Written by Jim Welsh
As noted last week the market has been able to look forward to some piece of good news which has allowed investors to look past any soft economic news. The potential of a vaccine, getting past the election, and since August anticipation that Congress would pass a bill providing more fiscal stimulus for months proved sufficient to keep selling pressure at bay, while retail traders kept buying call options in record numbers.
Please share this article – Go to very top of page, right hand side, for social media buttons.
.
Call option volume has tripled since the end of 2019 and more than doubled since September.
On Friday Pfizer’s vaccine was approved and the market fell modestly. Today the distribution of Pfizer’s vaccine began in New York with the first inoculation being a nurse. The prospect of the vaccine cavalry coming caused the S&P 500 to rally almost 1% in the first 2 hours of trading only to close lower. In the face of news investors have been anticipating for months, the failure to rally on Friday and subsequent selloff today suggests much of the good news has been priced in.
The realization that the vaccine will not be a panacea for the current surge in hospitalizations that is beginning to swamp the medical resources in many cities around the country may also be setting in.
A good friend of mine’s brother-in-law had major cancer surgery on his neck on Thursday and was told he would be in the hospital for 3 days. On Friday and less than 24 hours after his surgery he was told the hospital needed his bed and that his wife would have to bring him home. This underscores the decisions that doctors are being forced to make as they try to provide medical care to more people than they can handle. As long as this persists the quality of care many patients will receive will be less than what they may need to recover. It also highlights how those who don’t have COVID-19 are being affected.
About 80% of the U.S. economy has adjusted to this new world, with many employees working from home and corporate meetings on Zoom allowing companies to function as if there were no Pandemic. The stark contrast between the 80% world and the world the other 20% occupies hasn’t motivated Congress to act. Almost 20 million unemployed workers will stop receiving any unemployment benefits within two weeks, with potentially up to 40% of small businesses in the U.S. teetering on the abyss.
It is inconceivable that Congress has allowed politics to prevent both parties from moving quickly to address those in great need. I have to believe that at the end of the day Congress will act before Christmas 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. If the rally runs out of steam quickly and reverses lower, it will invite more selling.
The two Senate races in Georgia are likely too close to call. If the Democrats do manage to win at least one seat, the odds of higher tax rates and capital gains taxes will increase. Some investors who have accrued significant gains in technology stocks in 2020 may decide the risk of waiting to find out who wins in Georgia is too great not to take some chips off the table.
As long as the market is moving higher those considering some selling are being paid to wait. But if the market begins to sell off and investors see some of their gains melting away, they will be motivated to sell into weakness.
Since the market has rallied since the end of November, the potential for selling by pension funds needing to rebalance portfolios may still materialize in the next two weeks. As discussed a few weeks ago, roughly $10 trillion in global assets utilize the 60% stocks / 40% bonds allocation. With stocks performing better than bonds, large pension funds may have to sell stocks to bring their allocation to stocks down to 60%. The sales could top $100 billion and add to selling pressure before year end.
Stocks
Measures of bullish investor sentiment have been excessive for weeks, i.e. the Option Premium Ratio, Call / Put Ratio, NAAIM exposure above 100%, AAII survey, and Investors Intelligence survey. This exuberance was on full display last week in the IPO market as speculative behavior is approaching levels last seen in 1999.
The missing ingredient for identifying a top has been momentum which has been strong.
For the first time in weeks though, some cracks are beginning to form as upside momentum is running out of steam. The NYSE Advance – Decline line is starting to roll over as market breadth has begun to weaken. The A-D line is still well above its blue 27 day moving average, so the overall trend is still positive. The NASDAQ Advance – Decline is line weakening but not as much as the NYSE. The Nasdaq 100 is below the high it posted on September 2, which shows the big Mega Cap stocks have been lagging.
The 21 day average of Advances minus Declines Oscillator measures how many stocks are participating in any move whether it’s up or down. More often than not, the Oscillator will begin to diverge before the price trend reverses. At a top the Oscillator will record a lower peak even as the S&P 500 is making a higher high.
