Written by Jim Welsh
Macro Tides Weekly Technical Review 05 April 2021
The economy is on the path to a Grand Reopening, job growth is exploding, major stock averages and median home prices are making new all time highs, Treasury yields are behaving, and the Federal Reserve has vowed to keep refilling the punch bowl until the Unemployment rate falls to 4.0% and inflation has rebounded to the highest level in more than 25 years.
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As Wavy Gravy exclaimed at Woodstock,
“We must be in heaven man!”
On Friday April 2 the Labor Department reported that 916,000 jobs were created in March while the Unemployment rate held steady at 6.0%. After hitting a trough in December monthly job growth is clearly in an uptrend and there will be a month when over 1.2 million jobs are created, maybe as soon as June. Despite the step forward there are still about 11 million fewer jobs than before the Pandemic. There is a good chance that half of the shortfall will be made up in the next 6 months.
As discussed in the April Macro Tides there are supply chain imbalances that are impacting delivery times, inventories, and pressuring prices. The March ISM report found that Supplier Delivery times are the longest since at least 2005. Supply chain problems are being exacerbated by an increase in new orders. The delay in deliveries has a domino effect on supply chains since every major manufacturer has developed a production process based on just-in-time inventory management. This rippling effect is one reason why inventory levels are at the lowest level since at least 2005.
As discussed in the April Macro Tides the auto industry has been in the cross hairs of the supply chain issue as a computer chip shortage is hurting production and profits, even though demand is strong and the buyers are paying on average $600 more per vehicle. GM and Ford have announced that the chip shortage may trim 2021 profits by $1.5 – $2.0 billion at GM and more than $2.0 billion at Ford:
“At the end of February, dealers had 2.7 million vehicles in stock, a 26% drop from the same month last year, according to Wards Intelligence. Dealers had about 414,000 pickup trucks at the end of February, roughly half the number from a year earlier. Many auto makers have curtailed the deep discounts they offered early in the pandemic. Car companies on average spent about $3,562 per vehicle on discounts and other sales incentives in February, a $600 drop from the same month a year earlier, according to research firm J.D. Power. For car and truck buyers this means they are paying $600 more for their new vehicle. With the supply of new cars and pickup trucks down, more new vehicle buyers are choosing instead to buy a used car. The Manheim Index for Wholesale used vehicle prices applies statistical analysis to its database of more than 5 million used vehicle transactions annually. The Manheim Index for Wholesale used vehicles was up 23.7% in mid March from March 2020. The increase was led by a surge of 43.1% for pickup trucks, 20.4% for luxury cars, 19.0% for SUV’s, and 17.6% for vans.”
Analysts forecast that March vehicle sales would total 16.4 million, but instead ran at an annual rate of 17.8 million 8.5% above the estimate.
The ISM Manufacturing Index reached its highest level since at least 2005 in March, easily surpassing prior peaks in 2011 and 2018. With inventories at such a low level, the ISM Manufacturing Index is likely to hold above 60 in coming months. Since 1980 the S&P 500 has underperformed when the ISM Index has been above 60. This has to be put into context.
After Paul Volker became Chairman of the Federal Reserve in 1979, the FOMC was focused on bringing inflation down. The FOMC increased the federal funds rate to 20.0% in February 1981 after inflation soared to 14.4% in May 1980. With the real federal funds rate above 5.0%, inflation soon succumbed and quickly fell below 4.0% by 1987. The drop in inflation and the subsequent decline in interest rates provided the foundation for the great bull market in the 1980’s.
The Fed also more fully implemented the Phillip’s Curve in guiding monetary policy after Paul Volker brought more discipline to the institution. As noted in the March 22 WTR, A.W. Phillips found an inverse relationship between the level of unemployment and the rate of change in wages in the U.K. As slack in the labor market fell as measured by the unemployment rate wages began to grow faster, company’s increased prices and inflation rose. In the U.S. the relationship between the unemployment rate and increases in the Personal Consumption Expenditures (PCE) index was fairly tight for decades.
In the past decade it has weakened noticeably as Chair Powell has noted in recent years. At the March 17 FOMC meeting the FOMC made it clear that the Phillips Curve will not govern monetary policy going forward. The FOMC will no longer increase rates based on projections of higher inflation, but instead will wait until inflation materializes, even though there is a risk the Fed could fall behind the inflation curve.
Readings above 60 in the ISM Manufacturing Index may have frequently elicited a series of rate increases by the FOMC as those high readings often coincided with a low unemployment rate. This was especially true in the 1950’s, 1960’s, and 1970’s when manufacturing comprised a larger percent of GDP than today. The change in how the FOMC will conduct monetary policy suggests the historical link between ISM Index readings above 60 and weak S&P 500 performance will be weaker.
Of course, how the FOMC responds and how the Treasury bond market reacts are two different things. As noted in the March 22 WTR:
“In coming weeks, members of the FOMC will act as disciples for the new gospel of allowing the economy to grow, inflation to exceed 2.0%, and the FOMC refraining from hiking rates. In the short term this ‘forward guidance’ may restore some calm to the Treasury market and allow yields to come down. However, inflation is likely to run hotter than the Fed expects and the Treasury bond market will test the Fed’s commitment by pushing yields higher until the Fed is forced to launch Operation Twist. The members of the FOMC may believe in the New Gospel but there are many traders (sinners) in the bond market that lack the faith to keep them from selling when headline CPI inflation holds above 3.0% for a few months.”
