Written by Jim Welsh
Macro Tides Weekly Technical Review 14 June 2021
As noted previously markets want to believe that Jay Powell will be right and that the surge in inflation will prove transitory. The market’s reaction to the higher than expected Consumer Price Index (CPI) indicates that markets now do believe that this bout of inflation will be fade quickly.
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The headline CPI for May was up 5.0% from a year ago and up from 4.5% in April, while the Core CPI jumped from 3.0% in April to 3.8% and miles above the Fed’s 2.0% target. When the April CPI was released on May 12 and exceeded estimates, the 10-year Treasury yield jumped from 1.617% to 1.695% and the S&P 500 dropped to 4061 on the opening from the close of 4128 on May 11.
The decline in Treasury yields since the peak in March and in the face of scary CPI’s has confused most investors. On CNBC today one Macro Strategist called the decline in yields ‘befuddling’. This is another example of why incorporating technical analysis, positioning, and sentiment can help identify counter trend moves as discussed in the April 5 Weekly Technical Review:
“After Treasury bonds experienced the largest decline in a single quarter, sentiment is even more negative according to the weekly survey by Consensus. In the last decade sentiment has only become this negative on four other occasions. This suggests that Treasury bond yields could fall for a period before the rising trend reasserts itself. 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%). This type of inter market divergence often occurs near trend reversals, even if it is short term in nature. In this instance the 10-year could fall to 1.50% as the 30-year drops to 2.25% at a minimum. TLT has the potential to rally to $143.00. Once this decline in yields runs its course, Treasury yields are expected to rise to higher highs in the second half of 2021.”
The chart is from the April 5 WTR.
When the 10-year Treasury yield spiked up to 1.765% on March 30, most analysts were forecasting that 2.0% was coming soon and repeated that forecast after the April CPI was announced on May 12. The Treasury market was ‘telling’ them inflation was likely to be a problem, since markets discount the future. The inter market divergence noted in the April 5 WTR was not on their radar but proved prescient as yields have continued to fall as expected. In the June 2 WTR the expectation was that Treasury yields would at least retest the lows on May 7 after the big miss on job growth (only 266,000 new jobs versus the 1 million forecast) for April.
“Treasury yields are expected to drift lower and could test their May 7 lows of 1.47% for the 10-year and 2.16% on the 30-year.”
After the may CPI was announced last Thursday the 10- year Treasury fell to 1.450% and the 30-year yield dipped to 2.141%.
After the Treasury market befuddled investors even more when the CPI was announced last week, some analysts have changed their tune about the direction of Treasury yields. Since Treasury yields didn’t go up on June 10 as they did on May 12, I heard analysts say that the decline in Treasury yields was ‘telling’ them that the bond market agrees with Chair Powell. So for them the inflation problem is already behind us.
The construct that markets correctly discount the future is one of the most widely embraced Axioms on Wall Street and is taken as Gospel. If markets do discount the future why then are they so often completely wrong at major tops and bottoms:
- In 1981 was the bond market telling us that Weirmar Republic inflation was right around the corner after 10-year Treasury yields rose to more than 15%?
- When Gold leapt to more than $1,900 an ounce in September 2011, was it forecasting that the increase in the Federal Reserve’s balance sheet was about to cause hyperinflation as the Gold market suggested?
- When the Dow Jones Industrials and S&P 500 were making new all-time highs in October 2007, was the stock market flashing an all clear sign about housing and the economy?
- In March 2009 as equities were plunging the depths of a bottomless pit, was the stock market discounting Armageddon and the end of civilization as we knew it?
The beauty in believing markets discount the future is believers always have an answer.
The FOMC meets tomorrow and Wednesday and will announce that it is not changing the federal funds rate or lowering its $120 billion in monthly QE. When Chair Powell holds his press conference, he will be asked if the FOMC discussed tapering. Powell will acknowledge that tapering was discussed but the majority of members think it is too soon to make any changes until the labor market improves further.
The FOMC will publish their forecast for real GDP, Unemployment rate, and Core PCE inflation after the June 16 meeting. Market participants will focus on the forecasts to see how much these estimates change from the March 2021 forecasts. +
When Chair Powell is asked what the FOMC will do if inflation appears not to be transitory, Powell will reiterate the FOMC’s expectation that the surge in inflation will be short lived. He will note that the FOMC’s forecast for Core PCE inflation in 2021 and 2022 calls for inflation to fall back to near 2.0% as Base Effects dissolve and supply chains issues are resolved.
Powell will be asked what the FOMC will do if the transitory forecast is wrong. Even though Powell sees that as unlikely, he will reassure everyone that the FOMC has the tools to manage that too. Powell won’t mention though that the tools the FOMC would use are tapering, rate hikes, and yield curve control. Hopefully the Fed’s tools are as effective as those used by the Ghostbusters.
The FOMC wants to avoid a second Taper Tantrum and will continue to use their forward guidance. In coming weeks expect to hear more Federal Reserve District presidents and a few FOMC members openly discuss tapering so financial markets get used to it and become progressively numb. The FOMC hopes this strategy will minimize the reaction by the markets when the FOMC announces the time table for tapering.
My guess remains that the actual tapering won’t begin until late this year or in January 2022, and will gradually progress over the following 12 months. Financial markets are not likely to suffer much pain from tapering. The real risk is that financial markets will begin to ‘discount’ the potential of the FOMC having to move more aggressively in 2022 after Core inflation holds above 3.0% in coming months.
The March 2021 Dot Plot showed that 3 members of the FOMC expected one increase in the federal funds rate in 2022 with 1 in favor of 2 hikes. If the June 2021 Dot Plot shows that 6 or 7 members are projecting an increase in the funds rate in 2022, it also means that 11 or 12 members favor no increase. The doves are likely to hold sway as the FOMC waits for data on inflation and more importantly on additional improvement in the labor market.
