Written by Jim Welsh
Macro Tides Weekly Technical Review 21 December 2020
When COVID-19 circulated the globe in March and April countries were forced to enact stringent lockdowns to control the spread of the virus and prevent hospitals from being overrun. As the magnitude of the economic impact became known the financial markets reacted violently. As liquidity dried up, global equity markets plunged by more than 30%, Gold prices fell and even Treasury bond prices declined. The Dollar rose as international money flowed in as the ‘safe’ haven.
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The Federal Reserve injected several trillion dollars and backstopped the corporate bond market, municipal bond market, provided $500 billion in swaps to address the Dollar liquidity problem, and enabled the Treasury department to extend loans to Main Street. Financial markets stabilized and then rallied as investors focused on the combination of monetary accommodation and trillions in government spending. Corporations have since borrowed more money in 2020 than in any other year, including companies that are rated as junk, while extending the maturities of their outstanding debt.
The stock market rallied as investors bought those companies that benefited most from the new stay at home economy, while cyclical stocks languished.
This dynamic changed on November 9 when Pfizer announced it had an effective vaccine. Cyclical stocks soared as a furious rotation developed that has elevated the Russell 2000 by 17% and energy stocks (XLE) by more than 12%. More than 90% of NYSE stocks are above their 200 day average, which is the highest level since September 2009 and January 2004.
These prior instances occurred 6 months after the market bottomed in March 2009 and 9 months after the low in March 2003. After January 2004 the S&P 500 rose less than 1% before chopping sideways until November 2004. The S&P 500 was 12% higher in April 2010 only to fall 15% by July 2010 before resuming the uptrend.
The high percentage of stocks above their 200 day average is a sign of strength as the experiences in 2004 and 2009 indicate. The one big difference is that the economy was not dealing with a Pandemic in those years. The ability of the market to ignore or look past any negative news for months has generated a high degree of complacency, which has been fortified by the arrival of not one but two effective vaccines.
This is evident in the Option Premium Ratio (OPR) which hit its lowest level ever last week as option traders overwhelmingly buy call options. The OPR fell to a low level (under red horizontal line) in September 2018 which was followed by a 20% drop as investors worried the Fed would keep hiking rates in 2019.
In February 2020 the OPR was quite low just before COVID-19 led to a 35% drop, and in August 2020 just before a -5% to -7% fall in the S&P 500. The OPR suggests the S&P 500 is on the cusp of a pullback but the depth of the drop will be dictated by how much of an incentive to sell investors perceive.
As hospitalizations rose to record highs every day after Thanksgiving, the Nasdaq 100 rallied for 11 consecutive days as traders bought the Mega Cap stay at home stocks irrespective of the economic fallout from the spread. Thanksgiving proved to be a super spreader event as family and friends celebrated together and more than 40 million Americans traveled during that holiday weekend. Last year 115 million Americans flew on an airplane or by traveled car to visit family and friends for Christmas. Even if half of those who traditionally travel for the holidays decide to stay home in 2020, more people will travel than during the Thanksgiving weekend.
The Christmas holiday could be an even bigger spreader event, as more people who are infected unknowingly get together with their family and friends. With hospital capacity already stretched in many cities and states, any meaningful increase in hospitalizations will lead to even more stringent lockdowns. The average for all the states as of December 16 was 74.6%, so it won’t take much to climb above 100% in many states.
After restrictions were relaxed in Great Britain and in Europe in November, another resurgence of the Pandemic has led many countries to impose restrictions again. On December 19 Great Britain significantly increased restrictions after a new strain and potential mutation of the COVID-19 virus was discovered in London and southern England.
It was reported that this new strain is 50% more infectious than the original virus. Whether the mutation is more deadly is unknown, although the consensus is that it won’t be.
A number of European countries and a total of 40 countries have now banned flights from Great Britain, but based on what we know, (30% asymptomatic, 5 days before symptoms appear) this new strain of the virus has likely already spread throughout Europe and has probably reached the U.S.
The assumption is that the current vaccines will be just as effective for this new strain, and others that will surely follow, but no one knows until actual research proves this to be true. Even if the efficacy is similar, it won’t help much if hospitals around the world are overrun in coming weeks because this new strain is 50% more infectious.
If the holidays are another super spreader event and this new strain accelerates the spread and hospitalizations, more countries around the world and states within the U.S. will be forced to enact more restrictions that could remain in effect for January and possibly February.
As the Pandemic hurtles toward a crescendo in the next 6 weeks, there is the potential that financial markets experience a mini replay of March as economic activity in the U.S. and around the world grinds to another halt. This would allow the Dollar to rally, Treasury yields to fall, as equity markets experience a sharp decline 7% to 10% drop, and Gold, Silver, as well as Gold stocks get hit too. The chart patterns and sentiment for each market supports this conclusion, which reinforces the potential.
Dollar
One of the most crowded trades going into 2021 is strategists expecting the Dollar to continue to fall. The Dollar topped on March 23 as the stock market was bottoming, so a weaker Dollar has been supportive of a rising stock market. Investors have been adding to their short positions in the Dollar as the Dollar has fallen, which is why it’s so easy to be negative about the Dollar.
A survey of currency traders shows that just 9% are bullish the Dollar, so just about everyone who can sell the Dollar has already done so. Positioning against the Dollar is more extreme now than it was in February 2018. Any rally in the Dollar will provide fuel for a stronger rally as the short positions are bought back. The missing ingredient is a reversal in the Dollar’s trend which remains down. The Dollar could receive the spark it needs if another lockdown leads to a flight to quality that lifts the Dollar as it did in March.
