Written by Jim Welsh
Macro Tides Weekly Technical Review 22 June 2021
The June 7 Weekly Technical Review was entitled “A Period of Risk Off is Coming Soon” and the market’s reaction to the FOMC Dot Plot and Chair Powell’s press conference last week was the first indication that the Risk Off period is at hand.
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Powell said:
“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.”
In the days after the June 7 WTR and before the FOMC announcement on June 16, the S&P 500, Nasdaq 100 (QQQ), New York Composite Index, and the Value Line Composite Index hit new all time highs. A larger number of the major averages failed to make a new high including the DJ Industrials, DJ Transports, DJ Utilities, Russell 2000, Midcap Index, and Equal Weight S&P 500 (RSP).
When the majority of major market averages are in sync, whether they are trending up or down, the trend is confirmed. Turning points are often signaled when some averages make new highs or lows and other averages fail to confirm. The failure of so many averages to post a new high in the last few weeks is another sign that a trend change is developing, which is expected to lead to a 7% to 10% correction.
The FOMC didn’t do anything that was unexpected to me. However, frequently it isn’t the message that is important but how markets react to the information or data. It seemed likely that the number of FOMC members favoring a rate hike in 2022 would increase from 3 in the March Dot Plot to 6 or 7 in June:
“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.”
In fact 7 members are comfortable increasing the federal funds rate at least once next year. This change shouldn’t have come as a surprise and understanding that the majority of FOMC voters are not in favor of any rates hikes in 2022 was overlooked at least initially.
As noted previously markets want to believe that Jay Powell will be right and that the surge in inflation will prove transitory. I’ve heard a number of people using the plunge in Lumber prices as an example of Base Effects and proof that the surge in the CPI will fade away. Lumber prices fell from $1000 in September 2020 to $500 in October 2020, before soaring to $1711 in May. Since topping Lumber has dropped to $890 a drop of 48% in less than 6 weeks, which is why Lumber is being used as the poster child by those attributing the surge in inflation to Base Effects.
What is being overlooked is that Lumber is still up 137% from a year ago when Lumber traded at $375 and up 112% from January 2020. As long as Lumber holds above the rising trend line, Lumber is still in an uptrend. What has occurred in Lumber is being repeated in many other commodities that have declined meaningfully from their 2021 peak but remain well above pre-Pandemic levels from two years ago. Companies will be pressured to raise prices unless costs fall to near their pre Pandemic levels.
Confirmation bias is the tendency to interpret new evidence as confirmation of one’s existing beliefs or theories. Those who want to believe Jay Powell and the FOMC will be right about inflation will focus on any data point that supports the inflation will be transitory thesis. Headline inflation likely peaked in May and will drop in coming months as the year-over-year price changes moderate in July and beyond.
Core inflation is expected to hold well above 3.0% in coming months, which could prove an inconvenient truth for the Inflation will be transitory narrative and lead financial markets to throw a tantrum. The stubbornness of core inflation will come as a surprise to those who are only looking at data that confirms their view.
Markets
In the June 7 WTR I discussed how price patterns can help identify when a correction to the preceding trend was likely to develop:
“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.”
I’m going to revisit the markets that appeared to be nearing a turning point and note what has occurred since June 7.
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 (GSG) appears to have reversed after finishing wave 5.
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 5 effects on other emerging market currencies.”
The Yuan hit its high on May 30 and has been trending lower, so Wave 5 appears complete.
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.”
The Dollar traded down to 89.54 so it didn’t fall below 89.21 as expected. The Dollar was expected to rally as currency traders were forced to cover their Dollar short positions and the shift toward a less accommodative monetary policy changed sentiment toward the Dollar. The rally on the FOMC news lowers the odds the Dollar will fall below 89.21.
The Dollar tagged the declining trend line and its RSI pushed above 70 so in the short term a pullback is likely. The low in the Dollar will be confirmed once the Dollar closes above the down trend line.
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.” The following is from the June 14 WTR. “Gold 6 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.”
Gold failed to rally above $1915 as expected and fell below $1845.40 in the minutes after the FOMC meeting. Gold’s failure to hold above $1840 diminishes the bullish outlook somewhat. After plunging to $1752, Gold’s RSI fell below 30 which should result in a rally as it did on November 30 and after the early March low. Gold’s seasonality is also supportive of a rally into August or September.
The initial target of a rally would be $1835 to $1850 and a test of $1915 if Gold closes above $1850.
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.”
Silver failed to rally above $28.61 and instead dropped to $25.58 on June 21. Although Silver’s RSI didn’t fall below 30.0 it is oversold when compared to prior trading lows in September, November, and March.
The favorable seasonality for Gold in August and September is expected to lift Silver as well. A rally back to $28.00 and potentially above $28.61 could occur in August or September.
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.”
This is from the June 14 WTR:
“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.”
GDX failed to rally above $40.13 and failed to hold $37.40, so this correction proved deeper than expected. GDX’s RSI fell below 30, which has consistently led to a rally, even when GDX was trending lower from $45.78 to $30.64.
GDX is expected to rally to $36.73 to close the gap created on June 17. If Gold’s seasonality performs as it has in the past, GDX can be expected to rally into August or September, and could test or exceed $40.13.
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%, and were stopped out on the second half at $35.62 for a slim profit of 1.07%. 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%, and were stopped on the second half at $25.50 for a gain of 9.7%.
Traders were recommended to take a 66% long position in GDX at an average price of $31.94. Traders were instructed to sell half at $38.27 for a gain of 19.8%, and the second half was stopped out at $38.50 for a gain of 20.5%.
Traders can take a 50% position in IAU, SLV, and GDX on the opening on June 23.
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 pullback last week was wave 4 from the May 12 low in the S&P 500. The S&P 500 retains the potential to rally to the wave 5 target range of 4294 – 4315.
The S&P 500 is approaching a new high due to the strength in Mega Cap stocks (QQQ) which are benefitting from the decline in Treasury yields. The Nasdaq 100 (QQQ) recorded a new high on June 22. A deeper correction is expected once Treasury yields bottom and reverse higher.
Treasury Yields
This is from the June 14 WTR:
“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%.”
Treasury yields popped after the FOMC news on June 16 but quickly reversed lower. In overnight trading on Sunday June 20, Treasury yields plunged with the 10-years testing 1.40% and the 30-year dropping below 2.00%. The reversal from the price highs and low yields on Sunday are likely the extent of the rally, but the levels reached on Sunday may be tested.
Last week I suggested that investors
“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.”
TBF traded down to $16.8197 on June 17 and $16.69 on June 18.
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.
As noted in the June 7 MTI,
“The preponderance of markets that are sporting a similar wave 5 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 MTI peaked on April 30 and has been trending lower, which is supportive of a correction in the third quarter.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
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