Written by Jim Welsh
Macro Tides Weekly Technical Review 23 November 2020
Contrary Opinion Contrarianism
Contrary opinion is a useful investment tool that depends on identifying when the majority of investors have become excessively bullish or bearish. Extremes are reached after a trend has been in place for an extended period and the economic news has supported the rising or falling trend in stock prices. Bear market bottoms are formed after terrible economic news and significant losses cause a final surge in selling pressure. Bottoms are the result of an exhaustion of sellers followed by economic news that is less bad and eventually better.
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Since fear is a stronger emotion than greed, market bottoms take far less time than market tops, unless an event causes an unexpected reversal in the economy. Most market tops since World War II were formed after the stock market had been trending higher for years and economic growth was good. This combination caused investors to become more positive and invest more aggressively in anticipation that the good times were going to last. As the economic cycle progressed the Federal Reserve would respond to growing inflation pressure or the fear inflation would emerge by increasing interest rates. Slowly but surely higher interest rates would slow growth and often tip the economy into a recession.
Measures of sentiment are helpful in determining whether investors have become too bullish or too bearish. A good example is provided by the weekly Investors Intelligence data. As the market was bottoming in September 2015, February 2016, December 2018, and March 2020, the percent of bears exceeded the percent of bulls. Prior to the periods of weakness in 2015, 2016, 2018, and 2020, the percent of bulls overwhelmed the bears by more than 40%.
The same thresholds were evident at the lows in 2010 and 2011 when bears exceeded bulls and the percent of bulls dwarfed bulls prior to the declines in 2010 and 2011. The extreme nature of the 2007-2009 bear market caused the percent of bears to outweigh bulls by more than 25% in 2008 (green horizontal line).
On the past three Monday’s a drug company has announced that it has developed a vaccine for the COVID-19 pandemic, with each vaccine showing an efficacy of more than 90%. This is great news and far beyond the expectations of a vaccine that would prove 50% to 60% effective. As would be expected investors have responded by buying cyclical stocks and becoming wildly more bullish, despite the current grim reports of more hospitalizations and death. A number of sentiment surveys are showing a high level of bullishness in addition to the Investors Intelligence data that last week that showed the percent of bulls exceeded the bears by 41.4%. (59.6% bulls-18.2% bears)
Bank of America’s Fund Manager Survey found that cash levels are down to 7.0% the lowest since April 2015 and well below the 50% of respondents who were overweighting cash in April 2020.
Short interest rises and falls in response to the market’s trend. In 2008 short interest zoomed higher as the market was falling apart and came down after the bull market took hold in 2009. Short interest also ticked up in early 2016 as oil collapsed and the stock market declined. The plunge in March 2020 was so quick that short positions couldn’t be placed in size, which is why short interest percent didn’t go up. But in recent weeks it has dropped sharply as the vaccine news raised expectations for growth in 2021.
As an avowed contrarian I would normally react to the big increase in bullishness as a warning that a top in the market was fast approaching. But this cycle is unlike any other post World War II environment since the last pandemic was in 1918. Market tops since World War II formed after economic news had been good for a long time and the Federal Reserve had begun to raise rates. In those prior cycles the economy couldn’t get any better since it didn’t have another gear to shift into that would elevate growth. If the vaccines are 90% effective, the economy may have more than one gear to shift into by mid 2021, and the Fed isn’t going to increase rates for a very long time.
While sentiment indicators can tell us if investors are becoming too bullish or bearish, momentum and trend analysis must be incorporated to identify when the trend is reversing. In 2015, 2016, and 2018, the market held up for awhile after sentiment got giddy before corrections developed, so turning negative solely based on sentiment is often a mistake. Prior to those corrections, technical indicators like the NYSE Advance – Decline line, % of stocks above their 200 day average weakened, and then the S&P 500 broke below prior support.
As discussed last week the big improvement in the Advance-Decline line and % of stocks above their 200 day average since October 30 is constructive:
“The longer term outlook is positive based on the improvement in market breadth. The percent of stocks above their 200 day average reached 78% on November 13, the highest level since September 2016. Since October 30 the percent has jumped from 46%, underscoring the move into cyclical stocks. The NYSE Advance – Decline line recorded a new high today, which shows that the rally has broadened out after relying too much on just a small number stocks for months.”
The NYSE A-D line recorded another new high on November 23, and the percent of stocks above their 200 day average rose to 83% on Friday November 20.
The Nasdaq A-D line is also making a new high despite the relative weakness in the Mega cap stocks. The new highs in the NYSE A-D line and Nasdaq A-D line is positive longer term. In the short term the improvement in positive breadth has pushed the 21 day Advances minus Declines Oscillator on the NYSE and Nasdaq into overbought territory (above red horizontal line).
The high level of bullishness is a concern but the economy has the potential of improving significantly in 2021 as the vaccines are distributed and the technical underpinnings of the market are healthy. This is why being a contrarian may not be appropriate despite the high level of enthusiasm in the short term. In addition to being overbought, there is another issue that could lead to a near term correction and it has nothing to do with hospitalizations or vaccines.
U.S. and global pension funds use a 60-40 investment allocation meaning they allocate 60% of their assets to stocks and 40% to bonds, and usually rebalance their portfolios at the end of each quarter. This usually isn’t a big deal at the end of most quarters, unless there has been an outsized move in either stocks or bonds.
Since September 30, the broad market has outperformed the S&P 500 and Nasdaq 100 by a wide margin. The Russell 2000 is up a stunning +20.6%, Midcaps have jumped by +17.4%, while the S&P 500 is only up +6.4% and the Nasdaq 100 is up just +4.5%. The performance discrepancy is due to the big run up in cyclical stocks on the vaccine news which has hurt the stay at home Mega Cap stocks that dominated until September 2 when the Nasdaq 100 topped.
