Written by Jim Welsh
Macro Tides Weekly Technical Review 07 December 2020
On Friday December 4 the major market averages rallied to new all time highs after the Labor Department reported that job growth had slowed in November to 245,000 from 638,000 new jobs in October. Some of the weakness was due to a drop of 93,000 in census government jobs. The unemployment rate fell from 6.9% to 6.7% but that was because 400,000 people stopped looking for a job.
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The U6 unemployment rate measures the number of workers who are working part time but would prefer a full time job. The U6 rate was 12.0% in November.
While investors may have been encouraged by the decline in the unemployment rate, a deeper dive shows that the labor market is weakening.
It is noteworthy that the monthly jobs report is canvassed in the week that contains the 12th day of the month. In the 3 weeks that have passed since the data was collected the labor market has softened as the number of COVID-19 hospitalizations has soared and more restrictions and shutdowns have been announced. On October 31 there were 47,486 people hospitalized from the Pandemic.
In less than 5 weeks the number of people who are hospitalized has more than doubled to 101,487 on December 6. In some parts of the country this is already putting tremendous stress on medical resources, which is leading to the closure of businesses considered the most risky in terms of spread.
In California restaurants can’t serve customers indoors and can only provide pick-up or delivery. Bars, barbershops, hair salons, gyms, and churches are now closed. Retail stores are open but only at 20% of capacity. The new restrictions will remain in effect for at least 3 weeks and only when ICU capacity is above 15%. The restrictions will impact 33 million of California’s 39 million residents, and roughly 10% of the U.S. population.
The dire Pandemic news and soft employment report couldn’t stop the stock market from rallying on Friday as investors chose to believe the weak jobs report would pressure Congress to pass the long awaited stimulus plan.
This is a good example of bad news being good news. Normally, it’s bullish if the stock market rallies in the face of bad news, as it indicates that sellers are exhausted. This was certainly true last April and May when the economic news was awful but the stock market went up.
After 8 months of rallying it’s difficult to say the market’s response indicates that sellers are exhausted with the major market averages at new highs. Instead it is an indication that bullish sentiment is so entrenched that investors are simply playing the market’s upward momentum and ignoring any news that isn’t positive
Traders have been rewarded by buying every dip and the habit of buying every dip won’t be broken until it doesn’t work. In 2016 and 2017 the 20 day average of call option volume held between 7 million and 9 million contracts a day. After the 2016 election call volume increased to an average of 9 million to 11 million contracts.
In 2020 the 20 day average of call volume has doubled to 22 million contracts per day during a Pandemic. Since the Pfizer vaccine news on November 9, the 20 day average has jumped from 16 million to 22 million an increase of 37% in less than one month.
As discussed in August the huge increase in Call volume has forced the dealer community to hedge their risk of being short the calls purchased to buy the underlying stock. Much of the buying has been concentrated in the FAMANG stocks which represent 47% of the Nasdaq 100, which has been up 10 days in a row. These are the stocks that have benefited most from the Pandemic and the recent surge in hospitalizations has led traders back to these Mega Cap stocks. The surge in Call buying has been concentrated in small traders who typically buy 10 calls or less and account for 22% of call options purchased.
The demand for Call options has crushed the Put/Call Ratio which is the inverse of the Call/Put ratio.
I began using the Call/Put ratio in the 1980’s after reading an article written by Marty Zweig. Most of the world has adopted the Put/Call ratio as shown in the chart above. The current daily Put/Call volume ratio is near the level seen in the dot.com bubble and is in the 2 percentile of all readings since 1997.
For months the market has been able to look forward to some piece of good news, from the potential of a vaccine, getting past the election, and since August anticipation that Congress would pass a bill providing more fiscal stimulus. Congress will act in coming days to pass additional unemployment funding and loans for small business. The stock market will rally on the news and gap higher if the announcement is made before the market opens for trading.
Once this news comes investors won’t have anything to look forward to and may begin to pay more attention to the increase in hospitalizations and additional lockdowns. In the past 5 weeks hospitalizations have more than doubled. If they simply increase by another 50% in the next 5 weeks, there is a significant risk that hospitalizations could become a serious problem for many cities.