The price pattern in the Dollar suggests it is near an important low as it has almost completed 5 waves down from the high in March. Wave 5 began after the Dollar traded up to 94.30 in late September to complete Wave 4 from March. The Dollar appears to have completed 3 waves of wave 5 on December 17. All that’s needed is a short term bounce for wave 4 of Wave 5, and then another lower low to complete the whole move down from the high in March.
If this pattern analysis is correct, the Dollar could rally in the next few weeks for wave 4 of Wave 5 as more restrictions are put in place in the U.S. Once the peak in hospitalizations is reached by the end of January or early February, the Dollar would fall to one more new low before a significant rally follows. By mid 2021 Dollar strength could become a serious headwind for the stock market.
Treasury yields
There are two vaccines that should help contain the virus by the end of the third quarter and Congress is about to pass another $900 billion in fiscal spending to help the unemployed and small businesses, which is greatly needed. The bill will send $600 for every adult and up to 2 dependents in each family if they are under the age of 16, even though most of those who will receive these funds don’t need it. Despite this good news Treasury yields are holding below recent peaks. The 10-year Treasury yield is moving into the apex of a triangle so a big move is coming and my guess is the 10-year Treasury yield will fall in the next few weeks and close below the rising trend line.
The 30-year Treasury yield has been holding up better. This positive divergence suggests yields are likely to fall rather than rise which is the consensus. Positioning reflects the consensus and shows that Large Speculators and Leveraged Funds have a bigger short position than in October 2018, while the Commercials and Asset Managers have a larger long position. Treasury yields topped in early November 2018 after peaking at 3.45%, and have trended lower ever since. The positioning has become more constructive since March as the 30-year Treasury bond fell from above 180 to 170. The smart money Commercials and Asset Managers have been buying as the price fell.
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 $165.00 is possible if the Pandemic overwhelms hospital resources in many cities across the country.
Gold
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 then traded down to $1822.
Gold threw a bit of a curve as it traded up to $1905.60 in the overnight session on December 20, and then reversed lower to $1868. The overlap of the high at $1874 suggests the rebound is still a corrective bounce (a up, b down, c up) from the low on November 30. Although Gold could rally to $1925, where the two legs up (a=c) would be equal, Gold is still expected to fall below $1766 and could trade down to $1730 before a trading low is established.
If a selling wave envelops the financial markets due to more lockdowns around the world, Gold could get hit as other assets fall just like last March. The next decline is expected to be a good buying opportunity for a rally above the August 2020 high of $2070.
Silver
Silver traded down to $21.92 on November 30 and was not expected to trade above $26.00. In the overnight session on December 20 Silver traded up to $27.26, and continues to show better relative strength than Gold. Silver could trade above $27.26 to complete the rebound from the November 30 low, and potentially from the low of $21.78 on September 24.
Silver is expected to drop below $21.78 and may test its 200 day average at $21.17, which is rising by more than $0.20 a week.
By the end of December the 200 day average could be up to $21.55 and not much below the September 24 low of $21.78. The coming low is expected to establish a good buying opportunity that could be followed by a rally above $30.00 in the first half of next year.
Gold Stocks
The relative strength of Gold stocks (top panel) to Gold has been weakening which supports the outlook of lower prices for GDX. GDX continues to make lower highs and lower lows since its peak in August. GDX is expected to fall below $33.25. Traders can establish a 33% position if GDX drops below $32.00.
Stocks
The Advance – Declines for the NYSE and Nasdaq continue to make new highs, so it’s difficult to get too negative. However, we live in strange times and sentiment is so bullish despite mounting evidence of a global resurgence in the Pandemic that the market could be vulnerable to a quick sharp decline. In order for this to develop, investors will have to be hit on the head with a wake-up call that shakes their mindless buy every-dip-complacency.
For the first time since the low in late October, the 21 day Advances minus declines Oscillators on the NYSE and Nasdaq recorded a negative divergence as the S&P 500 and Nasdaq 100 made new highs last week. This indicates that market breadth was modestly weaker even as new price highs were made and usually signals an increase in vulnerability.
A similar divergence developed in late August as the S&P 500 made a new high which was followed by a quick pullback of -10.0%. The divergence for the Nasdaq was much larger and long lasting as the Mega Cap stocks kept zooming despite the divergence. The Nasdaq 100 subsequently dropped -14.1%.
On November 11 the S&P 500 had an intra-day low of 3633 and the intra-day low on December 21 was 3633. The expectation is that the S&P 500 will close below 3630, which should lead to an additional drop to 3500 -3550. A close below 3500 would open the door for a drop to near the late October low of 3300. (green trend line)
The DJ Transportation average is often a leading indicator for the stock market. On December 9 the Transports made a new all time high but its RSI failed to confirm and was also under 70. Momentum divergences that occur when a market average makes a new price high when the RSI is below 70 are usually significant. This negative divergence suggests the Transports are setting up for a correction, with a drop to 12,000 at a minimum. A close below 12,000 could lead to a quick drop to 11,000 which is where the Transports bottomed in last September and October.
A pullback to 3550 seems likely and could extend to 3450 if the S&P 500 closes below 3520. If the Pandemic gets ugly in the next few weeks, the S&P 500 has the potential to fall quickly to 3300 – 3350. The Nasdaq 100 (QQQ) also recorded an RSI divergence and could fall to 275 – 280.
The upcoming correction is expected to set up a rally to 4,000 and above in the first half of 2021.
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 and potentially as low as 3350 if the Pandemic overwhelms hospitals and more restrictions are enacted that extend well into 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.
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