall drag on the traction speed of the economic recovery. The protests in almost 40 large cities with the majority of protestors not wearing a mask, while shouting slogans and epitaphs is ideal for COVID-9 spread, even though being outdoors. A few of the FAMANG stocks could get hit with profit taking, if the dispute with China over Hong Kong escalates and China retaliates with actions that negatively impact U.S. corporations doing business in China.
The Call / Put Ratio reached a level last week that reflects a bit too much optimism and complacency in the short term. The market is ripe for a modest correction with a drop below 2800 likely by the end of June.
In the May 25 WTR I noted that the S&P 500 had traded in a very narrow range for an extended period which has historically led to a correction:
“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.”
There is a first time for everything and this may be one of those times that the S&P 500 can avoid even a modest decline given how infatuated investors are with what the Federal Reserve has done and the prospect of more spending by Congress.
The Volatility Index (VIX) typically trends down if the S&P 500 is rising, and when the S&P 500 falls the VIX goes up. When the VIX deviates from this pattern it can be a clue that a trend change is near. As the S&P 500 pushed to a new high on February 19, the VIX was rising (red tend line) rather than falling as would be expected. This was a hint that a turn lower was coming. The same divergence has developed in the past few days, with the S&P 500 rallying while the VIX trends higher rather than falling (red tend line). As long as the VIX doesn’t drop to a lower low, it is suggesting a trend change lower is coming soon.
Three 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 recommended adding 12.5% to the position in RWM if the Russell 2000 traded up to 1395.00. The Russell 2000 gapped higher on May 26 opening above 1395, and RWM trading at $37.72. If the market corrects in June as expected RWM may be able to revisit $44.00 again.
COVID-19 Vaccine Hype Update
Gilead Science announced on April 29 that its COVID-19 drug had shown promise, which is why it didn’t wait until late May as previously scheduled to provide an update. I have questioned the timing of the announcement on April 29 since it followed a dismal GDP report and offered enough hope that the Gilead news overshadowed the down beat economic news.
On the news Gilead’s stock jumped +5.7%, which helped the S&P 500 gain 2.6% on April 29.
I’ve suggested that potentially positive vaccine news was being used to prop up the stock market as I discussed in the June Macro Tides. Gilead Science reported today that their drug Remdesivir was only marginally effective and the stock fell -3.4%. Since the announcement on April 29 Gilead’s stock is down -9.6% falling from $83.14 to $75.16.
Treasury Bonds
The 10-year Treasury yield continues to outperform relative to the 30-year Treasury yield suggesting that a trend change may be in the offing. The 10-year Treasury yield recorded a low of 1.394% in July 2012 and a low in July 2016 of 1.336%. With July 2020 right around the corner, watching for a trend change based on this 4 year pattern seems appropriate. 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 below 0.543% and may drop to the near the lows of March 9 (0.398%).
If COVID-19 follows the pattern of the swine flu in 2009 and infections plunge during July and August, the economy will get a boost as people become comfortable going out and spending money. Until that happens Treasury yields are likely to chop sideways, unless the 10-year yield closes above 0.75%.
30-year Treasury
Yield While the 10-year Treasury yield has been chopping sideways, the 30-year Treasury yield has been drifting higher. As long as the 30-year doesn’t close above 1.50%, 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 or lower.
Gold and Silver Ratio
A subtle change has been developing in the metals market. Gold has been outperforming Silver since 2011, which is why the Gold to Silver ratio has been rising, almost without interruption. However, this ratio can be deceiving as it was between September 2011 and late 2015. After peaking at $1920 in September 2011, Gold dropped to $1,046 in December 2015. The ratio of Gold to Silver rose because Silver fell more. This indicates that the Ratio is not helpful in discerning the trend of Gold and Silver.
The improvement in the past few weeks may be signaling that the period of underperformance by Silver might be coming to an end. Since Silver is more of an industrial metal than Gold, it is sometimes more influenced by the economy than Gold. If infections decline significantly in July and August, Silver could catch a bid as the perception of an improving economy takes hold.
Gold and Silver
In March Gold rallied above the high it reached in February, and then proceeded to hit higher highs in April and in May. In contrast, Silver still has not been able to surpass the high it reached in February. However, in the past week Silver has exceeded its May peak, as Gold has continued to hold below its May high of $1764. Silver is approaching a zone of resistance ($18.50 – $19.00), and its RSI of 76 indicates that it is overbought. After lagging for so long, the catch up by Silver in the short term is often what happens at the end of a rally, much like what happened with the lagging stock market indexes.
The positioning in Gold is still showing too many trend followers have jumped on Gold’s bandwagon and bullish sentiment toward Silver is excessive with more than 90% bulls.
Both metals are poised for a pullback that could prove deeper than expected, especially if the stock market suffers a mini-swoon in June. Confirmation that Silver is preparing to take the lead away from Gold would occur if Silver’s relative strength improves on a decline in both metals.
Gold Stocks
After GDX’s RSI recorded a second lower high relative to its high on April 24 and finally closed below the rising trend line, GDX quickly fell to $32.54. In response to the strong rally in Silver and bounce in Gold, GDX could make a new high, and register an even larger RSI divergence. The recent sharp decline appeared to be an a-b-c decline, which is typical of a wave 4 that would be followed by a wave 5 rally to a new high.
If Gold and Silver correct as expected, and the stock market corrects, GDX is set up to get hit hard. A decline to $29.75 is the minimal expectation, with the potential GDX could trade under $27.00.
Dollar
The Dollar closed below 98.75 (horizontal trend line) on May 28 and fell further on June 1. At this point the Dollar’s RSI is modestly oversold so a bounce is likely. The other consideration is why the Dollar dropped. The Euro is 57.6% of the Dollar Index and the Euro received a big boost last week after the EU decided to issue $750 billion in Eurobonds to help those countries most affected by the COVID-19 Pandemic. To get a better idea of where the Dollar may be headed one has to look at the Euro, especially after the Euro has made a big move on news.
The Euro reached 1.114 on March 27 before falling quickly to 1.072 on April 24, a decline of -3.8% in less than a month. From a low of 1.087 on May 25 the Euro climbed above the March 27 high by a small amount, and may have a bit more upside. Unless the Euro quickly follows through to the upside meaningfully, this move up appears to an a-b-c 8 rally from the low of 1.063 on March 23.
A flight to qualify enabled the Dollar to rally and it’s not a coincidence that the Dollar bottomed on March 23. If the Euro is near a high, the Dollar is going to rally back above 100.00. A close above 101.00 would lead to a test of 103.00, which could also pressure the stock market.
Emerging Market
The Emerging Market ETF EEM rallied from $36.50 on May 22 to $38.60 on June 1 and above the resistance level of $37.90. The sharp rally in the Euro and drop in the Dollar undoubtedly provided a tailwind. If the Dollar rallies in coming weeks, and the S&P 500 experiences a decline in June, EEM is expected to reverse and close back below $37.90.
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. The strength and persistence of the rally may allow the MTI to cross above the green horizontal line by June 8.
Although the MTI may confirm the probability of a bull market, it doesn’t preclude a correction as discussed. However, it does reinforce that the improvement in the lagging indexes suggests any correction is likely to hold above 2650 and may only retest the May 14 intra-day low of 2767.
It also increases the probabilities that a move to a higher high in the S&P 500 is likely after a correction.
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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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