Written by Jim Welsh
Macro Tides Weekly Technical Review 26 April 2021
Hurricanes are by their nature transitory. As a hurricane moves onshore or over cold water wind speeds drop significantly. Hurricane damage is determined by wind speeds and the amount of rain that falls in a short period of time. A Category 1 hurricane won’t cause much property damage due to wind speed but may produce severe flooding if it moves slowly. Conversely, a fast moving hurricane may not cause much flooding but can produce catastrophic damage it if is a Category 4 or 5 hurricane. Only 7% of the 243 hurricanes observed since accurate satellite measurements began in 1983 have reached an intensity of a Category 5 hurricane.
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Inflation is going to increase meaningfully in coming months and the odds of inflation only being a Category 1 or 2 are falling as commodity prices continue to zoom, and service prices and rents reverse higher, which will lift core inflation for many months. The only question is whether it will be a Category 3 inflation burst or a Category 4 or 5. If it proves to be a Category 3 bout of inflation, Chair Powell and the FOMC can probably stick to their mantra of a transitory period of inflation, even if financial markets get a bit wobbly.
But if financial markets begin to sense that the coming wave of inflation data could upgrade the forecast to a category 4 or 5 wave of inflation, the FOMC will find itself between a rock and a tough choice.
A review of the charts below make it clear that the large increases in the prices for a broad range of commodities makes it clear that the coming surge in inflation won’t be either a Category 1 or 2 fling of inflation as price pressure force companies to raise prices.
The computer chip shortage has gotten a lot of attention but supply chain disruptions extend beyond chips as discussed in the April issue of Macro Tides. There have been more articles discussing inventory shortages than at any time in the past 20 years.
The breakdown in supply chains is why delivery times have stretched out according to respondents in Markit’s monthly Purchasing Managers Survey.
No surprise then that with raw material prices soaring almost 80% of those in Markit’s survey report higher input prices.
Prior to the Pandemic, competition and moderate GDP growth of 2.5% for years prevented most companies from raising prices out of fear of losing market share. The U.S. is on the cusp of a surge in economic growth which will provide cover for companies in the sectors most impacted by the Pandemic to increase prices without fearing the loss of market share. This is going to lead to an increase in core service inflation in coming months that is likely to persist.
The burst of inflation from the increase in raw material prices will be followed by an increase in service inflation, which is why the coming increase in inflation will be at least a Category 3 storm. The inflation complacency markets have displayed in recent weeks will be replaced by increasing concern in the second half of this year.
Dollar
In the December 21, 2020 WTR I discussed why the Dollar was approaching a trading low:
“One of the most crowded trades going into 2021 is strategists expecting the Dollar to continue to fall. A survey of currency traders shows that just 9% are bullish the Dollar, so just about everyone who can sell the Dollar has already done so. Positioning against the Dollar is more extreme now than it was in February 2018. All that’s needed is a short term bounce for wave 4 of Wave 5, and then another lower low to complete the whole move down from the high in March.”
The Dollar recorded a trading low on January 4 of 89.21 and rallied to a high of 93.44 on March 31. Since that high the Dollar has been decisively trending lower, which suggests that Wave 4 ended on March 31. The Dollar’s RSI is nearing 30 so an oversold bounce is possible. Ultimately, the Dollar is expected to test and probably drop below the January 4 low, which could mark an important low. Let’s look at the bigger picture.
In January 2017 the Dollar topped at 103.82 and declined in 5 waves for about 14 months before bottoming in mid February 2018 at 88.25. I was expecting the Dollar to bottom in February 2018. As I noted in the February 20, 2018 WTR:
“I expected the Euro to exceed 1.2536 before a top is in place, and the Dollar to fall below its low of 88.44 before it bottoms. The Dollar dropped to a new closing low on Thursday and new intra-day low below its low on January 25, 2018 on Friday. Friday’s upward reversal was a key reversal day since Friday’s low was below Thursday’s low and high and was accompanied by a higher close. Sentiment toward the Dollar is very negative and positioning in the Dollar shows a net short position, which has preceded a rally in the Dollar in recent years.”
The Dollar subsequently rallied in a choppy overlapping fashion, which looks nothing like the strong move down from the January 2017 high.