This has been repeated overseas so U.S. and global pension funds stock allocation has climbed comfortably above 60%, as stocks outperformed bonds by a wide margin.
There are $7.5 trillion in U.S. defined pension funds, the Japanese government pension fund has $1.5 trillion in assets, and the Norwegian oil fund holds $1.2 trillion in assets. According to Goldman Sachs and J.P. Morgan these large pension funds may have to sell stocks before the end of the year to achieve their 60/40 allocation. It’s possible that the U.S. stock market may have to absorb as much as $100 billion of selling, while global sales could approach $160 billion. Even if good vaccine news is announced every Monday until year end, the upward trajectory in the broad market is likely to slow or reverse.
Cyclical stocks have enjoyed a big rally since hitting a low on October 30. For small cap stocks, 18% of the Russell 2000’s fourth quarter gain of +20.6% has come since October 30. The big rally leaves these stocks prone for profit taking which could be triggered if more shutdowns are announced in coming weeks.
Thanksgiving has the potential to be the perfect storm since the Pandemic is more widespread, just as millions of people travel to different parts of the country. Despite warnings from the CDC urging people not to travel for Thanksgiving, more than 1 million people got on an airplane this past weekend. COVID-19 fatigue is clearly playing a role, as small groups of family and friends are getting together, since they believe everyone has been careful and are therefore ‘safe’.
The problem is it only takes one person, who may be asymptomatic to spread the virus. Since the virus often doesn’t cause symptoms to appear for 5 days or longer, that small group of safe family and friends can easily spread the virus to 20 or 30 other people after their ‘safe’ get together. It would be a miracle if there isn’t another surge in hospitalizations in the next three weeks and just before Christmas. If hospitals are overwhelmed states will be forced to enact stricter lockdowns.
Investors may not fully appreciate the monumental task of distributing the vaccine in coming months to more than 300 hundred million people not once but twice, and maintaining the proper conditions to keep the vaccine from spoiling. There are going to be missteps. The other issue is people’s willingness to get the vaccine when so many are skeptical and concerned the vaccines were rushed to be developed and distributed.
The internet will do a marvelous job of pandering to conspiracy theories claiming that the vaccine contains a tracking device so the government can monitor our every move. There are nut jobs out there that will believe this stuff and choose not to get vaccinated. Over time the reluctance to get vaccinated will fade as people if there are no meaningful side effects. Delays in getting the vaccines distributed and taken will slow how quickly COVID-19 is controlled.
Already some firms have lowered their fourth quarter GDP forecast but a few have forecast that GDP may contract in the first quarter of 2021. These are all reasons why cyclical stocks could experience a quick sharp correction before the end of the year.
The S&P 500 has the potential to pull back to 3400 with a lower probability that a decline to 3200 develops. In the first half of 2021 the S&P 500 could rally to 4000.
Gold
The expectation was that Gold would close below $1849 and eventually fall below $1800. Today’s close below $1849 reinforces that expectation. As noted in the last two WTR’s, Gold’s decline from the high at $2070 to $1849 was a 3 wave move, as was the rally from $1849 to $1964.70. The initial decline from $2070 to $1849 is Wave A, and the rebound from $1849 to $1964 is Wave B. Gold then plunged to $1853.00 on November 9 from $1964 in what should be the beginning of Wave C. If Wave C is equal to Wave A (2070-1849 = 211), Gold could fall to $1753.
Silver
Gold closed below its support trend line on November 23 and Silver broke below its trend line of support from the low in April. The pattern in Silver is similar to Gold, with the decline from $29.75 to $21.78 representing Wave A, and the rebound to $25.75 being Wave B. If Wave C is equal to Wave A (-$7.97), Silver could drop to $17.98.
Gold Stocks
When the outlook for Gold and Silver became more negative two weeks ago, the expectation was that Gold stocks could get hit hard. This is why I recommended selling the small position established on October 29 in GDX at $36.01 on the opening of November 10. GDX opened at $39.03 on November 10. On November 23 GDX closed at $34.36.
GDX may be following the same pattern as Gold and Silver. GDX’s decline from the high at $47.78 on August 5 to $37.08 was a 3 wave move, as was the rally from $37.08 to the high on November 6 at $41.81. The initial decline from $47.78 to $37.08 is Wave A, and the rebound from $37.08 to $41.81 is Wave B. If Wave C is equal to Wave A ($47.78-$37.08 = $10.70), GDX could fall $10.70 from the high of $41.81 to $31.11. Traders can establish a 33% position if GDX drops below $32.50.
Dollar
The Dollar traded down to 92.00 this morning and then quickly bounced to 92.80. This strength seemed to be the straw that cracked Gold below $1850. A close above today’s intra-day high would be positive and should lead to more strength. Until that occurs the Dollar still has the potential to drop to a new low below 91.75.
TLT
In the November 2 WTR I recommended taking a position in TLT on weakness, and the recommendations were filled at an average price of $155.48. TLT was expected to rally to $162.00 and possibly $165.00. On November 20 TLT traded up to $161.54. Raise the stop to $157.20 and sell half of the position if TLT trades up to $163.00.
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. 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).
What wasn’t expected was the development of not one but two vaccines before the end of 2020, with both showing an efficacy of more than 90%. As a result a decline below 3209 is no longer likely, although a drop to 3450 or lower is possible. As expected COVID cases have increased and could result in even more restrictions than we’ve seen, especially if Thanksgiving turns out to be a super spreader event. The market has been able to look over valleys and the prospect of a vaccine could limit the downside. This is why a drop to 3200 is unlikely, even if lockdowns are worse than expected.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
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