This is what happened in January and February before the big decline in March. The divergence doesn’t indicate if a subsequent drop will be small or large, simply that the odds of a correction are rising. The Oscillator has yet to post a lower peak but it is clearly rolling over. The same pattern is evident in the 21 day Advances minus Declines Oscillator for the Nasdaq.
Confirmation of a short term high will be provided when the red 5 day moving average for the S&P 500 and Nasdaq 100 drops below the green 13-day moving average. A close below 3630 for the S&P 500 will likely open the door for a drop to 3550, while a close below 298.00 on the Nasdaq 100 ETF (QQQ) will be followed by a drop to 290.00.
A pullback to 3550 seems likely and could extend to 3450 if the S&P 500 closes below 3520. The upcoming correction is expected to set up a rally to 4,000 and above in the first half of 2021.
Gold
The choppy correction since Gold topped in August is wearing Gold bulls down as measured by the Daily Sentiment Index (DSI). Since 2013 Gold has trended lower during the fourth quarter and made a trading low in either November of December. If Gold falls further the DSI bullish sentiment will drop more and will become even more supportive of a solid rally in the first half of 2021.
Gold’s RSI fell below 30 on November 30 after Gold spiked below its 200 day average and fell to $1766.50. Gold bounced from this low to work off how oversold it had become but was not expected to trade above $1900. The rebound topped at $1874.00 on December 8 and Gold has since traded down to $1822. Gold is expected to fall below $1766 and could trade down to $1730 before a trading low is established.
Silver
Silver traded down to $21.92 on November 30 and has rebounded. Silver was not expected to trade above $26.00 and I thought it would fail below the down trend line at $25.05. On December 8 Silver traded up to $24.77 before dropping to $23.84 today. Silver is expected to at least test its 200 day average at $20.84 and could fall to $18.00 based on its pattern.
Gold Stocks
The relative strength of Gold stocks (top panel) to Gold has been weakening which supports the outlook of lower prices for GDX. A rally to relieve the oversold condition appears over, and GDX is expected to fall below $33.25. 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
The positioning against the Dollar is historically high as foreign currency traders are certain the Dollar will continue to fall. The 12% decline from the high of 102.99 in March has also created a deeply oversold condition that is supportive of at least an oversold rally in the Dollar.
The Dollar may have completed wave 5 of Wave 3 at today’s low. If correct, the Dollar should bounce before dropping to a lower low. As previously noted the Dollar’s RSI fell to 22.7 on December 4. Such a low reading is often a precursor to a bounce before a lower price low establishes a RSI divergence.
The Dollar is getting closer to a good trading low but may not complete the process until year end. Currencies often wait until the end of one year or beginning of the next to mount a trend change. 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
Last week I noted that 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%. My conclusion was that this inter-market divergence between the 10-year and 30- year Treasury yields suggested another decline in Treasury yields was likely. So far yields have drifted modestly lower despite the arrival of the vaccine.
The 10-year Treasury bond and 30-year Treasury bond have tested their June 5 peak and November 9 high in yield but have failed to close above this resistance. Near term Treasury yields are likely to decline as economic data reminds investors that the Pandemic is hurting the economy. If Congress does pass additional support for the unemployed and small businesses, I don’t think Treasury yields will breakout. If correct that should lead to a further decline in yields. Treasury yields rose on December 14 as the first inoculation of Pfizer’s vaccine was administered, only to subsequently fall.
This outlook will be confirmed if the 10-year Treasury yield closes below the rising trend line that has formed after the 10-year yield bottomed in late September. A close below the rising trend line will lead to a decline in the 10-year yield to 0.75%, which was prior resistance.
The expectation is that the 10-year Treasury yield will ultimately close above 0.95% and potentially move up to 1.30% or higher in the first half of 2021. The breakout level for the 30- year Treasury yield is 1.75%. The expectation is the 30-year yield will climb to 2.40% once the 30-year closes above 1.75% for two days.
TLT has continued to hold above 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.
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 S&P 500 is expected to fall to 3550. A subsequent failing rally would then set the S&P 500 for a decline below 3520 and potentially down to 3450 in January. Once this correction is complete the S&P 500 is expected to rally to 4000 and potentially higher in the first half of next year.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
.
include(“/home/aleta/public_html/files/ad_openx.htm”); ?>
