Written by Jim Welsh
Macro Tides Weekly Technical Review 08 March 2021
An Inflection Point Is Coming
When a car is running smoothly all of the pistons are firing in sync with the other pistons. When the ‘timing’ is off the engine loses power and begins to run less smoothly. In the stock market, the pistons are the major market averages, or Gold, Silver, and Gold stocks in the precious metals market, and in the Treasury market, it is the different maturities. After the employment report on Friday, March 5, an inter-market divergence developed in the Treasury market and the stock market.
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As discussed in the March 1 WTR:
“The spike high in Treasury yields on February 25 has all the earmarks of a wave 3 crescendo. The yield decline to date would be considered wave 4 which could stretch out for a bit before wave 5 lifts Treasury yields above the February 25 intra-day spike high.”
On March 5 the 10-year Treasury yield pushed to 1.626% and above the February 25 high of 1.614%. The 30-year Treasury yield however only climbed to 2.35% on March 5 and well below the high of 2.402% on February 25. The failure of the 30-year to confirm the higher high in the 10-year Treasury yield created an inter-market divergence. This is often at least a short-term positive.
There are good reasons to believe this positive inter-market divergence will not last and the 30-year Treasury yield will exceed the February 25 high. The 10-year Treasury yield is also likely to record a higher high. From a low of 0.907% on January 4, the 10-year yield climbed to 1.187% on January 12 an increase of 0.28% (wave 1). The wave 4 low was 1.403% on March 2 after the spike high on February 25. If wave 5 is equal to wave 1, the 10-year would rise to 1.683%. As noted in the February 22 WTR the 10-year has the potential to rise to 1.82%:
“The 50% retracement of the decline in the 10-year yield from its high of 3.248% in November 2018 to 0.40% in March 2020 would allow for the 10-year yield to rise to 1.82%.”
Since the 30-year Treasury bond has been weaker than the 10-year the expectation was it would retrace more:
“The 61.8% retracement of the decline in the 30-year yield from its high of 3.455% in November 2018 to 0.837% in March 2020 would allow for the 30-year yield to rise to 2.455%. The 30-year closed at 2.18% on February 22 so it may reach 2.30% – 2.45% soon.”
Although the 30-year rose to 2.402% and within the target range, the price pattern suggests there should be a wave 5 that will lift the 30-year yield higher. From a low of 1.638% on January 4, the 30-year rose to 1.915% on January 12, an increase of 0.277% (wave 1). The wave 4 low was 2.177% on March 2 after the spike high on February 25. If wave 5 is equal to wave 1, the 30-year would rise to 2.454%.
The longer-term Treasury ETF (TLT) is expected to fall below the February 25 low of $136.61 in its wave 5. From June of 2019 until mid-January 2020 TLT traded above and below $135.00 so this should provide significant support. TLT closed at $138.54 on February 25 and its RSI was 16.8. On March 8 TLT closed at $137.83 but the RSI is 28.6, so it has already recorded a positive RSI divergence. TLT should still drop below $136.61 since that is the end of wave 3 and TLT needs to complete wave 5 by falling below that level.
Positioning in Treasury bond futures has improved as investors and institutions have become more defensive. The consensus view is GDP growth could accelerate to 5% to 7% for the remainder of 2021 as fiscal stimulus provides consumers plenty of spending money, vaccines allow for a reopening of the economy in the second of this year, and inflation rises.
At the end of 2020 Large Speculators were long 25,249 10-year Treasury futures contracts but have flipped to being short -95,611 contracts as of March 1.
The smart money Commercials have become more bullish as they have flipped from being short -6,134 contracts to being long +278,002 contracts. This is the largest long position by the Commercials since mid-February of last year.
The positioning in the 30-year futures is not as positive. Large Speculators were short -174,958 at the end of December and are still holding -190,334 contracts short. The Commercials have become modestly more constructive increasing the number of long contracts they hold from +176,333 to +232,454. The positioning in Treasury futures is constructive and supportive of a counter-trend rally developing after wave 5 ends.
