Written by Jim Welsh
Macro Tides Weekly Technical Review 24 May 2021
As you may recall Chair Powell responded to a question of when the FOMC might consider adjusting policy after the July 29, 2020 meeting.
“We’re not even thinking about thinking about thinking about raising rates. I wouldn’t be looking for us sending signals about cutting back on facilities or anything like that for a very long time.”
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On November 9, 2020 Pfizer announced it had developed a vaccine, the first vaccine was administered in December, and now more than 40% of the U.S. population has been fully vaccinated. In the first quarter of 2021 GDP grew 6.4% and could exceed 10.0% in the second quarter. The Unemployment rate has fallen from 10.2% in July 2020 to 6.1% in April 2021, and the Core CPI jumped to 3.0% in April.
As the economy more fully opens job growth will accelerate and the unemployment rate is likely to drop sharply in the next six months, so the labor market will make a lot of progress quickly. Core inflation is already above the FOMC’s target of 2.0% and is expected to push higher as service inflation rebounds, goods inflation only softens modestly, and shelter inflation rises.
The June issue of Macro Tides will discuss the four components of the current wave of inflation and explain why inflation is likely to remain high for longer. Although Base Effects will temper headline inflation after July, strong demand will keep goods prices elevated. Supply Chain disruptions are likely to persist and also offset some of the unwinding of Base Effects.
The computer chip shortage will last at least another 4 months and could endure to some extent into 2022. This will limit the increase in the supply of cars and trucks, which will keep demand for used cars and trucks high and prevent prices from falling much.
Many industries are struggling to find workers and have increased wages or offered bonuses to attract new hires. If this continues more firms will be forced to increase wages in order to retain existing workers. There are many dynamics at work in the labor market and to some extent Federal unemployment assistance is keeping some workers from going back to work. More than 22 states will suspend the Federal unemployment 3 benefits by the end of June, which could alleviate a portion of the apparent labor shortage. If core inflation exceeds 2.5% through the end of this year, the FOMC’s ‘inflation is transitory’ narrative will come into question.
The minutes from the April 28 FOMC meeting were released on May 19 and caused a brief stir in the financial markets:
“A number of participants suggested that if the economy continued to make rapid progress toward the committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases. Many officials echoed Chairman Jerome Powell’s view that the Fed should give markets plenty of advance warning before it begins reducing the purchases.”
The April minutes suggest that this is the first warning, as some members of the FOMC have begun to think about thinking of adjusting the $120 billion in monthly QE purchases.
After the release of the FOMC minutes the 10- year Treasury yield jumped from 1.639% to 1.692%, as Treasury bond traders mulled the market impact of less Fed buying on Treasury bond prices.
Two members of the FOMC were beginning to worry about the FOMC getting behind the inflation curve, since there is a 6 to 12 lag between changes in monetary policy and its impact on economic activity. Minutes from the April meeting said:
“However, a couple of participants commented on the risks of inflation pressures building up to unwelcome levels before they become sufficiently evident to induce a policy reaction.”
These concerns were expressed before the CPI report indicated that inflation pressures were already manifesting and not simply building. This will be a topic for discussion at the June 16 meeting. Chair Powell’s post meeting press conference will be difficult as he attempts to maintain a balance between the transitory narrative and actual data points.
The May employment report will certainly show far more than the 266,000 jobs created in April. As noted in the May Macro Tides:
“If monthly job growth averages 1.0 million or so in coming months and inflation jumps as much as expected, the FOMC may be forced to consider tapering its monthly QE purchases at the July 28 meeting, and if not at the July 28 meeting then certainly at the September 22 meeting. Prior to these meetings a number of FOMC governors will provide hints as to which meeting the discussion will occur.”
When the minutes of the June 16 meeting are released on July 7, there will be more participants discussing the appropriate time to adjust asset purchases. I doubt a decision will be made at the June meeting but it will be used to provide the markets another signal, and the markets will react on July 7.
Stocks
The Major Trend Indicator (MTI) is effective in identifying when stocks are in a bull market or a bear market, which is why I include it in every Weekly Technical Review. As noted the MTI generated a Bear Market Rally (BMR) buy signal when it crossed above the red moving average on April 16, 2020 as the S&P 500 closed at 2800. A new bull market was confirmed on June 4, 2020 when the WTI rose above the green horizontal line. As long as the MTI is above the green line the risk of a large correction is low.
As a devout tinkerer I wondered if there was a way for the MTI to provide more information other than the major trend. A few months ago I added the Relative Strength Indicator (RSI) on the MTI to see if the MTI could provide more intermediate signals, especially at a trading low.
When the MTI’s RSI drops below 30 it indicates that the market is nearing a trading low (lower horizontal line). The MTI’s RSI dropped below 30 on May 19 just as the S&P 500 fell to 4061 as it tested the May 12 low of 4057. After testing 4057 the S&P 500 rallied and closed at 4115 on May 19, which suggested the retest of 4057 was successful.
As noted last week:
“The NYSE Advance – Decline reached a new high before the recent correction which suggests the S&P 500 is likely to rally to another new high before the end of June. The stock market would get some support from the bond market if Treasury yields don’t exceed their March 30 highs, and even more support if yields fall.”
The NYSE Advance – Decline is less than 200 issues from making another new high, so the S&P 500 is on track to make a new all time high soon.
The chart analysis for the Nasdaq 100 last week was helpful:
“As long as the Nasdaq 100 doesn’t close below 316.00 (last week’s low), the Nasdaq 100 could also rally to a new high.”
