Written by Jim Welsh
Macro Tides Weekly Technical Review 07 June 2021
A Period of Risk Off is Coming Soon
Markets have been feasting since March and April of last year powered by the concept of liquidity. A review of numerous charts suggests that markets are approaching a fork in the road as the Federal Reserve communicates the timing of its tapering and persistent high inflation calls into question Chair Powell’s definition of ‘transitory’. The coming reset in risk will follow one more push higher in June in the majority of markets with some posting new highs and others merely retesting a recent high.
Please share this article – Go to very top of page, right hand side, for social media buttons.
The trigger will come when investors realize core inflation is holding well above the FOMC’s 2.0% target even as headline inflation recedes. Treasury yields will reverse higher in the second half of this year and rise to new highs with the 10-year Treasury yield hitting 1.95% and possibly 2.15%. Currencies are likely to anticipate a less accommodative Fed by selling other currencies which will allow the Dollar to rally. Conjecture about how soon the FOMC will begin tapering the Fed’s purchases and more importantly when the FOMC will be forced to raise the federal funds rate will be disruptive. Complacency is the dominant feature of the financial markets currently and the May employment report only reinforced this. By the time the coming reset is nearing an end, complacency will have been replaced by concern.
Job growth improved in May with 559,000 new jobs compared to 266,000 in April, but less than the 675,000 forecast. I thought this was possible as discussed in the June Macro Tides:
“The May employment report due on June 4 could come in below forecasts. Sidelined workers who are concerned about getting sick, mothers waiting for their children’s school to reopen, or those enjoying an extended vacation funded by government benefits may result in fewer new jobs than the 675,000 estimate. Each of these reasons is going away as more people get vaccinated, every state reopens, states eliminate benefits, schools restart in-person learning, and Federal unemployment benefits end on September 4. This suggests job growth should accelerate in July and continue to be strong going into the fall.”
When the June employment report comes out on July 2, job growth will be stronger than in May. The minutes of the FOMC’s meeting on June 16 will released on July 7 and show that the FOMC discussed tapering extensively and highlight a difference of opinion with some members wanting to hold off and others pushing for a quicker change.
While tapering is important, the issue of transitory inflation is the bigger deal since Chair Powell has drawn a line in the sand. Bank of America has produced a chart that pretty much mirrors my analysis of the path Core CPI inflation is likely to take for the remainder of 2021 and early 2022, as noted by the dashed line. If core inflation significantly exceeds the FOMC’s median estimate of 2.4% for the Core PCE inflation through the end of this year, the FOMC’s ‘inflation is transitory’ narrative will come into question.
Investors want to believe Powell will be right as that would allow the FOMC to keep policy easy. But as job growth accelerates in the third quarter and core inflation holds above 3.0%, investors will begin to worry that the FOMC is behind the curve and might be forced to play catch up by raising the federal funds rate in 2022. That’s all it will take for the reset to intensify and lead to a period of risk off across many markets.
Markets
When the major trend is up, the price pattern will show a 5 wave advance, or a 5 wave decline when the major trend is down. Once a 5 wave move has completed a retracement of the prior move occurs. If the prior move was up, the retracement will be a decline, and rebound if the prior move was down. There are many markets that are near the end of their wave 5 rallies, which supports the fundamental view that investors are going to be surprised by the intensity and persistence of inflation in the next 6 months.
Commodities – S&P Goldman Sachs Commodity Index
The ETF that tracks the S&P Goldman Sachs Commodity Index is GSG and since the low in April 2020, it has completed waves 1 through 4 (red). Wave 5 is also breaking into 5 waves (black) and has either completed wave 5 or will do so with one more push higher. The coming correction could bring GSG down to the late March low (-15.0%), and possibly down to the late January level (down -20.0%).
The S&P Goldman Sachs Commodity Index is weighted 54.0% toward energy and 46% non-energy, as the table shows. The broad based composition suggests the coming decline will pull the majority of commodities lower.
Chinese Yuan
After reaching a low against the Dollar in September 2019 the Yuan rallied into January 2020 (wave 1). As the COVID-19 outbreak hit China the Yuan gave up most of its wave 1 gain before bottoming in May 2020 (wave 2). The Yuan then rallied strongly into February 2021 (wave 3) before pulling back (wave 4). Wave 5 is either complete or will be with one more modest rally. Last week the Chinese government took steps to weaken the Yuan against the Dollar so the strength of the Yuan has become a problem. This suggests the Chinese government will do whatever it takes to weaken the Yuan. If the Yuan does correct, it will likely have knock on effects on other emerging market currencies.