If financial markets discount the Fed raising the federal funds rate sooner in 2022 and more increases, a period of risk off will ensue and create a buying opportunity. Investors will eventually realize that the FOMC is not likely to increase the federal funds rate for many months and will remain patient, even if the Core PCE holds above 3.0% in coming months.
The economy is going to downshift in 2022 but growth should be decent and earnings will continue to grow. In effect the markets will discount an outcome that is unlikely to occur. As noted last week:
“Complacency is the dominant feature of the financial markets currently. By the time the coming reset is nearing an end, complacency will have been replaced by concern.”
If this proves correct the coming correction is only a correction and not the beginning of a bear market. The FOMC is not going to drive the bus over a cliff.
The FOMC message on June 16 is likely to be dovish, which Chair Powell will reinforce during his press conference. If correct, stocks, gold, silver, gold stocks, and Treasury bond prices are likely to rally, but the Dollar is expected to drop below the January low of 89.21 before a bottom is in place.
Dollar
The Dollar has been in a correction after topping in January 2017, which has resulted in a big increase in negative sentiment and the size of positions that are long other currencies and effectively short the Dollar (red). The current positioning is similar to late 2017 and the first quarter of 2018 when the consensus was looking for the Dollar to continue to decline (Dashed line is the broad Dollar Index).
In September 2017 the cash Dollar Index fell to 91.01 just as positioning against the Dollar reached an extreme. The Dollar rallied to 95.14 in November 2017, before slumping to 88.25 in February 2018. The decline from the peak in January 2017 until the low in February 2018 was a clear 5 wave decline.
Since peaking in March 2020 the Dollar has completed 4 waves of what should be a 5 wave decline. Visually you can see how similar the decline after the January 2017 high and March 2020 peak are. The Dollar is expected to fall below the January 4, 2021 low of 89.21(wave 3) before wave 5 from the March 2020 peak is complete. The Dollar could drop by 1.3% if Powell & Co. is dovish.
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 to at least 95.00 and potentially above 100.00 in the next 12 months.
Stocks
If Treasury yields declined as expected, the Mega Cap stocks in the Nasdaq 100 (QQQ) were expected to lift QQQ to a new high. The QQQ rallied to a new high on June 14.
Despite the new price high the percentage of Nasdaq stocks making a new 52 week high is far below the levels of February. This indicates that the current rally has less participation which is not positive and suggests there is more under the surface weakness lurking. The red trend line is about 1% above the June 14 close. A top may be signaled if the Nasdaq 100 (QQQ) pops above the red trend line and subsequently falls below it.
The S&P 500 has rallied to a new high so it has fulfilled the minimum expectation. As noted in the June 7 WTR:
“The wave 5 short term rally in black could reach 4294 – 4315 in the next two weeks.”
Once the current rally runs out of steam and wave 5 is complete, the S&P 500 will have also completed 5 waves since the September low (blue), and wave 3 from March 2020 (red). If correct, the S&P 500 will be vulnerable to a 7% to 10% correction that could approximate the 9.8% correction after wave 1 (red) topped in September. This correction would be wave 4 (red) and be followed by another rally to a higher high, as long as the S&P 500 holds above 3750.
Gold
Gold appears to have completed wave 4 off the March 8 low of $1677.60. As long as Gold holds above today’s low of $1845.40, Gold is expected to rally above $1915.40. Wave 5 would equal wave 1 at $1938, but Gold could test the January 2021 high of $1958.
Silver
Gold fell below to its June 3 low of $1861.20 on June 14 when it traded down to $1845.40. On June 14 Silver traded down to $27.50 and well above its June 3 low of $27.12.
Silver’s failure to drop to a lower low represents a positive inter market divergence and supports the view that Gold and Silver are poised to rally above recent highs in the next few weeks as the charts suggest. Silver should rally above $28.80 and could test $30.00, and could potentially reach $32.00.
If Gold and Silver rally to new highs, the completion of the 5 wave rally will lead to a correction. 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 Stocks
Since its low of $30.64 GDX on March 3, GDX has rallied and needs another higher high (wave 5 black) to complete wave 3 (red). GDX is expected to rally above the May 19 high of $40.13.
If things get a little crazy, which is always possible with Gold stocks, GDX could make a run at $41.18. Once GDX moves above $40.13 it will have completed 5 waves up and will be vulnerable to an 8% to 10% correction for wave 4. If wave 4 holds near $37.40, GDX is expected to rally to $43.00 and potentially test the August 2020 high of $45.78.
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 triggered 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 as expected, and then buy them back once the reset in the precious metals appears finished.
Treasury Yields
In July 2012 the 10-year Treasury yield dropped to a low of 1.394% and fell to 1.336% in July 2016. These lows represent support and it will take a lot to drive the 10-year Treasury yield below them. As the 10-year yield began to rise off a low of 0.64% on September 30, a nice trend line was formed. That trend line comes in near 1.36% which is another level of support. I don’t expect the 10-year Treasury yield to fall below 1.30%.
The trend line for the 30-year Treasury yield comes in near 2.06%. The low in July 2016 for the 30-year Treasury yield was 2.102%. Investors can take a 50% position in the 1 to 1 inverse Treasury ETF (TBF) if the 30-year Treasury yield falls below 2.10%.
My guess is TBF could trade down to $16.82 if Treasury bonds rally after Chair Powell speaks on June 16. Treasury yields could rise if Powell is perceived as too dovish and the bond market enters the expected wave 5 push to higher yields. This is not likely but a turn in yields is coming and it’s not if but when it starts.
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 3950 and could drop to 3725 in the third quarter if Treasury yields spike higher.
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%.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
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