Written by Jim Welsh
Macro Tides Weekly Technical Review 01 February 2021
Manic Reddit Chat Traders and Sir Isaac Newton
Clearly, Isaac Newton who became Sir Isaac Newton after being knighted by Queen Anne of England in 1705, was not only one of the brightest minds of his time but all time. But Isaac Newton was also human.
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The car trip we planned will take us somewhere we’ve never been so before we leave we enter the address into our phone to get directions. As we drive we are told when to turn right or left and as we approach the destination we are told that it is 500 feet on our right. The precision is unbelievable but it has become a normal facet of daily life.
Global positioning satellite technology makes this possible but few Gen Z’s or Millennials would know that the knowledge that made this technology possible was originally discovered more than 350 years ago by Isaac Newton in the 1660’s. Newton is also the fellow who famously developed the theory of gravity after observing an apple fall from the tree he was sitting under. From this simple observation Newton calculated the relative masses of the six known planets from their gravitational forces.
Newton explained the ebb and flow of tidal flows based on the Moon and calculated the dates of the equinoxes based on the gravitational pull of the Sun and Moon. Newton made all of these incredibly complex calculations without the aid of a computer, but on mathematical theories he mostly developed. In 1687, he published his most acclaimed work, Mathematical Principles of Natural Philosophy, which has been called the single most influential book on physics.
Clearly, Isaac Newton who became Sir Isaac Newton after being knighted by Queen Anne of England in 1705, was not only one of the brightest minds of his time but all time. But Isaac Newton was also human.
The British government announced the South Sea Company would take over most of the British national debt in 1720. Newton had invested in the South Sea Company and as shares rose in anticipation of the South Sea Act in April 1720 Newton sold all of his shares after they had doubled in value. As shares of the South Sea Company more than tripled after Newton had sold, he invested almost all of his money in July and August of 1720.
When investors realized that the profit projections that had been touted in pamphlets were unlikely to be met, the price collapsed in September 1720. Newton wound up losing all of his original profit and more as the price of the South Sea Company returned to the level it had traded in March of 1720. He is reported to have said that he
“could calculate the motions of the heavenly bodies, but not the madness of the people.”
Sir Isaac Newton was a genius but he couldn’t resist bending to the most basic human emotion – greed.
The attention Gamestop has received and the narrative it has created of small investors sticking it to big time hedge funds ala David versus Goliath is interesting for what it doesn’t address. Hedge funds who short stocks are bad and those who run them are greedy, but an army (mob) of small investors who are willing to pay $400 for GameStop just because it’s going up are gallant. Greed is playing a role in how these small investors are trading that is not much different than those who run a hedge fund.
Short selling hedge funds are being vilified but it was hedge funds that uncovered the fraud at World Com, Enron, and Wall Street’s role in manufacturing securities that contributed to the housing bubble and ultimately the financial crisis. Some hedge funds have certainly abused their financial muscle and are hardly considered beyond rebuke. This isn’t one of those times.
One narrative that has taken hold is that the big guys forced Robinhood to change its rules which hurt some of its small investors. Here are some of the comments by members of Congress, which include Ted Cruz agreeing with Alexandria Ocasio-Cortez. Just when it seemed bi-partisanship was dead, there it is.
House Financial Services Chairwoman Maxine Waters (D-CA) put out a statement later on Thursday January 28 calling for a hearing:
“Hedge funds have a long history of predatory conduct and that conduct is entirely indefensible. As a first step in reining in these abusive practices, I will convene a hearing to examine the recent activity around GameStop (GME) stock and other impacted stocks with a focus on short selling, online trading platforms, gamification and their systemic impact on our capital markets and retail investors.”
Silicon Valley Rep. Ro Khanna (D-CA) put out a statement Thursday saying:
“We’re done letting hedge fund billionaires treat the stock market like their personal playground, then taking their ball home as soon as they lose. We need more regulation and equality in the markets.”
