by Jim Welsh
Macro Tides Weekly Technical Review 12 October 2020
Selective Hearing and Options Redux
Any parent who has raised a teenager or doing so now can appreciate and understand the concept of selective hearing, since teenagers have mastered the technique. I have no idea if hormones play any role or if it is simply part of growing up. Financial markets go through teenage like periods when fundamental news is overshadowed by expectations of a better, or worse future and by the market’s current momentum, whether it is up or down.
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In recent weeks the market has ignored economic data which shows that economic growth has stalled after the weekly Pandemic Unemployment Assistance program ended on July 31. Since then the weekly benefit has dropped from $900 ($600 plus $300 average state unemployment amount) to $600 after President Trump tapped $44 billion of FEMA funds to pay $300 a week. Those FEMA funds have run out and now millions of people are trying to get by on $300 a week. The $1,200 checks to individuals, $2,400 for couples, and $500 for dependent children lifted the savings rate significantly in the spring. Consumers are using the increase in their savings to make up for the shortfall in weekly income since the end of July, which is why the savings rate has toppled from 33.7% to 14.1% in August.
Unless Congress acts soon to provide additional unemployment benefits the savings rate will likely drop below 8.0% in coming months. It is not a coincidence that Weekly Jobless Claims have stopped falling since the end of July, so the majority of unemployed workers are not getting their job back anytime soon.
Small businesses were thrown a life line through the Payroll Protection Program but those funds are long gone. Many small businesses were unable to pay rent in October, which means their landlord was probably unable to pay their mortgage to the bank. 2 It will be telling to see how much additional funds banks set aside for upcoming commercial loan losses and consumer loans when they report earnings in the next few weeks.
Restaurants have been one of the hardest hit sectors and according to the National Restaurant Association (NRA) restaurants will lose $240 billion in sales to the Pandemic. Employment at restaurants and bars has dropped from 12 million to less than 10 million after 2.3 million workers were let go. The National Restaurant Association estimates that 100,000 restaurants will close in 2020 double the annual average of 50,000. The majority (75%) of the 22,000 restaurants that closed between March 1 and September 10 had less than 5 locations, underscoring the impact on small local businesses. As of September 29 the number of small businesses that were open was down -24.1% compared to January 2020.
While investors have ignored much of the less than stellar economic data, they have remained enamored with the FAMANG stocks. As discussed in detail in the September 4 WTR:
“After posting an intra-day low of 3355 on August 20 the S&P 500 rallied to 3588 on September 2, a gain of 233 points in just 9 trading days. Much of this gain was not due to improving economic activity but instead was driven by a boom in call option buying.”
As the S&P 500 rebounded from its low of 3209 on September 24 option volume has remained high. The monthly average of option volume was 27.9 million at the end of August and was 27.7 million as of October 9, which is up 60% from the average volume from 2007 through 2019. Options that expire in less than 2 weeks have represented 75% of total option volume, which is due to option traders buying options on individual stocks and specifically FAMANG stocks.
When an investor buys a call option, the dealer who sells the call option is effectively short the stock. If the underlying stock rises more than the value of the option sold, the dealer loses money and must buy the stock back to stem losses. The potential of a short squeeze intensifies as the Friday expiration date approaches. This coming Friday is not only an expiration of weekly options, but also monthly options.
A number of Wall Street firms recommended the FAMANG stocks again before the market opended on October 12, which led to huge gains in Apple +6.3%, Amazon +4.8%, Face book +4.3%, Google +3.6, Microsoft +2.6%. As a result the Nasdaq 100 was up +3.1% compared to a gain of +1.6% for the S&P 500, and the Russell 2000’s gain of just 0.7%. Clearly, the options tail was wagging the dog today.
After President Trump called off talks to arrive at another stimulus bill on October 6, the S&P 500 peeled off a quick 76 points after dropping from 3431 to 3355 in less than an hour. Reportedly, Presidednt Trump was surprised by the extent of the drop and by week’s end was supportive of a bigger bill than the $2.2 trillion the Democrats wanted. When it became apparent that Senate Republicans were not on board for a bigger deal and Speaker Pelosi wasn’t either, the talks collapsed over the weekend. The stock market has been expecting a deal for months, so why did the S&P 500 rally from 3447 on October 8 to 3550 on October 12?
