Written by Jim Welsh
Macro Tides Weekly Technical Review 19 April 2021
The Labor Department has announced March figures for headline and core inflation for the Producer Price Index (PPI) and Consumer Price Index (CPI), and all of the numbers exceeded the estimates.
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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%. On April 13 the headline CPI was up 2.6% from March 2020 versus an expected increase of 2.5%, and the Core CPI rose 1.6% compared to 1.5% in the forecast survey.
The reaction to the higher than expected inflation data was fairly muted, in part due to widespread expectations that the data would show more inflation, and the role base effects are playing.
As discussed last week, in order to factor out the extreme volatility in the subcomponents within the PPI and CPI, economists attempt to calculate the Base Effect. When the Pandemic hit in March 2020 commodity prices plunged and then rebounded significantly after monetary and fiscal policy stabilized the economy.
The best example of the violent swing in a subcomponent within the PPI and CPI is gasoline. 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 March headline PPI was up 4.3% but Base Effects accounted for 3.0% of the increase, according to Mizuho Securities.
This suggests that the headline PPI on a trend basis was up less than 2.0%, rather than the reported 4.3%. The spike lows in many data series were reached in April and May last year and won’t distort the Y-O-Y calculations as much when data for June, July, and beyond are reported. Inflation will appear to be falling after reaching a Y-O-Y high.
Everyone who knows how the PPI and CPI are calculated knows this and assumes that after the brief spurt in inflation for April and May (reported in May and June), inflation will conveniently recede. Chair Powell has reassured everyone that the increase in inflation will prove transitory so there is no need for the FOMC to alter its accommodative policy.
On the surface this will appear to be true for headline inflation, which will drop as the Y-O-Y surge in gasoline prices and other prices flat line compared with prices in July and August 2020. However, the core CPI inflation rate is likely to increase in the third quarter as headline inflation drops. This is something few are expecting.
As noted in the April Marco Tides the sectors that were hit the hardest during the Pandemic are just now reopening after absorbing losses for the past year:
“The sectors that have been most severely impacted by the Pandemic are likely to raise prices as demand increases to make up for some of the lost revenue when they were effectively shut down. Cheap air fares are going to be hard to find (airfares may rise 14% by June according to Hopper), hotels won’t be offering as many low cost ‘Get Away’ packages, movie ticket prices will be increased, and restaurants won’t have as many special meal discounts.”
In March the cost to rent a car or truck jumped by more than 10% from February, while the price of a hotel, motel, and lodging from home was up by 4%. These one month increases were compared to February and are likely to keep climbing as the reopening of the economy progresses and more Americans travel.
Restaurants are likely to increase their prices to offset the increase in food costs and as demand ramps higher. CokeCola announced it was raising its prices due to increase costs, even though the soda business is extraordinarily competitive.
Commodity prices bottomed in the spring of 2020 and have rallied smartly and will continue to pressure prices in the next few months. The service sector of the U.S. economy accounts for 80%+ of GDP and absorbed a drop in demand as lockdowns rippled through the economy to stem the spread of the virus. Core service inflation has just bottomed and will trend higher in coming months.
From 2014 until March 2020, Core Service inflation hovered above and below 2.5% and could rise by 1.0% from its current level, if it simply returns to its pre Pandemic level. After peaking in May or June, commodity inflation will cool, but service inflation will offset some of the decline. More importantly, service inflation is likely to keep rising in the second half of the year which will enable core inflation to continue to move higher even as headline CPI inflation eases.
The March PPI report revealed a high level of pipeline inflation as the prices for processed goods experienced the largest increase in many years. The price of steel, lumber, plastics, and chemicals are soaring with some experiencing the biggest price increase since 1947 or 1974! The magnitude of these price increases will force many companies to accept smaller profit margins, raise prices, or do both.
The surge in demand from the reopening of the economy will make it easier than it’s been in a long time for companies to pass along at least a portion of the increase in material costs. Given the scope of the price increase in some of the basic materials profit margins are going to be squeezed to some extent. If companies choose to raise prices it will show up in the cost of finished goods in the next few PPI reports.
The coming increase in service inflation on top of additional pipeline inflation could become problematic for Chair Powell and the financial markets. In a few months financial markets aren’t likely to as complacent about inflation.
Treasury Yields
Attempting to understand financial markets without using technical analysis can be extraordinarily frustrating. Inflation came in higher than expected and Retail Sales posted the second highest reading in at least 20 years. Any normal sane person would have assumed that Treasury yields rose after such news and were probably mystified to see Treasury yields fall. As discussed for weeks the Treasury market had revealed many technical reasons why yields were likely to fall irrespective of the economic or inflation news. This is another example of why combining technical analysis with the fundamentals is imperative.