The Nasdaq 100 (QQQ) bottomed at 316.30 on May 19 before closing at 322.59. Despite the FOMC minutes revealing that some members were thinking about discussing tapering, Treasury yields held below their March 30 high and then fell. The modest dip in Treasury yields also provided the Mega Cap stocks a lift. The QQQ is expected to rally above the high of 342.80 before a more significant top is in place.
Treasury Yields
When the CPI came in much higher than expected on May 12 the 10-year Treasury yield jumped to 1.70%, which was noteworthy since this spike higher was so much lower than the 1.765% high on March 30. The reaction to the FOMC minutes was a repeat performance as the 10-year only traded up to 1.692% on May 19. On the surface the combination of higher inflation and the prospect of tapering should have lifted the 10-year yields above 1.765%. The fact that this doubly bad news didn’t increases the odds that Treasury yields may approach or modestly fall below their May 7 lows, before the counter trend move lower in yields is complete.
Commodity prices have been falling which could be expected to be supportive of keeping Treasury yields consolidating for a longer period, as noted last week. Treasury yields may fall more if the CPI for May is less than 4.2% when it is reported on June 10.
Since the peak of 2.505% on March 30, the 30-year Treasury yield has recorded lower highs and lower lows, which is the definition of a downtrend. Until the 30-year Treasury yield closes above 2.417%, the trend lower must be respected irrespective of poor inflation news and the eventual tapering the FOMC will announce in the next 3 months.
If Treasury yields test the May 7 lows before the end of June, it may be setting up an opportunity to short Treasury bonds in anticipation of a big increase in yields in the second half of this year. Before year end the 30-year Treasury yield is expected to climb to 2.85% and could jump to 3.15%.
If Treasury bonds are tracing out an a-b-c pattern for Wave 4 from the high in March 2020, TLT could be expected to rally above $142.00 during wave c of Wave 4. Longer term TLT has the potential to decline to $125.00 and potentially as low as $110.00.
Dollar
A decline in commodity prices helps keep any change to monetary policy at bay, which would also be a negative for the Dollar. In addition, the rate of vaccinations have ramped up in the EU and estimates for growth are being raised which should give the Euro a lift in the near term.
As noted previously the long term pattern in the Dollar suggests it should fall below the January 4 low of 89.21 before an important low is established. It’s possible the Dollar index could briefly dip below the February low of 88.25 as explained previously:
“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 could bottom .83 below the February low of 88.25. This is why it’s possible for the Dollar to not only drop below the January 2020 low of 89.21 but also under the February 2018 low of 88.25, although it is not required.”
Gold
As noted the last two weeks,
“A rally above $1900 is expected, with a test of $1950 possible.”
The high last week was $1886.90. The upcoming high is likely to be followed by a correction. Gold’s RSI is already above 70 so it will become even more overbought if it does rally above $1900 as expected. From a risk management perspective, selling into the next rally is smart.
Silver
The high last week was $28.61 and just below the September 1, 2020 high of $28.88. A close above $28.88 should be followed by a test of the February 1 high of $29.79. A close above $30.00 could lead to a rally to $33.00 – $36.00. Even if Silver manages to trade above $30.00 it won’t be in a straight line. Silver is likely to make a short term high in the next few weeks below $29.79 and then correct. The push toward $30.00 or higher will come after a pullback.
The Gold ETF IAU had a reverse two for one split effective on May 24, so all the prior prices have been doubled. Traders sold half of the Gold ETF IAU at $17.62 ($35.24) after buying it for $16.66 ($33.32) for a modest gain of 5.75%. Sell the remaining half at $36.60 and raise the stop to $34.94. Traders took a 50% position in the Silver ETF (SLV) at $23.25 and sold half at $25.87 for a gain of 11.0%. Sell the remaining half at $26.75 and raise the stop to $25.05.
Gold Stocks
Traders were recommended to take a 66% long position at an average price of $31.94, and were stopped at $34.70 for a gain of 8.6% when GDX corrected more than expected. A rally to $37.50 was expected and GDX reached $38.22 on May 10. Traders were instructed to sell half at $38.27 for a gain of 19.8%. Sell the remaining half at $40.70 and raise the stop to $38.50.
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, 2020 as the S&P 500 closed at 2800. A new bull market was confirmed on June 4, 2020 when the WTI rose above the green horizontal line. The S&P 500 is expected to push to a new high above 4238. The trend is higher until Treasury yields reverse higher and the Dollar bottoms
Sector Analysis and recommendations
In the February 22, 2021 WTR I recommended buying Industrials (XLI), Basic Materials (XLB), Financials (XLF), and Materials (XME). 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. The average profit for each ETF is based on the February 22 closing price and would have been larger if each ETF was purchased on weakness as recommended.
Industrials
On February 22 Industrials XLI closed at $91.27 and on February 23 traded down to $90.19. The average sell price was $103.60 and the gain from the February 22 close was 13.4%.
Basic Materials
On February 22 the Basic Materials XLB closed at $75.34 and on February 26 traded down to $73.07. The average sell price was $84.24 and the gain from the February 22 close was 11.8%.
Financials
On February 22 the Financials XLF closed at $32.71 and on February 26 traded down to $32.19. The average sell price was $36.48 and the gain from the February 22 close was 11.5%.
Materials
On February 22 the Materials XME closed at $38.35 and on February 26 traded down to $35.83. The average sell price was $43.92 and the gain from the February 22 close was 14.5%, and could have been larger if one had bought XME on the dip after February 22.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
Caption photo credit: South American Tapir, by veverkolog via Pixabay. Full image:
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