On Friday the Governor of the Bank of Japan Kuroda said the BOJ would not allow the yield for the JGB 10-year to rise above the prevailing band of +0.10%:
“We need to keep the yield curve stably low. I don’t think we need to widen the band.”
Speculation had developed that the BOJ might expand the band after the yield on the 10-year JGB had climbed to 0.17%. After his comments, the JGB dropped to 0.09%. The ECB is expected to consider increasing its bond purchases at their meeting on March 11, which could be expected to push government yields lower.
The spread between U.S. Treasury yields and government bond yields in Japan and the EU have widened to the point that foreign investors can purchase U.S. bonds and generate a good return. The 10-year German Bund yields -.278% so buying U.S. Treasury bonds is attractive. After wave 5 is complete U.S. bond yields have the potential of falling by 0.25% to 0.35% in the next few months, even if yields eventually move higher by year-end.
Stocks
In the February 22 WTR I noted that investors were reevaluating growth stocks since the outlook for cyclical growth had measurably improved and higher interest rates were squeezing Mega Cap valuations:
“The perception of muted growth is changing and forecasts for GDP growth in the second half of 2021 are jumping with some estimating growth of 5% to 6%. Owning expensive growth stocks doesn’t look attractive. The other factor that has started to pressure growth stocks is the increase in Treasury yields which is forcing investors to reconsider what the proper multiple the FAMANG stocks deserve. The FAMANG stocks still represent 22.2% 5 of the S&P 500 and will drag the S&P 500 down as they correct. If cyclical sectors pullback a bit, the S&P 500 can drop to the blue trend line near 3750 and may test the January 29 low of 3694.”
On March 4 and March 5 the S&P 500 traded down to 3723 and 3730 but managed to close above the green trend line and 3750 on both days. After the intra-day low on Friday and the inter-market divergence with the Nasdaq 100 (QQQ), the S&P rallied from 3730 to an intraday high of 3881 on March 8. In the process, the S&P 500 tagged the black rising trend line connecting the October 30 and January 29 lows, which it had broken below last week. This has the look of a snap-back rally to the scene of the crime (broken trend line) before the S&P 500 falls below 3723.
The 10-year Treasury yield jumped from 1.20% on February 16 to 1.60% on March 5. The Nasdaq 100 peaked on February 16 and by March 5 had dropped by -12.1% as Treasury yields rose. The correlation between Treasury yields and the Mega Cap stocks is high, which suggests that pressure on the Mega Cap stocks will continue until Treasury yields top.
If Treasury yields rise in wave 5 as expected, the Mega Cap stocks can trade lower. The low on March 5 is important. The QQQ’s fell from 338.19 to 311.00 (-27.19), bounced to 324.33, and then fell to 297.45 (-26.88), so the 2 declines missed being perfectly equal by 0.31 points. This pullback in the QQQ’s may have completed an a-b-c correction from the high at 338.19. If QQQ falls much below 297.45, the rally from the low on Friday could be a b wave and be followed by an equal decline of -40.74 for wave c from the March 8 high of 310.06. This would target a low near 269.32 that completes a larger A-B-C decline from 338.19 that might coincide with a peak in Treasury yields in the next two weeks.
There is a Head and Shoulders top in the QQQs. The Head is 338.19 and the neckline is 311.00 so the width of the pattern is 27.19 points. With QQQ trading below the neckline, the pattern projects a decline to 284.00.
If the Mega Cap stocks decline more and higher Treasury yields cause the cyclical stocks to take a breather, the S&P 500 could test 3650 (red trend line on S&P 500 chart). The decline in Treasury bonds has potentially unbalanced the traditional 60% stocks / 40% bonds that pension funds employ. Some pension funds may be forced to increase their Treasury bond allocation and decrease their equity allocation to reestablish their 60/40 balance before March 31.
With economic growth expected to surge in the coming months, pension funds may want to hold more cyclical stocks and lower their holding of growth stocks before the end of the quarter. This may be another source of selling pressure for Mega Cap stocks and growth stocks in general.
After this pullback, the S&P 500 is expected to rally above 4000 fueled by the next round of stimulus checks.
Dollar
As noted last week:
“The Dollar had been expected to rally above 92.00 and that potential is back on track. It may provide another reason for Gold and Silver to correct more in the next few weeks.”