The expected increase from Thanksgiving in the next two weeks sets the stage for another surge as people travel for the holidays. Last week’s WTR was entitled, “Surge Upon a Surge.” Hanukkuh starts on December 10, and with Christmas following 15 days later, there is a risk that the U.S. will experience a ‘Surge Upon a Surge Upon Another Surge’ that may swamp the capacity to handle the increases in hospitalizations.
Pfizer announced last week that it was cutting the projected doses by half before the end of 2020. If other manufacturing delays develop while hospitals are being overrun by COVID-19 patients in early January, the stock market may not ignore just how dark it may become before the dawn. Bad news may be viewed as bad news and the selling pressure may overwhelm the buy-the-dippers.
If the stock market rallies on the news of Congress agreeing to additional fiscal spending, I would recommend selling into the news in anticipation of a deeper correction taking hold.
The NYSE Advance – Decline line and the Nasdaq Advance – Decline line made new highs on December 4, and the percent of stocks above their 200-day average climbed to 91% the highest since 2010. Long term tops are usually preceded by weeks and months of deterioration in the A-D line, which is obviously not the case now.
Historically, the percent of stocks above their 200 day average peaks well before the S&P 500 tops out, and usually doesn’t warn of an intermediate correction until the percent falls below 60%. The corrections in the summer of 2015, early 2016, and the fourth quarter of 2018 unfolded after the percent had fallen under 60%. In February 2020 the percent on February 12 was 66% and down from 72% on January 12. Although it wasn’t below 60% it was weakening and the rapidity of the Pandemic didn’t allow for the normal deterioration to take place.
The strength in the Advance – Decline lines and high percentage of stocks above their 200 day average suggests that any decline is likely a correction within a bigger uptrend, even if it proves to be a quick 5% to 7%.
In the short term the 21 day Advances minus Declines Oscillators for the NYSE and Nasdaq are still overbought and neither has recorded a lower peak which normally appears before a correction of any magnitude.
The 5 day average of the S&P 500 and Nasdaq 100 (red) is above the 13 day average (green) so from a price perspective, even the short term is positive.
The Option Premium Ratio has reached an extreme that proved timely in February 2020 and last August, just before the declines into the end of September and October. It is more extreme than it was in January 2018 which was followed by an 11.8% drop, and September 2018 which preceded a 20.0% decline.
While a correction of -12% to -20% is not likely in coming weeks, the probability of a correction is higher based on the signal from the Option Premium Ratio.
A pullback to 3550 seems likely and could extend to 3450 if the S&P 500 closes below 3520.
Gold
Gold has been expected to close below $1849 and on November 23 it did. In last week’s WTR and based on an analysis of the pattern, Gold had the potential to fall to $1753. On November 30 Gold traded down to $1766 and its RSI fell to 30 indicating that Gold was oversold. It has since bounced which has worked off the oversold condition.
Gold is not expected to trade above $1900 and is expected to subsequently fall below $1766.
Silver
Silver traded down to $21.92 on November 30 and has rebounded. Silver is not expected to trade above $26.00 and may fail at the down trend line at $25.05. Silver is expected to at least test its 200 day average at $20.74 and could fall to $18.00 based on its pattern.
Gold Stocks
The Gold stock ETF’s (GDX) RSI fell to 30.5 on November 24 when GDX dropped to $33.25, after topping at $41.81 on November 6. A rally to relieve the oversold condition has continued, but GDX is expected to fall to a lower low in coming weeks. 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 $32.00.
Dollar
Asset managers have their largest short position in the Dollar on record and are far more short than they were in February 2018. After bottoming in February at 88.25, the Dollar rallied to 95.00 by the end of May 2018. The record short position will matter once the trend has reversed higher.
The Dollar has experienced persistent selling pressure since November 2 when it traded up to 94.30. On December 4 the Dollar traded down to 90.48 and its RSI fell to 22.7, which is quite oversold. After the Dollar’s RSI dropped to 16 on July 30, the Dollar bounced and then fell to a new low on August 31 but its RSI was 31.
