Written by Jim Welsh
Macro Tides Weekly Technical Review 12 April 2021
On April 9 the Labor Department reported that the Producer Price Index (PPI) rose 4.2% from March 2020 and comfortably above the forecast increase of 3.8%. The Core PPI, which excludes food and energy, rose 3.1% from a year ago and higher than the estimate of 2.7%.
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The increase in energy prices since the onset of the Pandemic in March 2020 contributed significantly to the big jump in the PPI. The FOMC has emphasized that monetary policy will not be altered even if inflation, as measured by the Core Personal Consumption Expenditures Index (PCE), jumps above the FOMC’s target of 2.0%.
Chair Powell has repeatedly stated that the FOMC’s expectation is that the coming surge in inflation will prove temporary and thus not warrant any change in policy. In an interview on 60 Minutes broadcast on April 11, Chair Powell was asked if the Fed might increase the federal funds rate in 2021. Powell stated that it was “highly unlikely.”
It is important to note that the first change to monetary policy will not be an increase in the fed funds rate but instead a tapering of the $120 billion in monthly purchases of Treasury bonds and mortgage backed securities. A tapering is possible before the end of 2021, but will only occur after the FOMC has provided financial markets hints of a change many months before any actual change.
One reason why the FOMC will be patient and look through the coming increase in inflation is illustrated by the huge swings in gasoline prices. In January 2020 gas prices were up 20% from January 2019, only to plunge to a year over year (Y-O-Y) decline of more than -60% by April 2020. The absolute increase in gas prices, based on the national average as provided by Gas Buddy are up more than 60% since March 2020. The annual rate of change increase within the PPI report though is almost 100%.
In order to factor out the extreme volatility in the price of gasoline, and producer and consumer prices in general, economists attempt to calculate the Base Effect. Through March 2 the Core PPI was up 4.3% but Base Effects accounted for 3.0% of the increase, according to Mizuho Securities. (The cutoff date Mizuho used is different than the Labor Department which is why the Core PPI’s are not identical.)
This suggests that the Core PPI on a trend basis was up less than 2.0%, rather than the reported 4.3%. In a few months the spike lows in many data series that were reached in April and May last year will no longer be in the Y-O-Y calculations and inflation will appear to be falling, even if the current prices remain stable. This point was discussed in the April Marco Tides:
“According to Gas Buddy, the average price for regular gasoline has risen to $2.86 a gallon as of March 29 from $1.74 in March 2020, an increase of 64%. The Bureau of Labor Statistics calculates the Consumer Price Index and gives gasoline a weighting of 3.36% within the CPI. Based on its weighting and the 64% increase in national gas prices, the headline CPI could be lifted by 2.1% just from the increase in gas prices. The CPI for March will be released on April 13. In July 2020 National gas prices had recovered to $2.20 a gallon, so gasoline’s contribution to the CPI will fall to about 1.0%, if gas prices hold near $2.86 a gallon through June.”
According to Gas Buddy’s data compiled from more than 150,000 gas stations and 11 million individual price reports, the average price for a gallon of gas on April 12 was $2.85.
Base Effect can’t account for the huge increase in the price of lumber which has soared from under $400.00 to $1,125. This increase has added more than $24,000 to the cost of the average new home built in the U.S.
Gasoline prices traded in a range between $2.10 a gallon and $2.72 from 2015 through March 2021. The only deviation was during the collapse in oil prices in 2015 and 2016 after Saudi Arabia increased production and during the Pandemic. In comparison lumber prices are more than double the range that held from 2008 into early 2020 below $400, after a brief foray above $400 in 2018. The increase in lumber prices is being driven by demand for housing in the U.S. and is not due to a supply shortage that might ease quickly.
The price of Hardness Rockwell C steel traded under $650 a Short ton from 2009 through 2020, except a for short term spurt in 2011 and during 2018. As of April 8 the price was $1350, which is 50% higher than the peak in 2018 and 2011 and is in response to an increase in demand.
The Fed can’t explain away the increase with the Base Effect description.