Rep. Rashida Talib, D-Mich., a member of the Financial Services Committee, went further, calling Robinhood’s move “beyond absurd” and demanding a hearing on:
“Robinhood’s market manipulation. They’re blocking the ability to trade to protect Wall St. hedge funds, stealing millions of dollars from their users to protect people who’ve used the stock market as a casino for decades.”
No doubt every one of these Congressional members believes in regulation so it is a bit ironic that none of them understand that Robinhood was forced to tighten its trading rules by security regulators. Given the surge in new accounts and soaring trading activity Robinhood was told it needed to increase its capital base due to the increase in market exposure its clients had taken in extraordinarily volatile stocks. Robinhood first limited additional exposure from new and existing clients and in the last three days has raised $3.4 billion in additional capital to satisfy regulatory requirements.
For the media and members of Congress this part of the story doesn’t jive with the more attractive narrative of railing against the machine in defense of the average Joe and Jane, especially when the machine is hedge funds.
The hedge funds that were short the stocks targeted by the Reddit mob had a tough choice – either cave in, take losses, and live to fight another day, or follow the research that placed a value on Gamestop of less than $10. In order to stick to their guns some hedge funds decided to sell some of their liquid stocks that have performed well to raise the money needed to meet margin calls due to the losses on their short positions. This is likely why the Mega Cap stocks were weak last week and why they rallied today, after GameStop and the other heavily shorted stocks lost ground.
At some point in the not too distant future, GameStop, AMC, and the other targeted stocks will be down 75% or more and the Robinhood newbies will get their first real lesson in market risk. When that happens AOC, Maxine Waters, et al will be on to other more important issues and won’t notice the carnage from the access to trade they championed.
Stocks
Last week I presented a number of charts that suggested that the market’s upward momentum was faltering suggesting the market was primed for a pullback. In order to confirm a high, the major market averages needed to show some price weakness:
“Since the lows in the major averages at the end of October, the S&P 500, Nasdaq 100, and Russell 2000 have continued to make higher highs and higher lows. In order to confirm that at least a short term high has been established in the S&P 500, Nasdaq 100, and the Russell 2000, these averages will have to fall below a prior low. Until that happens all trends are up, despite the RSI negative divergences and softening in market breadth. The table is set for a correction but prices have to confirm.”
As the market sold off last week market breadth was decidedly negative and every market average did fall below a prior low. The weakness was pronounced enough that the 5-day price average fell below the 13-day average on the S&P 500, Dow Jones Industrials and Transports, Russell 2000, but didn’t on the Nasdaq 100. The 21-day moving average of Advance minus Declines fell to the lowest level since last October on the NYSE, while the Nasdaq 21-day moving average of Advance minus Declines became modestly oversold.
These indicators suggested the market was poised to bounce and in recent months Mondays have generally been up days. Investment flows probably played a role with today being the first day of a new month.
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As noted last week the number of stocks posting a new 52 week high was contracting with the 5-day average of net new highs falling below the 21-day average, even as the S&P 500 was making a new high:
“On January 14 the 5-day average (green line) of net new highs was 302 but was only 228 on January 25, and the 21-day average (black line) has slipped from 246 on January 14 to 228.”
The contraction in new highs intensified last week and didn’t improve with today’s rally. The 5-day average fell below the low on January 4 which suggests there is more underlying weakness now.
The 21-day average of net new highs as a percent of NYSE issues traded has also dropped below its moving average and the January 4 low.
The low on Friday January 29 on the S&P 500 was 3694 and the expectation is that the S&P 500 will close below 3694 which should lead to more selling. The S&P 500 is expected to drop to near 3550, which would retrace 50% of the rally from the low of 3234 and high of 3871.
If the Nasdaq 100 (QQQ) retraces 50% of its rally from the low on November 2, the QQQ would fall to 295.00 and the blue horizontal trend line. After the coming correction, the S&P 500 is expected to rally above 4000.
Dollar
As noted last week:
“the initial phase of a rally in the Dollar will likely come from short covering which could be ignited by negative news out of Europe that weakens the Euro rather than good news that strengthens the Dollar. The rollout of the vaccine in the EU has been slower than in the U.S., so the EU economy could prove noticeably weaker than the U.S. in coming months.”
