Written by Jim Welsh
Macro Tides Weekly Technical Review 15 March 2021
Before the end of the first quarter the financial markets are likely to be buffeted by several factors. The Federal Reserve meets on March 16 and March 17 and will provide its quarterly assessment of the economy, inflation, and monetary policy, with Chair Powell answering questions in the post FOMC meeting press conference. Pension funds will rebalance their portfolios to maintain their 60% / 40% allocation to equities and bonds.
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Many funds are likely to lower their allocation to equities and increase bond holdings after Treasury bonds fell in the first quarter while equities rose. The Treasury will distribute $410 billion of stimulus checks to individuals and families in the next few weeks and some portion of this money will find its way into stocks. The race between vaccinations and the COVID variants may also play a small role.
I reviewed the FOMC’s Dot Plot from their December 2020 meeting in the January Macro Tides. The Dot Plot illustrates when each of the 17 members of the FOMC expect the federal funds rate to be increased. Only one member supported an increase in 2022, while 3 members expect the funds rate to be 0.375% at the end of 2023, with one member projecting the funds rate at 0.625%, and one looking for the funds rate to be 1.125%.
The other 11 FOMC members were projecting no increase in the fed funds rate until after 2023. With Congress passing the $1.9 trillion stimulus bill and vaccine progress accelerating, the FOMC’s Dot Plot is likely to change with more members projecting at least one increase before the end of 2022. If correct, Treasury yields may tick higher and the stock market drops led by the Mega Cap stocks.
The probability of the FOMC increasing the funds rate before the end of 2022 has jumped from 22% in early February to near 80% last week, according to the fed funds futures market.
The markets were comforted last week after the headline CPI held steady with an increase of 1.7% in February which was exactly what was forecast.
The Core CPI actually fell in February compared to January and at 1.3% was lower than the 1.4% expected.
In coming months the inflation news is going to become far less friendly. When the CPI for April is reported in May the headline CPI inflation will be north of 3.0%, and could approach 3.5% when the data for May is reported in mid June. As the inflation data becomes less sanguine the federal funds rate market will begin to price in more rate hikes (and earlier in 2022) by the FOMC.
With the looming prospect of higher Treasury yields coming, some market participants are eager to hear if Chair Powell hints about the FOMC implementing Yield Curve Control (YCC), which would be expected to minimize any increase in Treasury yields. I doubt Chair Powell will provide even a hint that the FOMC is considering YCC anytime soon. If correct, the Treasury market may be disappointed and sell off.
Chair Powell is going to reiterate the FOMC’s commitment to keep rates down so unemployment can fall and tolerance of any pick-up in inflation toward its target of 2.0%. Chair Powell will state the Fed’s expectation that the coming rise in inflation is likely to be temporary, so the FOMC will not react by hiking rates if the Core PCE is above 2.0% for a period of time.
The coming bout of inflation is likely to prove temporary as discussed at length in the February Macro Tides. Surprises are likely to be negative, which will lead to commentaries stating that the Genie is out of the bottle and that the Fed is behind the curve. This sentiment could easily lead to the Treasury market to test the FOMC by lifting rates aggressively and eventually forcing the FOMC to move toward YCC.
The FOMC may first choose to launch another Operation Twist program in which the Fed shifts its buying from short term Treasury bonds to increasing its purchases of longer date Treasury bonds. This ‘Twist’ would lift shorter term rates while lowering longer term yields. This may be a more attractive option than YCC in the short term.
Through March 15 the S&P 500 is up +5.7% but a better appraisal of how the average stock has performed since the end of 2020 is the performance of the Equal Weight S&P 500 ETF (RSP) which is up +12.4%. In contrast the Treasury bond ETF TLT is down -13.2%, the Core Aggregate Bond ETF (AGG) is off -3.6%, while the High Yield ETF (HYG) is only down -0.95%.
The spread between the average stock as measured by RSP up +12.4% compared to the performance of government and corporate bonds is wide. It is estimated that between $50 billion and as much as $110 billion of stocks may be sold and a comparable amount of bonds purchased by the end of March by defined benefit pension plans to rebalance their portfolios.
Offsetting this selling pressure will be purchases by those who use a portion of their stimulus check to buy call options on stocks. It has been estimated that 10% or more of the $410 billion going out in the next 3 weeks could be used to buy stocks either directly or through options. A recent survey found that more than two-thirds of those under the age of 34 intend to use their stimulus money to invest in the stock market, and more than half of those under the age of 54 do as well.