The Consumer Price Index will be released Tuesday April 13 and has the potential of showing more inflation that forecast. The key in coming months will be how much of the coming surge can honestly be explained by Base Effect and how much will prove more persistent. My guess is that inflation will be more persistent than the FOMC expects and the bond market will gradually challenge the FOMC by increasing Treasury bond yields in the second half of this year.
Treasury Yields
In the near term the expectation is that Treasury yields are likely to fall further, even though the longer term trend is up for Treasury yields. Counter trend moves often appear after a market reaches a number of technical thresholds. The following points also appear when a market is near an important low, but don’t apply to the Treasury market now given the economic fundamentals of stronger growth and higher inflation:
- Market becomes over sold or over bought
- Momentum divergence as price makes a new low or high
- Sentiment reaches an extreme – too negative or positive
- Inter market divergence between similar instruments in a sector
- Market fails to respond to news
- In the March 1 WTR I noted that the weekly RSI for the Treasury bond ETF (TLT) had fallen below 30 for only the fourth time in the past decade.
- In the March 22 WTR I noted that on March 18 TLT traded down to $133.19 before closing at $133.92. TLT’s RSI recorded a significant positive divergence suggesting that TLT had bottomed and Treasury yields have topped.
- In the March 29 WTR I discussed how negative sentiment in the Treasury market had become:
“Sentiment toward Treasury bonds is about as sour as it can be. The percent of bond Bulls fell to just 20% last week, according to the weekly survey of bond traders by Consensus. This is in the bottom 1.7% of all surveys during the past 34 years.”
- In the April 5 WTR I discussed how 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%).
The hot PPI report on April 9 could have lifted Treasury bond yields significantly. Although yields finished up on the day, yields actually fell after the news was announced. The yield for the 10-year and 30-year Treasury bonds rose by less than 1 basis point today, so there was no delayed reaction. The CPI report tomorrow will provide another test. But when a market fails to respond to news it is a sign that the prior trend has become exhausted.
The 10-year Treasury yield has been holding in a tight range (1.59% – 1.765%). The expectation is that the 10-year Treasury yield will fall below 1.50% in coming weeks, as long as there is no close above 1.77%.
The 30-year Treasury yield is expected to drop to 2.25% as long as it doesn’t close above 2.47%. The Treasury bond ETF (TLT) is expected to rally to $142.00 – $143.00, as long as TLT doesn’t close below $134.80. The fall in Treasury yields and rebound in TLT has been expected to be choppy as these moves are against the bigger trend of higher rates. This counter trend move is thus more likely to consume time and not retrace a large portion of the prior move.
Stocks
There are signs that the market is nearing a short term high after some additional strength in the next few days. As noted last week, the S&P 500 was approaching a trend line that was expected to provide initial resistance.
“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.”
This upward sloping trend line was up to 4130 on April 9 and will climb to 4150 on April 16. The S&P 500 did pullback modestly after to touched this line (1 and 3), and a deeper correction after point 5.
The Nasdaq 100 is close to setting a new all time high, but the Nasdaq Advance – Decline line continues to show underlying weakness, as it has now made a series of lower highs. This suggests that after the Nasdaq 100 makes a new high (QQQ could rise to 340.00 – 342.50), the Nasdaq could be vulnerable to a pullback to at least the breakout level of 324.50 or 310.00.
The Russell 2000 has been lagging which is supportive of the expectation of a near term high in the stock market. The S&P 500 recorded a new all time high on April 9, the Nasdaq 100 QQQ is less than -0.5% under its high, but the Russell 2000 is -5.8% below its all time high. A close below 2210 would open the door for a drop to 2100. The Russell 2000 peaked on March 15 just days before Treasury yields topped and has trended lower as yields trended lower. The expectation is that Treasury yields will decline more which would be a headwind for the Russell 2000.
The NYSE Advance – Decline Line continues to make higher highs, which suggests there will be another rally to a higher high in the S&P 500 after any pullback.
