Written by Jim Welsh
Macro Tides Weekly Technical Review 02 November 2020
Election Outcomes
The stock market has been focused on additional fiscal stimulus for months bobbing and weaving in response to every twist and turn of the negotiations between Treasury Secretary Mnuchin and Speaker Pelosi. The market rallied whenever it looked like progress was being made and declined when deadlines came and went.
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When talks ended with no deal, the stock market consoled itself with the promise that a Blue Wave would lead to a bigger than $1.8 trillion plan, even if it was delayed until the first quarter. This suggests the stock market may prove sensitive to the prospect and size of the next stimulus plan if the prospect of a larger plan dims, at least in the short term.
I have no idea how the presidential election will turn out or whether the Democrats will be able to take over the Senate. It does seem likely that the answers may take days or weeks since only 17 states begin counting votes before Election Day, while 33 states don’t including Michigan, Nevada, Pennsylvania, and Wisconsin. This is a bigger deal than in the past since more votes will be cast in this election and a disproportion of them will be mail-in votes.
The number of voters casting their vote on election day has fallen from 77% in 2004 to an estimate of 32% in 2020. The number of votes already cast is more than double the level in 2016.
In prior elections democrats voted before the election by a ratio of 2 to 1, so pundits are inferring that the surge in pre-election voting means Joe Biden will be the next president and his coat tails will help the Democrats take the Senate. This analysis fails to take into account how the COVID-19 Pandemic is likely leading more Republican voters to vote before the election than in prior years, so the ratio will be less than 2 to 1.
As noted in the November Macro Tides, when Gallup asked registered voters ‘Whether they were better or worse off than four years ago’ in September 2020, 56% of the respondents said yes. That’s a higher percentage than any of the prior incumbents received.
There is a good chance you haven’t heard the results of this poll as it doesn’t conform to the negative narrative that dominates the mainstream media. It has been reported that some people are reluctant to admit to a pollster that they will vote for President Trump, but many voters do vote based on their pocket book. This explains why President Trump is receiving more Hispanic and Black votes than in 2016 and why the election may be closer than many polls suggest.
The polls suggest that Joe Biden’s margin of plurality has narrowed in many key states, which could result in a number of the Senate races being ‘too close to call’. Whichever side comes out on the short end of a close vote, we can expect claims of voter fraud to follow along with demands for a recount. It would be a major surprise if we know who controls the Senate by this Friday November 6.
There are four possible outcomes in this election:
- Blue Wave – Joe Biden wins and the Democrats win the Senate
- Joe Biden wins but the Republicans retain the Senate
- President Trumps wins reelection but the Democrats win the Senate
- Red Wave – President Trumps wins and the Republicans retain the Senate
The stock market would like a Blue Wave as that would mean more stimulus spending and potentially a bill to increase spending on infrastructure. The S&P 500 could quickly rally above 3500 if the election produces a Blue Wave. The other three options would result in less government spending as the losing party feels it has little to gain to help the other party. A Red Wave would also lead to less spending since some Republican Senators believe additional spending is not needed. A Blue Wave means an increase in spending of $3 trillion while a Red Wave would be closer to $1 trillion.
My guess is that Joe Biden will win, but the Republicans will hold onto the Senate. If this proves correct, the S&P 500 is likely to drop below 3200. Options 3 and 4 would likely produce the same result, since additional stimulus may not get passed until after Inauguration Day.
Stocks
The 21 day Advances minus Declines Oscillator for the NYSE and Nasdaq became oversold on October 30, just as it was on September 24. (Horizontal green line) The S&P 500 rallied after the September 24 low and today’s rally is the start of an attempt to move higher to relieve how oversold the internals had become.
The S&P 500 held modestly above the September 24 low (3209) on October 30 (3234), which provided traders a reason to buy. Although the S&P 500 fell below the October 28 low of 3269 on October 30, market breadth wasn’t as negative, which is why the 21 day Advances minus Declines Oscillator for the NYSE recorded a slight higher low. There was no positive divergence in the 21 day Advances minus Declines Oscillator for the Nasdaq.
Investors remember that the S&P 500 rallied in 2016 once the results of the election were known, and there may be some speculation that the market will behave the same way in 2020. Doesn’t make sense to me since the world is in a very different place than in 2016, but there is a cohort of inexperienced investors that have learned to buy every dip.
The reflex to buy every dip and the bullishness it reflects suggests that sooner or later the dip buyers will be tested, as the S&P 500 and Nasdaq 100 fall below a prior low. The Call / Put ratio highlights that short term traders remain resolutely bullish. The 10-day average as of October 30 was as high as it was January and February 2020, which was signaling too much bullishness and a top.