Something similar is likely before the end of 2020, which is expected to set up a larger rally that could carry the Dollar above 94.00.
An indication that the Dollar has reversed higher will occur when the 5 day moving average (red) crosses above the 13 day average (green).
Treasury yields
On December 4 the 10-year Treasury yield rose to 0.986% and above the spike high of 0.975% reached on November 9, after the Pfizer vaccine announcement, and higher than the 0.957% on June 8. However, the 30-year Treasury yield failed to climb above the November 9 peak of 1.767% on December 4, topping at 1.749% and below the June 5 high of 1.761%.
The inter-market divergence between the 10-year and 30-year Treasury yields suggests another decline in Treasury yields is likely. This opportunity will be reinforced if the divergence is maintained after Congress announces that another fiscal stimulus plan is coming.
In the November 2 WTR I recommended taking a position in TLT on weakness, and the average price of the position was $155.48. I advised raising the stop to $157.80 last week which was triggered on December 1 when TLT fell below $157.80. TLT traded down to support as noted by the green horizontal trend line on December 4 and has bounced.
TLT could rally to $160.50 to $161.50, although a move to $163.50 is possible if the Pandemic overwhelms hospital resources in many cities across the country.
Housing
I discussed housing at length in the December issue of Macro Tides and thought a quick review of the housing ETFs would be interesting.
The iShares Housing ETF (ITB) has most of its assets in the home builders. Housing has been quite strong in 2020 as the migration out of major cities and into the suburbs has resulted in a surge in demand for New and Existing homes.
The home builders have been the primary beneficiaries of this societal shift and the strength is expected to continue into the first half of 2021 as discussed in the December Macro Tides:
“The imbalance between supply and demand driven by COVID-19 will moderate in 2021. In 2020 the supply of homes for sale dropped to a record low as home owners didn’t want prospective buyers who might be infected walking through their home. As a vaccine becomes widely available by mid 2021, more home owners will be comfortable in putting their home up for sale which will increase supply.
The fear of living in a densely populated city prompted a surge in demand for homes and apartments in the suburbs. This fear will fade as people become confident that the vaccine will control the spread of COVID-19 in cities.
The dramatic increase in employees working from home will moderate by the middle of 2021. More employees will spend less time working from home and more time in the office, so the need for more home space for work will diminish.
The number of people moving out of cities will slow, which will also dampen demand for larger homes in the suburbs. When prospective city dweller movers compare the cost of renting to buying, the decline in rents and higher home prices will persuade many to stay put.
All of these factors will contribute to a slowing in the appreciation in home prices by mid-2021, and by the end of 2021 there will be some areas that will experience small declines.”
The relative strength of the ITB (top panel chart below) continued to improve until mid October, before losing ground. It’s interesting that the shift in relative strength coincided with the 10-year Treasury yield breaking out above 0.75% in mid October. ITB has fallen to $51.50 three times and bounced, so any close below $51.50 would be negative.
If Treasury yields rise as I expect they will in the first half of 2021, ITB will likely fall below $51.50.
XHB’s relative strength improved until the end of November, so it has proved more resilient than ITB as Treasury yields rose. This makes sense since ITB has more exposure to home building, while XHB is more dependent on furnishings. XHB benefits from an increase in Existing home sales and is less dependent on New home sales. Key support for XHB is the rising black trend line which coincidently is $51.50.
XHB looks better than ITB but both could break below their respective support if mortgage rates tick higher and the exodus out of the cities slows as expected.
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 3550 or lower is possible. As expected COVID cases have increased and more restrictions are being implemented. If Thanksgiving turns out to be a super spreader event, the number of hospitalizations could rise to a level that compares to a national emergency.
In the spring and summer, the outbreaks were concentrated first in the Northeast and then in the South. The current outbreak is spread throughout the country so the capacity to move nurses and other medical staff to hot spots will not be possible. The market has been able to look over valleys and the prospect of a vaccine could continue to limit the downside. A drop to 3200 is unlikely, but if lockdowns are worse than expected a decline to 3400 or lower can’t be ruled out.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included
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