Stocks
If stocks are going to succumb to another selling wave the Nasdaq 100 could provide timely information. The Nasdaq 100 ETF (QQQ) has pivoted around the 310 – 312 level. After closing below this level it quickly dropped to 297 on March 5. If the Treasury market is upset by what Chair Powell doesn’t say about YCC, the Mega Cap stocks could experience another quick decline. The expectation is that the QQQ’s will not break below 297. However, if Treasury rates jump after Powell’s press conference there is a small chance the QQQ’s could fall to 284. As discussed last week:
“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.”
On March 5 the Nasdaq was oversold as the 21 day average of Advances minus Declines fell below -400. It has since become modestly overbought so it is set up for another decline. While the DJIA, DJ Transports, S&P 500, and Russell 2000 rallied to new highs, the Nasdaq 100 only recovered 55% of the loss. This indicates that money was being pulled out of the Mega Cap stocks even as the majority of stocks were running to a new high.
The Nasdaq Advance – Decline line is below its recent high while the NYSE Advance – Decline has made a new high, as cyclical stocks rallied.
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Mega Cap stocks came under pressure as Treasury yields moved up since the beginning of the year. If interest rates record a short term high and subsequently fall as expected, the Nasdaq 100 and technology stocks in general are likely to perform better. Conversely, financials and cyclical stocks could be vulnerable to a quick bout of profit taking before the end of the quarter before resuming their uptrend.
If the S&P 500 does correct before the end of the quarter, it is expected to rally above 4000 fueled by the next round of stimulus checks.
Treasury Yields
The 10-year and 30-year Treasury yields were expected to exceed their intra-day highs posted on February 25 to complete wave 5. On March 12 the 10-year Treasury yield climbed to 1.642% and the 30-year hit 2.404%.
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Despite the new high in yields the RSI for the 10-year and 30-year made a lower high, which suggests that the momentum behind the move up in yields is running out of steam. How Treasury bonds respond to Powell’s comments will indicate whether yields have already peaked or will after one more push higher.
Confirmation of a top in yields will be provided when the 5-day moving average (red) falls below the 13-day moving average (green).
The 13-day average on the 10-year is 1.54% and is 2.27% on the 30-year. The first indication will develop when the daily yield for each falls below these levels. Once yields top, the expectation is that they can drop at least by 0.20% to 0.30% for the 10-year and 30-year Treasury bonds in coming weeks.
A decline of this magnitude would likely result in buying of the Mega Cap stocks. Once the decline in yields runs its course, Treasury yields are expected to record higher highs as the inflation news released in May and June spooks the bond market.
Dollar
The Dollar strengthened as the yield on the 10-year Treasury bond rose from 1.0% at the end of 2020 to 1.64% and short positions against the Dollar were covered. The Dollar has the potential of exceeding the recent high of 92.50 especially if the bond market is disappointed that the FOMC is not ready to discuss YCC publically. The Dollar may set a short term high if it does rally above 92.50 but fails to push past 93.21. The Dollar’s RSI did reach 70 so a multi-week pullback could follow any near term high.
Gold
After Gold topped last August money continued to pour into Gold backed ETFs even though Gold fell from $2070 to $1900 in November. Once Gold fell below $1900 money started flowing out Gold ETFs, and the outflow accelerated after Gold dropped below $1800. Clearly sentiment has become sour toward Gold which is why it may be in the process of bottoming.
Gold may experience another dip if the Dollar does rally above 92.50, but it may not make a new low below $1677. Any additional weakness is a buying opportunity since Gold may regain its favor once inflation rises enough to grab traders attention. Two weeks ago 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 is expected drop below $24.90 and could test $24.50. Silver is expected to rally above $30.00 by mid-year.
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 violated the triangle after it rallied above $32.00 and the upper trend line that was defining the triangle.
The relative strength of the Gold stocks has improved and a close above the green declining trend line would be positive. The improvement in relative strength and a close over the green trend line would suggest buying GDX on the next pullback. I will monitor GDX and send an email if things line up. Traders can add 33% to the GDX position on a pullback to $32.35.
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 still has the potential to revisit 3700, if Treasury yields post new highs and Mega Cap stocks correct again. 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.
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