Once the S&P 500 jumped above 3450 it triggered GAMMA options trades as explained above. But a different take on the election outcome and the size of the next stimulus also bill played a role. Since the end of September the odds of the Democrats wining the Senate have jumped from 48% to 62%, which is a big move in such a short period.
Rather than being disappointed that a new stimulus bill would not materialize before the election, investors have convinced themselves that after Joe Biden becomes the next President and the Democrats control the Senate, there is a growing probabliltiy that the next stimulus bill may look much like the $3.2 trillion bill passed by the House in May. As noted in the October Macro Tides the Federal Reserve will fund whatever fiscal stimulus Congress passes, which Chair Powell made clear in a speech last week. Investors are willing to wait until January 21, 2021 as long as a larger bill is coming.
Candiate Trump became President because he won Pennsylvania, Michigan, and Wisconsin by a grand total of 90,000 votes. In 2016 Trump held a thin advantage over Hillary Clinton in those 3 states, but now is trailing by a large margin. Importantly, Biden’s lead has widened in the last two weeks. In additon, the comfortable lead Trump enjoyed in 2016 in Ohio, Arizona, Georgia, and North Carolina are all deficits in 2020. The election is in 3 weeks and much can still happen, but the odds appear to favor Biden in these key states.
A few weeks ago the prospect of a sweep by the Democrats was viewed as a negative, since corporate taxes would rise from 21% to 28%, taxes for the top 5% would go up, and the level of regulation would increase. Goldman Sachs originally estimated that S&P 500 earnings would fall from $170 in 2021 to $150.00 if Biden won. A week ago Goldman changed its mind and now thinks the increase in government spending will lift S&P 500 earnings to $179.00 in 2021. Investors have jumped on this band wagon which is why cyclical stocks have been performing better.
The potential irony in all of this is investors will now be disappointed if the Democrats fail to win the Senate since the economy will have gone without additional stimulus until after the election at a minimum and whatever deal that does emerge will be less than expected.
Stocks
As noted last week there was the potential for the S&P 500 to test the black trend line connecting the January 2018 and February high in 2020 near 3550. Last week’s comment had a typo and indicated the trend line came in at 3500:
“The S&P 500 has the potential to rally back to the black trend line near 3500 with a deal.”
Today the S&P500 traded up to 3550 even though no deal appears to be coming before the election, but investors are excited that a bigger deal may be coming no matter who wins the White House.
On September 1 the S&P 500 spiked above the black trend line and may do so again before the options expiration on October 16. The primary purpose of this rally was to alleviate the oversold condition that developed as the stock market was recording a low just above 3200. The 21 day Advances minus Declines Oscillators for the NYSE and Nasdaq had became more oversold than at any time since April, as noted in the September 28 WTR and last week.
The 21 day Advances minus Declines Oscillators for the NYSE and Nasdaq are now overbought, as both Oscillators are above the red horizontal line. In all likelihood, the Oscillators are likely to record a high and then a lower high after a brief pullback before a deeper correction can take hold.
The expectation of more fiscal stimulus has allowed the cyclical stocks to rally helping the Advance – Decline lines for the NYSE to make a new high and almost and on the Nasdaq (blue line). This is a sign of short term strength and another reason why the market has the potential to hold up and rally a bit more.
The recent strength buys the market time but it is difficult to know how much of the move higher has been powered by option activity. The expectation is the S&P 500 can retest the late September low just above 3200 possibly in November. A deeper decline is dependent on a further increase in COVID cases and hospitalizations, the Democrats failing to win the Senate, and the potential for an unclear election and unrest should that occur.
President Trump has raised the issue of election fraud and it is resonating with voters. It is no surprise that Republican voters think fraud could play a fair amount or big role (81%) in determining the outcome of the election. It is a surprise that 62% of independent voters feel the same way, while only 40% of Democrats are worried.
No matter who wins the election the risk of violence has grown significantly since 2017 when only 8% of Democrats and Republicans thought it was OK to use a little violence or more to achieve political goals. In September 2020 33% of Democrats supported violence to achieve their political goals while 36% of Republicans did according to Politico.
The narrative of course is that President Trump is responsible for this increase but an objective listening to the level of vitriolic rhetoric by liberals is obviously resonating with Democrats as the increase in their support for violence shows. The rioting, looting, and destruction of private and public property in recent months would support this view no matter how just the cause.
