Written by Jim Welsh
Macro Tides Weekly Technical Review 19 October 2020
S&P 500 Poised for Test of 3220 At Least
Technically the S&P 500 is likely to test the September 24 low of 3209 and there are a number of fundamental reasons why an increase in selling pressure could develop. Although the election polls indicate that Biden has a comfortable lead, one never knows and control of the Senate may prove more important.
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Two months ago Goldman Sachs suggested a Biden victory would shave $20 off S&P 500 earnings due to Biden’s plan to increase the corporate tax rate from 21% to 28% along with income tax hikes. With the S&P 500 sporting a multiple of 20 that had the potential of slicing up to 400 points off the S&P 500.
Two weeks ago Goldman Sachs reversed itself and estimated that a Biden victory and a sweep of the Senate could lead to a delay in tax increases and acceleration in spending by Congress that would be good for economic growth. This combination could boost S&P 500 earnings by $7 and provide the market a lift.
The election could also weigh on the stock market if a number of keys states aren’t able to count votes quickly as voting by mail soars in many states. In 2000 the S&P 500 fell -13% as the country waited for the 2000 election to be resolved. In 2000 no one saw an undecided election as a risk but few would be surprised if the result of the 2020 election isn’t known for days.
As noted last week no matter who wins the election the risk of violence has grown significantly since 2017 from 8% of Democrats and Republicans thinking it was OK to use a little violence 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.
If the election isn’t decided for days there is a risk of marches, rioting, and looting by ardent supporters of both parties. And, if the election is close the odds of the losing side demanding a recount is almost a sure thing, especially in Senate races in some key states.
Many months ago Dr. Fauci said “We don’t set the time line the virus does.” In recent weeks the virus has returned with a vengeance. Whether it is a second wave or not the number of cases has soared in Europe and is rising aggressively in the U.S. There is no indication that the Pandemic is under control in 2 the EU, U.S., or globally as the number of cases continues to trend higher.
While the U.S. media breathlessly reports on the resurgence in cases in the U.S., far less attention is focused on the number of hospitalizations. The difference between cases and hospitalizations is critical, since hospitalizations stress the health care system, while an increase in cases does not.
The increase in cases is being driven by a massive ramp up in testing. The 7-day average of Daily tests was 964,792 on October 18, which is a 5 fold increase from early May and double the level of testing in July. The average of Daily cases was 48,638 and about 20% less than the peak in mid July.
Despite a doubling in testing since mid July the number of cases is down significantly. The peak in Daily cases in mid July coincided with a peak in the number of people being hospitalized near 60,000. In contrast the 7-day average of hospitalizations was 36,664 on October 18 and about 35% less than in July. In the past 6 months the medical community has learned a great deal about treating those with COVID-19, which is one reason why the number of people dying from an infection (393) is down about 75% from the peak of 2,000 in May.
The other reason is demographics as the big increase in cases has been concentrated in younger people who have a much lower fatality rate than those over 55 years of age.
In the early days of the Pandemic the deadly impact on older Americans was unknown, which is why there was a preponderance of deaths in those 75 and older. There has been a large decline in cases in the over 75 age groups since March/April as social distancing, mask wearing, and shut downs of retirement homes has helped limit the spread.
This discussion is not intended to minimize the increase in cases which have been hitting rural areas much harder than urban cities which bore the brunt of the first wave. Many rural hospitals don’t have the same resources that are widespread in large cities or the hospital bed capacity.
Although there is not yet a widespread hospitalization crisis throughout much of the U.S., there are some areas that are close to becoming overwhelmed. In April Dr. Fauci and Dr. Scott Gottlieb were hoping that a shutdown of the economy would bring the average infection rate down to less than 20,000 cases per day heading into the flu season. If the number of COVID cases continues to climb and this flu season is merely average, the risk that more hospitals will become overwhelmed will rise.
States will order another shut down only as a last result, but consumer behavior will change and become more conservative. A spike developed in Arizona, Texas, and Florida in June and July as people went indoors to avoid the heat. With winter and cold weather literally a few weeks away, more people will be spending more time indoors in close proximity, so an increase in the number of infections in the northern half of the U.S. seems likely. If the election is unsettling and infection cases and hospitalizations continue to increase, the stock market could experience an increase in selling pressure that brings the S&P 500 down to 3209 in a test of the September 24 low. A break of 3209 and close below 3200 would likely lead to additional selling that could allow the S&P 500 to test 3100.
Stocks
In the October 5 WTR I thought the S&P 500 might reach 3550 and tag the trend line connecting the January 2018 high and the February 2020 top:
“S&P 500 has the potential to rally back to the black trend line near 3550.”
The S&P 500 traded up to 3550 on October 12 before falling back to 3440 on October 15.