Dollar
The Dollar is the inverse to the Yuan and is nearing the end of a 5 wave decline that began in March 2020. The expectation is that the Dollar will fall below its January 4 low of 89.21 to complete wave 5. The big news is that the coming low may be the end of the correction that began after the Dollar peaked in January 2017 at 103.82. Wave A of the correction lasted from January 2017 until the Dollar bottomed at 88.25 in February 2018. Wave B of the correction carried the Dollar up to its high in March 2020, with Wave C now near completion. The price pattern suggests the Dollar has the potential to rally above 100.00 in the next 12 months.
Gold
After topping at $2070 in August 2020, Gold declined to a low of $1678 on March 8. Since then Gold has completed Wave 1 through 3 with last week’s low of $1861 representing wave 4. Gold is expected to rally above $1915 at a minimum and could possibly test the January 2021 high of $1958. Wave 5 would equal wave 1 at $1938.
Silver
After topping in August last year Silver chopped sideways until hitting a higher low in late March. Like Gold Silver has rallied and appears to have completed wave 4 last week. Silver is expected to rally above $28.61 and potnetially test the February 1 high of $29.79 as it completes wave 5 before a short term high is established.
The manner in which Gold and Silver correct after the upcoming high will reveal what to expect in the second half of this year. Gold can be expected to test or exceed its August 2020 high of $2070 and Silver could rally to $33.00 – $36.00, if inflation follows the expected course.
Gold Stocks
The Gold stock ETF GDX fell -33.0% after topping in August 2020 at $45.78. Since its low of $30.64 GDX has been rallying and needs another higher high (wave 5 black) to complete wave 3 (red). The coming correction would be wave 4 (red) and be followed by wave 5 which has the potential of testing the August 2020 high.
Instructions – From last week
- Sell the remaining half of the Gold ETF IAU at $36.60 and raise the stop to $35.62.
- Sell the remaining half of the Silver ETF (SLV) at $26.75 and raise the stop to $25.50.
- Sell the remaining half of the Gold Stock ETF GDX at $40.70 and keep the stop at $38.50.
These stops were trigger on June 3 when wave 4 proved deeper than expected. If you still have these positions, the sell instructions are worth considering. I still have these positions in my managed accounts and will sell if another rally develops, and then buy them back once the reset in the precious metals appears finished.
Stocks
After bottoming in March 2020 the S&P 500 has rallied with only shallow pullbacks along the way. The deepest correction occurred last September when the S&P 500 fell -9.8% in wave 2 (red). The red numbers reflect the major trend, the blue numbers convey the intermediate trend, and the back numbers reflect the short term trend. The expectation has been that the S&P 500 would rally above the May 7 high at 4238 to complete wave 5. This would also complete 5 waves since the September low (blue), and wave 3 from March 2020 (red). The wave 5 short term rally in black could reach 4294 – 4315 in the next two weeks.
If the S&P 500 tops at 4300 and experiences a -9.8% drop for wave 4, the S&P 500 would fall to 3879. The coming wave 4 correction (red not shown) has the potential to bring the S&P 500 down the March 4 low of 3723, which would be a drop of -13.0%.
The Mega Cap stocks were weak when Treasury yields rose during February and March. The weakness in these stocks was offset by strength in cyclical stocks, which helped limit the drop in the S&P 500 to -5.7%. If Treasury yields climb as expected, the cyclical stocks are likely to correct, rather than rallying as they did in February and March. With Mega Cap and cyclical stocks more vulnerable it’s easy to see how the S&P 500 might correct by more than -9.8%.
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 and could rally to 4294 – 4315 before wave 5 of wave 3 is complete.
The preponderance of markets that are sporting a similar pattern is unusual and the potential synergy in so many markets is amazing. What adds credibility to the patterns is the fundamental back drop, with the perception taking hold that monetary policy is going to become less friendly as inflation proves less than transitory.
This has the potential of providing a rude wake up call for investors who seem ridiculously complacent. The S&P 500 is expected to decline to 3850 and could drop to 3725 in the third quarter.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
Caption photo credit: Clip from Green and black umbrella on stair case, Piqsels. Full picture:
.
include(“/home/aleta/public_html/files/ad_openx.htm”); ?>