Since March 3 the Dollar has jumped from 90.63 to 92.42 on March 8. The strength of the surge suggests the Dollar could continue to rally up to 93.21 and possibly as high as 94.00 in the next two weeks. This additional strength could be triggered by Treasury yields moving higher, prospects for better growth in the U.S, and foreigners buying Treasury bonds.
Gold
As noted last week Gold had closed below the middle trend line near $1760 and looked poised for a drop below $1700. On March 8 Gold traded down to $1678 testing the horizontal trend line connecting trading lows from April last year ($1664), May ($1671), and June ($1672). Gold’s RSI is oversold at 25.58 and sentiment is far less bullish than in August when Gold topped at $2070. Gold fell from $2070 to $1766 on November 30, before rebounding to $1958 on January 6. An equal drop from this secondary high would target a low of $1654, so Gold could experience some additional weakness especially if the Dollar pushes above 93.20.
Last week I recommended increasing the position in IAU from 50% to 100% if IAU traded below $16.10. IAU traded below $16.10 on March 8 so it was purchased at $16.09. The average cost basis is $16.66 after buying the initial 50% at $17.23 on February 23. Gold is expected to rally to $1950 and possibly above $2070 this summer.
Silver
Silver closed below $26.30 so the expected drop to $24.60 is likely.
Gold Stocks
Traders were recommended to take a 33% long position if GDX closed below $32.00, and on February 26 GDX closed at $31.13.
GDX appears to be forming a triangle after trading down to $30.64 on March 3. If correct and once the wave 4 triangle is complete, GDX is expected to drop sharply in wave 5. The width of the triangle is $1.45 so GDX could fall to $29.19. Traders can increase the GDX position from 33% to 66% if GDX trades under $29.35.
A decline to $28.50 or a bit lower can’t be ruled out until GDX begins to show strength.
Confluence
It appears that the Treasury market, Mega Cap stocks, the S&P 500, the Dollar, and Gold, Silver, and Gold stocks could each be approaching an important inflection point within the next few weeks. The FOMC meeting on March 15 and 16 will undoubtedly play a role. Some market participants have expected (hoped?) that Chair Powell would hint at a willingness to enact Yield Curve Control. I don’t believe the Fed is ready to go that far.
While Treasury yields have risen corporate bond yields aren’t up much and spreads are still quite narrow, and overall liquidity will remain high as the Treasury’s balance at the Fed falls. For the members of the FOMC the increase in Treasury yields confirms the coming improvement in GDP growth as more Americans are vaccinated and inflation moves toward its 2% inflation target. Until financial conditions tighten to the point of threatening this outcome, the FOMC is likely to refrain from publically discussing Yield Curve Control (YCC).
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 still has the potential to revisit 3650, if Treasury yields post new highs and Mega Cap stocks correct further. Once this correction is complete, the S&P 500 is expected to rally, after the next round of stimulus checks are received, 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.
Stock Sectors
Now that the stimulus package is about to be voted into law, the focus will shift to infrastructure spending, which has had a measure of bipartisan support for years. Investors will be anticipating the increase in spending and happy to buy the sectors likely to benefit before the news is realized. In the February 22 WTR, I recommended buying 4 sectors on the weakness that has the potential of benefiting from an increase in infrastructure spending.
Industrials – After pulling back late last week to $90.19 on February 23, XLI continues to confirm the breakout.
Financials – February 22 WTR:
“The Financial ETF has closed above the high it made in 2007 and 2018 as illustrated on the monthly chart below. This breakout suggests it should move higher in coming months.”
XLF pulled back late last week to $32.19 on February 26.
Basic Materials – February 22 WTR:
“XLB has the potential of testing the higher trend line near $80.00.”
On February 26 XLB dipped to $73.07 and just above the trend line connecting the October 30 and January 29 lows.
Materials XME – February 22 WTR:
“Would wait for a pullback after such a big up day on February 22.”
XME quickly pulled back to $35.28 on February 26 from $39.86 on February 24. Getting back above the black trend above the current price will be positive.
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