If the S&P 500 tops near 4150 by the end of this week a pullback to 3850 -3900 is likely, before a subsequent rally takes the S&P 500 to a higher high. Meaningful market tops are usually preceded by the Advance – Decline Line making a lower peak, which is not the case currently.
Dollar
The Dollar was expected to top after rallying above 92.50. Although it rallied to 93.44 and a bit more than expected, it did roll over and has corrected. The Dollar is expected to drop to 91.30 – 91.60 before a bounce begins. The strength of the next rally will reveal whether the Dollar will retest the January 6 low at 89.21. A rally above 94.00 would lower the probability of a retest, while a bounce that fails to exceed 93.44 would increase the odds of a retest.
Gold
From the recent low of $1677 Gold rallied $80.00 to a high of $1757. It would be constructive if Gold held above $1715 (50% retracement) on any pullback. A close above $1757 should lead to a test of $1800 and the down trend line from the August 2020 peak.
Bitcoin
With the Federal Reserve expanding its balance sheet along with other central banks, and M2 money supply growing rapidly, there has been a plethora of articles about how monetary accommodation will cause inflation. Traditionally Gold has benefited from inflation but in recent months Bitcoin seems to have been the larger beneficiary. After peaking in the first week of January, Gold had been trending lower, while Bitcoin has soared to higher highs. There is more to the Bitcoin story than just inflation, but the apparent inverse relationship to Gold is hard to ignore. Tomorrow’s release of the CPI could provide some insight. If the CPI rises more than expected and Bitcoin rallies and Gold declines, it would further support the inverse theory.
One thing is certain: Bullish sentiment is extreme in Bitcoin and almost nonexistent in Gold. As a dedicated contrarian I have to believe there is more upside potential in Gold than in Bitcoin in the next few months.
Silver
After bottoming at $23.82 Silver rallied $1.74 to $25.56. It would be constructive if Silver is able to hold above $24.62.
If the CPI rises more than 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. Use a stop of $16.26. Traders took a 50% position in the Silver ETF (SLV) when SLV dropped to $23.25 on March 23. Use a stop of $22.69.
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. Two weeks ago traders were advised to add 33% to the GDX position on a pullback to $32.75. GDX fell below $32.75 on March 23, so the cost basis is $31.94. Use $32.10 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.
The Nasdaq 100 broke out above its short term resistance level and is ready to join the S&P 500 in making new all time high in April. The Russell 2000 has faltered after breaking above short resistance. The S&P 500 is expected to record a short term high near 4150, and a failure of the Russell to also make a new high, suggests a correction to 3850 -3900 is possible in the next few weeks. With the NYSE Advance – Decline making a new high, the S&P 500 is expected to exceed 4150 after a pullback.
Sector Analysis and Recommendations
In the February 22 WTR I recommended the following cyclical sectors in anticipation that an infrastructure bill would materialize in coming months:
“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 bi-partisan 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 each case I suggested to buy the sector on weakness and the market accommodated. On February 22, the S&P 500 closed at 3876 but traded down to 3806 on February 23 and 3790 on February 26.
Industrials
“The relative strength of XLI broke above the down trend line that has been in place since mid November. XLI is on the verge of breaking out above the recent highs.”
On February 22 Industrials XLI closed at $91.27 and on February 23 traded down to $90.19. Sell half of the position at $101.10.
Financials
“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.”
On February 22 the Financials XLF closed at $32.71 and on February 26 traded down to $32.19. Sell half of the position at $35.40.
Basic Materials
“An increase in infrastructure spending will increase the demand for the raw materials and chemicals. Here are two ETFs that have exposure to the sectors that will benefit. Basic Materials XLB has the potential of testing the higher trend line near $80.00.”
On February 22 the Basic Materials XLB closed at $75.34 and on February 26 traded down to $73.07. Sell half of the position at $81.10.
Materials XME
Would wait for a pullback after such a big up day on February 22.
On February 22 the Materials XME closed at $38.35 and on February 26 traded down to $35.83. Whereas Industrials, Financials, and Basic Materials have tested or bested their March high, Materials have underperformed. Use a stop at $37.80.
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