Written by Jim Welsh
Macro Tides Weekly Technical Review 26October 2020
S&P 500’s Close below 3415 is Bearish
As noted in the September 21 WTR, the S&P 500 was expected to rebound after finding a low just above 3200:
“The S&P 500 could rally back up to 3330 – 3355, but a dip below 3200 seems likely sooner or later.”
After an opening spike lower to 3209 on September 24, the S&P 500 rallied to a high of 3550 on October 12. Since that high the S&P 500 has been chopping lower and was expected to retest and likely fall below the September 24 of 3209, as discussed in the October 19 WTR:
“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.”
On October 19 the S&P dipped to an intra-day low of 3420 and fell to 3415 on October 22 (red trend line). Today’s close below those intra-day lows represents a break of support and suggests that additional weakness is coming. The S&P 500 could find some short term support near 3320 -3340 (green trend line) and more significant support near 3200 (blue trend line).
Additional selling is likely since sentiment was overly bullish even as the S&P 500 posted a lower peak at 3550 compared to the September 2 high of 3588. The Hulbert Stock Newsletter Sentiment Index was above 60 last week, which coincided with several trading highs during 2019 and in 2020 the February top and late August just before a decline of 10% in the S&P 500.
A similar picture is evident in the National Association of Active Investment Managers (NAAIM), comprised of asset managers who incorporate a tactical approach rather than simply sticking to a relatively fixed asset allocation. Last week it pushed above 90 which coincided with the highs in 2019 and in February and August 2020.
The Call / Put ratio illustrates that short term traders are still really optimistic and won’t become less complacent unless the S&P 500 declines more. The high level of bullishness reflected in these charts suggests that a decline below 3200 may be necessary to dampen their enthusiasm. At the trading lows in 2019 and in March 2020, the 10-day average of the Call / Put ratio fell below 1.00 (green horizontal trend line). The Call / Put ratio was 1.63 on Friday October 23 so it has a long way to go.
The internals of the stock market are far from being oversold as measured by the 21 day Advances minus Declines Oscillator, even after the weakness on October 26. This suggests that the market can absorb more selling pressure before it becomes oversold enough to support a sustainable rally.
Stock buybacks have been a major support for the stock market for years but is not likely to come to the rescue going into year end.
Joe Biden’s plan to increase capital gains taxes could be a source of selling, if he and the Democrats win the Senate. Investors with large gains in big tech stocks will have an incentive to sell before the end of 2020. This tax selling may not be enough to drive the market lower by itself, but it’s certainly a headwind.
All of the major technology stocks will report earnings this week and there is no reason not to expect good numbers. What will be more telling is how the stocks respond if the earnings are indeed good. My guess is the will try to rally but then fade, which will spill over into the rest of the market.
The other wild card is the ongoing negotiations between Treasury Secretary Mnuchin and Speaker Pelosi that may or may not yield another stimulus bill. Even if a deal is reached it will be weeks before it could pass and there is no assurance a $1.8 trillion bill could pass the House or the Senate. There are Democrats that want a bigger deal and Republicans who don’t support a $1.8 trillion deal. As our ‘leaders’ do nothing an increasing number of small businesses are not reopening.
I am somewhat incredulous that Congress has failed to act when there is so much legitimate need but most of these folks have never had to meet a payroll or run a business. Last week I offered the following instructions in anticipation that a deal would materialize:
“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.”
The S&P 500 just broke below 3420 but a rebound back to that level on news would not be a surprise. Traders can go 25% short the S&P 500 using the 1 to 1 ETF SH if the S&P 500 trades up to 3420 and 50% short if the S&P 500 trades up to 3450, using a stop of 3495.
Dollar
The Dollar is likely to set a new low before a multi-week rally commences. From last week:
“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 4 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 since it looks like another a-b-c move with wave a down, wave b up, and wave c wave down to 92.47, for what would be wave B. If this is what’s going on, the Dollar could rally up to 95.47 in wave C from the low of 91.75. The negative positioning against the Dollar is still large so the downside in the Dollar is likely limited.
Gold
The positioning in Gold still shows a wide plurality of bulls.
Gold is still holding below the declining trend line from the secondary high in mid August as Gold has made a series of lower highs. Gold is holding above the rising trend line from the low of 1849 on September 24 and has made a series of higher lows. Gold is nearing the apex of a triangle so a sharp move is coming as Gold breaks above or below one of the trend lines. It is not uncommon for the initial move out of a triangle to be a head fake, before a move dynamic move in the opposite direction develops.
The pattern in Gold still looks vulnerable for a decline below $1849, which could unfold after Gold briefly pops above the down trend line before falling below $1849. The expectation is that Gold will trade to a new high in the first quarter of 2021, so a quick drop below 5 $1849 could set up the bigger move to the upside. The plan has been to look to be a buyer if Gold drops below $1849 but the volatility could make it a bit tricky in the next few weeks.
Silver
As long as Silver holds below the declining trend line, Silver is expected to fall below the low of $21.78 on September 24 and could approach $20.00.
Gold Stocks
The Gold stock ETF GDX continues to trade in a down trending channel as it makes lower highs and lower lows. GDX closed beneath the rising trend line from the September 24 low on October 22, which opens the door for a decline to the lower channel trend line at $35.90. Investors can go 33% long GDX (whatever the normal allocation) if/when GDX trades under $36.05, 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
If TLT drops below $155.25, 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. Positioning is constructive as Large Speculators have a large short position similar to November 2018, which was followed by a big rally. This suggests the downside is likely small in coming weeks. I expect Treasury yields will rise in the first half of 2021, after Congress passes another stimulus bill.
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. In late August the expectation was that the S&P 500 was likely to decline to 3200, (it fell to 3209 on September 24) and then rally to 3550 (it rallied to 3550 on October 12). The strength of the rally from the September low lowers the probability of a decline to 2950 – 3000 in the fourth quarter. Unless all hell breaks loose in November, which is certainly possible, a drop to 3209 is likely, with a test of 3100 possible (black trend line).
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
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