The 10-year Treasury yield was expected to fall to 1.50% and dipped to 1.529% on April 15 after the blowout retail sales report.
The 30-year Treasury yield was expected to drop to 2.25% and fell to 2.207% on April 15.
The Treasury bond ETF (TLT) was expected to rally to $142.00 – $143.00, and traded up to $140.98 on April 15.
The decline in rates is a counter trend move in the context of the longer term expectation that Treasury yields will exceed their March highs in the second half of 2021. The 30-year has already reached its minimum target and the 10-year got close. In the short term yields are likely to tick higher, before another decline brings yields to below the lows of last week.
Stocks
I noted that the upward sloping trend line above the S&P 500 would climb to 4150 on April 16. The S&P 500 reached 4197 on April 16 and is expected to pullback more, as it did after it touched this line (1 and 3), and point 5.
The Russell 2000 has been lagging which is supportive of the expectation of a near term high in the stock market. As noted last week a close below 2210 would open the door for a drop to 2100. The Russell 2000 posted an intra-day low of 2208 on April 13 before rebounding. The Russell 2000 dropped from 2360 to 2100 and then rebounded to 2280. If the Russell 2000 experiences an equal decline it could drop to 2000 – 2030.
A close below 2210 would increase the odds of a decline to 2000 – 2030. The upper panel on the chart below shows the relative strength of the Russell 2000 to the S&P 500. As you can see the Russell 2000 has been underperforming noticeably since mid March, which suggests more weakness could be on the horizon.
The Nasdaq 100 (QQQ) was expected to set a new all time high near 340 – 342.50 and it has. On April 16 the QQQ reached 342.23.
The Nasdaq Advance – Decline line continues to make lower highs. The Nasdaq could be vulnerable to a pullback to at least the breakout level of 324.50 or 310.00.
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. The S&P 500 rallied from 3853 to 4197. A 38.2% retracement of the 344 point rally would bring the S&P 500 down to 4065. A close below 4065 would likely lead to a drop to near 4000 which is just above the 61.8% retracement level of 3985.
The S&P 500 is expected to rally to a higher high after this correction runs its course. A more meaningful top is likely around mid-year as investors begin to anticipate the FOMC telegraphing the onset of tapering its monthly QE purchases, the prospect of higher taxes, and the deceleration in GDP growth in 2022.
Dollar
The Dollar was expected to drop to 91.30 – 91.60 and dropped to a low of 91.03 on April 19. It is a bit oversold so a rebound is likely to kick in soon. 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
“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.”
The CPI did increase more than expected and the metals and gold stocks rallied. As noted last week a close above $1757 was expected to be followed by a test of $1800 and the down trend line from the August 2020 peak. Gold rose to $1789 on April 19 and then faded after hitting the down trend line which is normal.
The coming surge in inflation is still expected to lift Gold going into the summer so a close above the down trend line could be followed by a quick move up to $1820 – $1840. Ultimately a rally above $1900 is expected.
Bitcoin
As discussed last week the enthusiasm surrounding all things Bitcoin and CoinBase suggested crypto currencies could be at risk:
“As a dedicated contrarian I have to believe there is more upside potential in Gold than in Bitcoin in the next few months.”
Bitcoin plunged from a high of $64, 789 on April 14 to $51,985 on April 19 and could fall to $45,000.
Silver
Silver is expected to rally to $28.00 and potentially above $30.00 in the summer as inflation concerns intensify.
After buying the initial 50% in the 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 $16.45. Traders took a 50% position in the Silver ETF (SLV) when SLV dropped to $23.25 on March 23. Use a stop of $23.42.
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 $33.83 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 S&P 500 was expected to record a short term high near 4150, and it topped at 4197. The S&P 500 is expected to decline to 4065 with the possibility of a drop to near 4000 in the next few weeks. The failure of the Russell 2000 to make a new high suggests a correction to 2000 – 2030 is likely. The QQQ could pull back to 324 and possibly 310. With the NYSE Advance – Decline making a new high, the S&P 500 is expected to rally above 4200 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 – February 22 WTR
“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 13 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. XLI traded up to $101.10 on April 14.
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.”
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. XLF traded up to $35.40 on April 14.
Basic Materials – February 22 WTR
“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. On April 15 XLB traded up to $81.10.
Materials XME – February 22 WTR – 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 $38.60.
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