Since topping in March 2020 the Dollar has experienced another strong move lower that mirrors the decline after the January 2017 high. If the Dollar falls below the January 2021 low of 89.21, it will complete 5 Waves down from the March 2020 high. If the Dollar does record a lower low in the next two months, it would almost match the length of time (about 14 months) after the January 2017 high. The January 2017 high was 103.82 and was 102.99 at the March 2020 top. If the decline from the March 2020 high equals the January 2017 – February 2018 drop, the Dollar would bottom 0.83 below the February low of 88.25.
If all of this unfolds as described it suggests that the Dollar is nearing the end of the correction that began in January 2017 (Wave A 88.25 low, February 2018 – Wave B 102.99 high, – Wave C 87.00 – 87.50 low). This will set the stage for a large rally in the Dollar that could be expected to last at least 14 months and exceed the January 2017 high of 103.82. A rally of this magnitude would have a large impact of a number of markets. Emerging markets would be vulnerable as the drag from dollar denominated debt would be problematic. Stay tuned.
Treasury Yields
Treasury yields are expected to drop below recent lows before resuming their uptrend. Although the 10-year Treasury could tick up to 1.63%, it is expected to fall below 1.52%. In the second half of this year the 10-year is expected surpass 2.0% and could reach 2.25%.
The 30-year Treasury yield is expected to drop to below 2.207%, although it could first rise to 2.23%. Before year end the 30-year Treasury yield is expected to climb to 2.85% and could jump to 3.15%.
The Treasury bond ETF (TLT) is expected to rally to $142.00 – $143.00. Longer term TLT has the potential to decline to $125.00 and potentially as low as $110.00, if inflation becomes a Category 4 or 5 bout of inflation.
Gold
The coming surge in inflation is 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, with a test of $1950 possible. This positive outlook will be maintained as long as Gold holds above $1725.
Silver
Silver is expected to rally to $27.40 and test $30.00 in the summer as inflation concerns intensify. A close above $30.00 could lead to a rally to $36.00.
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 $16.58. Traders took a 50% position in the Silver ETF (SLV) when SLV dropped to $23.25 on March 23. Use a stop of $23.74.
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 9 position on a pullback to $32.75. GDX fell below $32.75 on March 23, so the cost basis is $31.94. Use $34.70 as a stop.
Stocks
If the big picture analysis for Treasury bonds and the Dollar is correct, the stock market could record an important high in the next few months. Measurements of sentiment have already reached levels that are consistent with tops in the stock market. Valuations are extreme but the positive outlook for the economy will keep institutions invested until something comes along to challenge the consensus view. A sharp increase in Treasury yields and strength in the Dollar could be part of the puzzle. There are likely to be clues in technical momentum indicators that provide a timely warning when whatever fundamental change develops that begins to convert the buy and hold crowd from holding to selling.
There are many momentum indicators that I use to help quantify when the stock market is losing upside momentum, which usually precedes short term, intermediate, or major tops. What determines the depth of any correction is the underlying health of economic fundamentals. If the economy is in good shape, a correction will often be limited to 4% to 7%. If economic growth is slowing and monetary policy is unfavorable, a correction of more than 10% is likely. Major decline of more than 20% are usually associated with recessions, but not always i.e. 1987.
One indicator is the NYSE Advance – Decline line has been quite helpful in the past in warning of intermediate and major tops. The A-D Line usually peaks before the S&P 500 tops. A high is further confirmed once the S&P 500 drops below a prior low or a trend line connecting the two prior lows. The longer the trend line the more significant the break of the trend line.
The following charts are weekly for this illustration. In the real world I use daily charts since daily charts provide more timely information.
The NYSE Advance – Decline Line continues to make new highs, which suggests the stock market is not showing signs of deterioration based on this valuable technical momentum indicator.
The Russell 2000 did close below 2210 but for only one day. Today the Russell 2000 closed above the range it has been trading in for almost 4 weeks. The breakout suggests the Russell 2000 is likely to test its all time high of 2360.
The S&P 500 made a new closing high on April 26 but its RSI failed to confirm. This could lead to a quick pullback to 4080 – 4110 before the next push higher. The shallowness of the recent pullback suggests that the S&P 500 will complete 5 waves up from the March 4 low before a more significant top forms.
The Nasdaq 100 (QQQ) sports a similar pattern to the S&P 500 and could rally to 343.00 – 345.00 this week.
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 could only deliver a drop to 4118 which shows underlying strength. The S&P 500 is expected to push to a new high if it experiences a short term dip to 4080 -4110.
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