Dollar
In last week’s WTR I reviewed how the Dollar had traded in late 2017 and early 2018 and how the current pattern was very similar:
“In late 2017 the Dollar rallied from a low of 91.00 in September to 95.14 in early November and it is clear the rally took the form of an a-b-c rebound (wave 4). Even though positioning was bullish, the Dollar subsequently dropped to a new low in February 2018. Since bottoming on September 1 at 91.75 the Dollar moved up to 94.74 on September 25 and in the process tagged the down trend line that extends back to the March 2020 high. (Chart below) The rally from the low of 91.75 appears to be an a-b-c move up, which is a corrective counter trend move that is very similar to the a-b-c rebound in 2017. The Dollar needs to rally soon or the risk of a decline to a new low will rise significantly. The next few days are critical for the Dollar but also the Euro, Gold, and Silver.”
On Friday October 9 Dollar closed below the rising trend line increasing the odds that an additional decline to a new low below 91.74 is coming. On October 12 the Dollar closed about 1.5% above the 7 intra-day low on September 1 so it won’t take much to register a new low. A new low will increase the potential for a more sustained rally since it will complete the decline from the March 2020 high.
I recommended buying the Dollar ETF UUP at $25.20 or lower in the July 27 WTR and set the stop on a close below $25.15 or an intra-day stop of $25.08. The stop was triggered when UUP closed at $25.14 on October 9.
Euro
The Euro has closed above the declining trend line, but needs to close above 1.190 to open the door for a rally above 1.20. If the Dollar only makes a marginal new low and then reverses higher, the probability of the Euro’s rally being a b-wave from just above 1.16 will increase. If the Euro fails to move above 1.19, a drop below 1.15 would likely ensue.
Gold
Gold’s chart continues to look very similar to the Euro with the only difference being Gold has yet to break above the declining trend line, which is now near $1937.00. The 50% retracement of Gold’s correction would allow it to rally to $1955.00 in what could be a b-wave. If the Dollar only makes a marginal new low and then reverses higher, the probability of Gold’s rally being a b-wave will increase. This would subsequently lead to another correction that would bring Gold below $1849. Conversely, if the Dollar’s new low carries it to near 90.00 or below, Gold would likely close above $1960 and quickly rally to above $2070. Aggressive traders can take a 50% position in IAU if Gold closes above $1960 using $1915 as a stop.
Silver
As noted in the last two WTR’s the pattern is Silver is different than Gold, since Silver was far weaker during the recent decline. As long as Silver holds below the declining trend line, Silver is expected to fall below the low of $21.78 on September 24.
Gold Stocks
Investors can go 50% long GDX (whatever the normal allocation) if/when GDX trades under $36.50, which is just above the lower channel trend line. Increase it to 100% if/when GDX trades under $35.20. (Just above red horizontal trend line)
Treasury yields
I have expected the 10-year Treasury yield would close above 0.75% the 30-year Treasury yield would close over 1.55%, and TLT would drop under $161.00 (Black trend line):
“When they do it will mean something and likely provide an opportunity to short Treasury bonds.”
On October 5 the 10-year closed at 0.766%, the 30-year Treasury bond closed at 1.567%, and TLT finished the day at $159.57. On October 5 TLT’s RSI closed at 28.7 so it is more oversold than at any time since the low in early June. I would prefer to wait for TLT to rally before recommending a short trade.
The positioning in the Treasury bond futures suggests that patience is wise as Large Speculators (green line middle panel), Leveraged Funds (blue line lower panel) have a larger short position than in November 2018, while the ‘smart’ money Commercials (red line middle panel) have their largest long position. This suggests that the 30-year Treasury bond could rally back to near the mid July high which would allow TLT to move up to near $170.00.
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 was confirmed on June 4 when the WTI rose above the green horizontal line. Although the MTI has confirmed the probability of a bull market, it doesn’t preclude a correction. The expectation has been that the S&P 500 was likely to decline to 3200, which it did in September. The strength of the rally from the September low lowers the probability of a decline to 2950 – 3000 in the fourth quarter. Instead the support just above 3200 is now more likely to hold unless all hell breaks loose in November, which is possible.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
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