Written by Jim Welsh
Macro Tides Weekly Technical Review 15 February 2021
Interest Rate Spike Could Derail the Equity Buying Binge
As noted in the February 8 WTR:
“The economy is on the mend and vaccine distribution is improving which provides the back drop supporting the buy-the-dip mentality no matter how shallow.
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“There is no doubt that the bull market that began in March 2020 after a 35% plunge has evolved into a speculative binge that has further to run. The expectation was that the S&P 500 would experience a sharp decline that would bring it down to 3550 before a subsequent rally took the S&P 500 above 4000.”
The market’s valuation is stretched but has been justified based on historically low interest rates which have been deemed low enough to support a P/E ratio of 20 for 2022 earnings. That is changing as Treasury rates have pushed higher and are now approaching the highs recorded in March 2020. If Treasury rates breakout above those highs the market could be vulnerable to a quick valuation check. With the bond market closed on President’s Day the only reference is the Treasury bond futures. The 30-year has broken below support near 169 – 170 and is trading where it was in mid February last year when the 30-year was yielding 2.05%. The next area of true support is under 160, which would equate with the 30year yield rising to 2.15% – 2.35%.
I expected Treasury yields to fall as higher COVID cases and more lockdowns hurt the economy. That indeed transpired but what I didn’t foresee was the vigilante Call option buying spree by novice traders that would keep the stock market momentum strong and override the deteriorating fundamentals. It seems the wildly bullish equity sentiment may provide a reason for the stock market to decline as expectations for a strong second half in 2021 and higher inflation spook the Treasury market. It appears that yields may jump now and subsequently subside after the stock market experiences a sharp decline. As noted in recent weeks:
“Longer term the 30-year has the potential to rise to 2.15% to 2.35%.”
Stocks
In 2020 bond yields fell as the stock market plunged when the Pandemic forced a lockdown of the U.S. economy. It would be ironic if higher rates in February 2021 were the cause of a correction in the S&P 500. The S&P 500 is expected to fall to below 3694 and could approach 3550 if the unwinding of dealer hedges are reversed related to excessive call buying.
Gold
Higher Treasury yields would likely prove a headwind for precious metals. 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. Gold could fall to $1660 during a spike low. Gold is expected to rally above $2070 this summer.
Silver
After peaking at $29.79 on February 1 Silver peeled off $3.77 before hitting a low on February 4. It rallied to $27.53 on February 8 and an equal decline would bring Silver down to $23.76. The recent strength suggests a drop below $22.00 is unlikely. Once this correction is over Silver is expected to rally well above $30.00.
Gold Stocks
If Treasury yields do spike higher, the declines in the precious metals and Gold stocks could unfold quickly and be complete by mid March. 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% position if GDX drops below $32.00.
Dollar
The Dollar is expected to rally above 92.00 in the short run and sometime this summer test 95.00. This constructive outlook for the short term is dependent on the Dollar holding above 90.00. The Dollar should benefit as international money is attracted by higher Treasury yields. However, a decline below 90.00 would increase the odds of the Dollar falling to another lower low before the move to 95.00 commences in earnest. Should the Dollar manage to close above 95.00, a subsequent move up to 98.00 – 100.00 will be possible.
TLT
TLT has been expected rally to $154.00 to $155.00, and possibly as high as $158.00. Three weeks ago traders were advised to take a 50% position if TLT dropped below $149.92, using $148.00 as a stop. TLT fell below $148.00 on February 12 when it opened at $147.70 triggering the stop. TLT has the potential to drop to $142.00 or lower if the 30-year Treasury yield rises to 2.15% – 2.35%.
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 has been expected to fall to 3550, but the willingness to buy the dip has precluded any meaningful correction. The S&P 500 still has the potential to revisit 3694 in coming weeks and possible drop to near 3600. Once this correction is complete (should it materialize), 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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