Euro
As discussed in the February Macro Tides, comments by an ECB governing council member last week hit the Euro and helped the Dollar rally. On January 27 Klaas Knot, who is the head of the Dutch central bank and a member of the ECB governing council, was interviewed by Bloomberg and was asked about the ECB’s inflation target and the strength of the Euro:
“That is something we of course monitor very, very carefully. It’s one of the factors, not the exclusive factor, but one of the factors we take into account when arriving at our assessment of where inflation is going to go.”
Klass went on to say that the ECB has the necessary tools, including interest-rate cuts, to prevent any further strengthening of the euro undermining inflation.
Silver
On Friday members in the Reddit chat room set their sights on running up the value of Silver and $800 million flowed into the Silver ETF (SLV). The 22-day average of daily volume in SLV was 29.7 million shares as of January 27. On January 28 volume soared to 151 million and then exploded today to 280 million shares. The new money flowing into SLV forces iShares to increase exposure to Silver by purchasing Silver contracts.
The huge rally in GameStop, AMC and the other stocks targeted for buying to squeeze large short positions were successful because there was a large short position in each of these stocks to force those short to buy, which sent those stocks to the moon. Large Speculators, Managed Money traders, and small traders are actually long Silver futures, so engineering a short in the Silver futures market doesn’t have the short positioning to feed a squeeze.
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At the high in SLV on February 1, SLV tagged a trend line connecting the highs in December. Silver traded up to $29.79 slightly exceeding the high of $29.75 back in August, but Gold is more than $200 below its August peak. This type of inter-market divergence is normally not a healthy sign and suggests that Silver is likely to drop and could fall below $24.00, which would bring SLV down to $23.50.
Gold
Gold is still expected to fall below $1766 and could fall to the down trending line that connects the low in August, September 24, and November 30 which is near $1700. Although unlikely, Gold could fall to $1660 during a spike low. Gold dropped $304 from the high of $2070 to the low of $1766 (Wave a?), before rebounding to $1960 (wave b?). An equal decline would bring Gold down to $1656 (wave c?)
If and when Gold does fall below $1766, the manner in which it does so will provide some clues as to whether the trend line at $1720-ish will be support.
Gold Stocks
The crazy trading and strength in Silver caused Gold stocks to bounce but GDX failed to close above the green down trend line. This failure suggests more downside is coming. If GDX follows the potential pattern in Gold, which would allow Gold to fall to $1656, GDX could drop below $28.00. Traders can establish a 33% long position if GDX drops below $32.00.
Treasury yields
The 10-year Treasury yield is expected drop to 0.95% before climbing to 1.266%. At some point in 2021, more likely in the second half of the year, the 10-year Treasury yield could spike up to 1.75% to 1.95%.
Long term the 30-year has the potential to rise to 2.15% to 2.35% but is expected to retest the breakout at 1.75% first.
TLT has been expected rally to $154.00 to $155.00, and possibly as high as $158.00. Two weeks ago traders were advised to take a 50% position if TLT dropped below $149.92, using $148.00 as a stop
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. Once this correction is complete the S&P 500 is expected to rally to 4000 and potentially higher in the first half of 2021.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
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Caption graphic clipped from The South Sea Bubble, a Scene in ‘Change Alley in 1720, Tate Galleries. Image released under Creative Commons CC-BY-NC-ND (3.0 Unported). Full image below (Click to enlarge, back arrow to return to this page.)
Display caption (from Tate):
The South Sea Bubble was a brief period of wild financial speculation in Britain. It was centred on the fortunes of the South Sea Company, which shipped people from Africa to become enslaved labourers on plantations in Central and South America. British aristocrats and leading politicians were shareholders, which gave a legitimacy to the company and its slave trading activities. The shares were extremely popular and rose rapidly in value. Many other companies, some fraudulent, issued stock. When the stock market collapsed in 1720 a large number of people were financially ruined.
Gallery Label, December 2019
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