As discussed last week, option traders were again exerting their influence over the market:
“Investors 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 October 16 expiration date approaches. This coming Friday is not only an expiration of weekly options, but also monthly options.”
After dropping to 3440 on October 15, the S&P 500 quickly rebounded to 3515 on October 16 in the first hour of trading, before fading in the last hour and closing at 3480. Once the upward lift from options ran its course the market sold off as the FAMANG stocks weakened.
If House Speaker Pelosi and Treasury Secretary Mnuchin pull a rabbit out their negotiation hats and announced a compromise stimulus bill, the S&P 500 could rally above 3515 and possibly above 3550. If the S&P 500 does manage to rally above 3515 traders can go 25% short the S&P 500 using the 1 to 1 ETF SH. Increase the position of 50% if the S&P 500 exceeds 3550 and to 75% if the S&P 500 touches 3595.
Dollar
Unless the Dollar is able to close above 94.00 and above the down trend line from the March high and all subsequent short term rally peaks, the Dollar is likely to set a new low:
“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.”
There is a small probability that the a-b-c rally from 91.75 is only wave a of a more complex rebound. The drop from the high of 94.75 could be wave b of the complex rebound. The Dollar rallied 3.00 points from 91.75 and the 61.8% retracement is 92.90. Until the Dollar closes below 92.80 (so far the low is 93.01), the Dollar could move up to 96.00 for wave c of the complex rebound, before falling to a new low. The negative positioning against the Dollar is still large so more upside in the short term can’t be dismissed.
Gold
The pattern in Gold looks vulnerable to a decline below $1849 whether the Dollar moves higher in the short term or not. The 50% retracement of Gold’s correction would allow it to rally to $1955.00 in what could be wave c of a b-wave. The initial decline in Gold brought Gold down from $2070 to $1869. The next leg of this correction from $2070 is likely to cause Gold to drop at least $120 (61.8% of the $201 decline) or close to $201.00 from $1955 if Gold does rally that much.
Assets in the Gold ETFs have continued to march higher despite the recent $201 correction. When Gold fell from $1700 to under $1500 in March, investors sold which caused assets to dip. The lack of any selling in response to lower Gold prices is a reflection of a stubborn level of long term bullishness. This complacency supports the view that Gold is capable of falling below $1849 and possibly under $1800.
Silver
Silver appears to holding onto the rising trend line from the low in March for dear life. 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
The Gold stock ETF GDX continues to trade in a down trending channel as it makes lower highs and lower lows. The expectation is that GDX will trade down to the lower trend line near $36.00. Investors can go 33% long GDX (whatever the normal allocation) if/when GDX trades under $36.10, and increase it to 66% if/when GDX trades under $35.20. (Just above red horizontal trend line) If things get ugly and Gold and Silver prove weaker than expected, GDX could trade down to $33.50. Traders can increase the position to 100% if GDX trades at $33.50.
Treasury yields
The positioning in the 30-year Treasury bond futures suggests that any increase in Treasury yields may not occur until after yields come down first. Large Speculators (green line middle panel) and Leveraged Funds (blue line lower panel) have a larger short position than in November 2018, which coincided with a significant high in Treasury bond yields. Conversely, the ‘smart’ money Commercials (red line middle panel) have the biggest long position since October 2018. This suggests that the 30-year Treasury bond could rally back to near the mid July high (180.00 – 182.00) which would allow TLT to move up to near $170.00.
Volatility has the potential to be extreme in the next few weeks in many markets. If TLT drops below $154.00 (horizontal green trend line) I would recommend buying TLT for a decent bounce to $162.00. If TLT rallies to $170.00 or higher it would provide the opportunity to go short.
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.
A Day that Will Live in Infamy
Today is the 33 year anniversary of the 1987 stock market Crash and I remember it well. The Advance – Decline line made a lower peak on August 25, 1987 when the S&P 500 reached a new all time high as noted by the red trend line. (Chart below) The negative divergence between the Advance – Decline line and the S&P 500 was a warning that market breadth was weakening. In early September 1987 the Federal Reserve increased the federal funds rate from 6.75% to 7.25%. Most investors don’t remember that the Dollar Index had declined from a high of 165.00 in 1985 and was below 90.00 prior to the Crash.
Germany had promised Treasury Secretary James Baker that Germany would not increase interest rates, since an increase would have strengthened the German Mark and further weakened the Dollar.
On October 6, 1987 Germany did increase interest rates which weakened the Dollar and higher Treasury bond yields. The combination of Germany raising rates, after they said they wouldn’t, and a sharp drop in the S&P 500 on October 6, 1987 led me to move my clients 100% out of mutual funds and into the money market. Although I expected the S&P 500 to decline, I certainly didn’t anticipate a Crash that was due to a misguided hedging technique called portfolio insurance.
This morning I Tweeted the following:
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