If a Blue Wave materializes it won’t matter, but if the other options develop the market could be vulnerable to a quick and sharp decline. The Option Premium Ratio (OPR) is another sentiment indicator that suggests that bullish sentiment is still too high. At the next solid trading low the OPR will rise to the black horizontal line at a minimum, as it did at the trading lows during 2019. If the S&P 500 falls to 3000 the OPR could approach the green horizontal line and indicate that bullishness had been replaced by too much negativity as in December 2018 and March 2020.
From the October 12 high of 3550 the S&P 500 fell 316 points to the low of 3234 on October 30. The 38.2% retracement of this drop would lift the S&P 500 to 3355, while the 50% retracement would allow the S&P 500 to rally to 3392. Volatility this week will be high as the market deals with the election and the Federal Reserve meeting on November 5, and for good measure the employment report for October on November 6. In this environment the S&P 500 could rally to 3429 which is the 61.8% retracement of the 316 point decline and just above the 3420 level the S&P broke down from on October 26.
Last week I offered this suggestion:
“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.”
The S&P 500 rallied to 3409 on October 27 before losing -3.6% on October 28. Based on the retracement numbers traders can go 25% short the S&P 500 using the 1 to 1 ETF SH if the S&P 500 trades up to 3390 and 50% short if the S&P 500 trades up to 3415, using a stop of 3470. Cover half of the position if the S&P 500 drops to 3175. Unless a Blue Wave occurs the S&P 500 is likely to drop below 3210 – 3230 and potentially fall to 3100 – 3125. (Black trend line on the top of pg. 4)
Dollar
The Dollar finally broke above the down trend line connecting every rally peak since the Dollar topped last March, which increases the probability that the Dollar is tracing out a larger a-b-c rebound from the low at 91.75. The next hurdle is for the Dollar to move above the high of 94.75. As noted last week the short position against the Dollar is large so taking out this prior high would inspire short covering and more Dollar strength.
The Dollar’s rally is due to the weakness in the Euro as European governments are responding to record COVID-19 cases by ordering partial lockdowns in France, Germany, and Britain. The new lockdowns and restrictions will slow Europe’s rebound which is why the Euro is being sold.
Euro
A decline below 1.16 should lead to a decline to 1.148 or lower, which will provide the Dollar a further lift.
Gold
After topping on August 7 at $2070 Gold has continued to make lower highs. The low of $1860 on October 29 is less than 1% above the September 24 low of $1849. A close below $1860 could lead to a quick washout and bring Gold down to $1820 or lower. The expectation is that Gold will rally to a new high in the first quarter of 2021, so a quick drop below $1849 could set up the bigger move to the upside.
Silver
Silver broke below the rising trend line from the March low on October 28. Silver has bounced but appears to testing the underside of the broken trend line which often occurs just before the next wave of selling kicks in. 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 dropped to $36.01 on October 29 before bouncing to $38.69 on November 2. From its peak on August 5 at $45.78 GDX fell in an a-b-c decline to $37.08 on September 24, before rallying in a three wave advance to $41.34.
There is a chance that GDX could experience a decline that matches the drop from $45.78 to $37.08, suggesting GDX could fall to $32.64. From its high of $41.34 GDX fell $5.33 to the low of $36.01 on October 29.
If today’s high of $38.69 is the high for the recent rebound, an equal drop would bring GDX down to $33.36. We’re entering a window of time when GDX could be highly volatile.
The instructions have been to:
‘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.’
The first position was triggered when GDX traded down to $36.01 on October 29.
Treasury yields
Large Specs (Green middle panel) have a bigger short position now than in October 2018, while the smart money Commercials have a larger long position. After bottoming in early November 2018, the 30- year Treasury bond rallied from 137 to 167 in august 2019. A rally of that magnitude is not likely, nor expected, but the positioning suggests the downside is limited.
TLT continues to make lower highs and lower lows so the trend since early August has been down. If TLT drops below $156.75, I would recommend buying a 50% position in TLT, and increase it to a full position if TLT drops below $155.00, using $153.00 as a stop. At a minimum TLT can bounce to $162.00 and potentially to $165.00 if TLT closes above the downtrend line. I do expect Treasury yields will rise in the first half of 2021, after Congress passes another stimulus bill. If a Blue Wave occurs yields could jump quickly.
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). A drop below 3209 is likely, with a test of 3100 possible (black trend line) if all hell breaks loose in November, which is certainly possible.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included:
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