Stocks
In last week’s WTR the swings between the Themes of Growth and Reopening were reviewed and concluded that the correction that began in mid February was nearing an end:
“Since QQQ led the way into this corrective period, the improving relative strength of QQQ suggests the correction may end once the weakness in the Russell 2000 runs its course.”
Specific prices levels were provide for QQQ and the Russell 2000 that would indicated when the next leg higher was starting, or if one more dip would appear before the S&P 500 rallied above 4000:
“There are key price levels on the Nasdaq 100 QQQ and the Russell 2000 that must be monitored. The Russell posted an intra-day low of 2085 on March 5 and 2100 on March 25. A close below 2085 would likely lead to a drop to 1975. A close above 2225 would likely be followed by a new high above 2360. The QQQ has a clearly defined level of support and resistance, with support at 310 and resistance at 324.50. A close below 308 would likely lead to a test of 297 and a close above 324.50 would indicate a test of the February high of 338 was coming.”
The Russell 2000 closed above 2225 on Thursday April 1, and QQQ breached 324.50 on April 5.
The proprietary Intermediate Trend Indicator (IT) for the NYSE and Nasdaq 100 generated buy signals on April 1 when the IT (black) crossed above the red moving average for each market.
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The expectation is that the Russell 2000 and Nasdaq 100 QQQ will join the S&P 500 and rally to new highs. The news is simply too good for any meaningful selling pressure to derail the market in the next week. However, on April 13 the Consumer Price Index (CPI) will be released and is likely to show a big increase in headline inflation which could cause a hiccup.
Treasury Yields
After Treasury bonds experienced the largest decline in a single quarter, sentiment is even more negative according to the weekly survey by Consensus. In the last decade sentiment has only become this negative on four other occasions. This suggests that Treasury bond yields could fall for a period before the rising trend reasserts itself.
The Treasury market generated an inter market divergence last week as the 10-year yield rose to a higher high (1.765% versus 1.754%), while the 30-year Treasury yield held well below its prior high (2.448% versus 2.505%). This type of inter market divergence often occurs near trend reversals, even if it is short term in nature.
In this instance the 10-year could fall to 1.50% as the 30-year drops to 2.25% at a minimum. TLT has the potential to rally to $143.00. Once this decline in yields runs its course, Treasury yields are expected to rise to higher highs in the second half of 2021.
Gold & Silver
An inter market divergence also developed between Gold and Silver last week. Silver undercut its March 5 low of $24.91 by -4.3% when it fell to $23.82 on March 31. Gold though did not fall to a lower low as it held $0.60 above its March 8 low of $1677.60 on March 31.
If the Dollar was able to rally more than expected, which it did, Silver was expected to drop to $23.75:
“Additional Dollar strength could push Silver down to $23.75.”
In the March 22 WTR I discussed how weakness in Silver might mark the end of the correction in Gold and Silver after they peaked in August 2020:
“Silver has been holding up better than Gold since both peaked last August. It would be classic for Silver to show more weakness now, which could be another sign of bullish sentiment in the metals being washed out. When the strongest sector finally caves after months of correcting, it often occurs at the end of the corrective period.”
The spike down in Silver and the inter-market divergence with Gold that subsequently developed are additional signs that the correction may be over.
Recent inflation reports have been benign which has created a high level of complacency regarding the coming wave of inflation, as detailed in the April Macro Tides. If the CPI surprises to the upside as is expected, Gold, Silver, and the Gold stocks could catch a bid and rally into the days following the CPI report on April 13.
After buying the initial 50% in Gold ETF IAU at $17.23 on February 23 and the second 50% position at $16.09, the cost basis is $16.66. Traders took a 50% position in the Silver ETF (SLV) when SLV dropped to $23.25 on March 23.
Gold Stocks
As Silver was posting a lower low and Gold was testing its prior low, Gold Stocks (GDX) displayed good relative strength by bottoming well above its March low. ($31.65 versus $30.64) A close above the upper declining black trend line would represent a breakout and suggest a rally to $38.00 was starting.
Traders were recommended to take a 33% long position if GDX closed below $32.00, and on February 26 GDX closed at $31.13. Last week traders were advised to add 33% to the GDX position on a pullback to $32.75. GDX fell below $32.75 on March 23.
Dollar
As noted in the March 22 WTR the Dollar was expected to rally above 92.50 and then top out:
“In the short term the Dollar has the opportunity to rally above its recent high of 92.50 in large due to weakness in the Euro.”
The Dollar rallied a bit further than expected as it reached 94.44 on March 31 supported by weakness in the Euro as lockdowns hit the EU economy and vaccination progress proceeds at a far slower pace than in the U.S. After peaking on the last day of the first quarter, which coincided with lows in Gold and Silver, the Dollar has rolled over. As long as the Dollar holds below the down trend line, the Dollar is expected to pullback further. If it does Gold, Silver, and the Gold stocks should get a lift.
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.
The Russell 2000 and Nasdaq 100 have broken out above short term resistance levels and are ready to join the S&P 500 in making new all time highs in April. The S&P 500 does have a trend line that could provide short term resistance (4110) but is expected to give way as the Russell 2000 and the Nasdaq 100 push up to a new high.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
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