Written by Jim Welsh
Macro Tides Weekly Technical Review 12 July 2021
Manufacturing and Services are Hesitant
The ISM Services PMI released on Tuesday July 6 declined from a record high of 64.0 in May to 60.1 in June and far weaker than forecast. This immediately raised alarm bells about how fast the economy was slowing. Concerns about the Delta variant also raised concerns that the economy might have to endure measures to slow the spread of this new highly contagious variant. Treasury yields plunged by more than 16 basis points from their July 2 close and the intraday low on July 8.
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Combined the ISM Service data, Delta variant, and drop in Treasury yields generated ‘talk’ that the Treasury market was ‘sniffing out’ a weaker than expected economy in coming months. The phrase ‘sniffing out’ implies that the bond market has super canine olfactory qualities. Strategists also like to say the bond market is better at forecasting the economy than the stock market, so investors need to listen when the bond market is sending a message or an odor that can be sniffed.
Overlooked were the subcomponents of the ISM Service PMI. The employment sub-index fell from 55.3 to 49.3 suggesting than employers are planning to hire fewer workers in coming months. Normally, that’s how this sub-index performs, but these are not normal times.
Employers cite hiring qualified workers as the biggest challenge. To dispel any doubt about tightness in the labor market, the Job Openings and Labor Turnover survey (JOLTs) showed that job openings rose to a record of 9.2 million. The largest contributor to the decline in the Services index was the drop in the Employment sub-index which in the real world is because firms can’t find enough workers no matter how hard they try.
The Delta variant is now in all 50 states, accounts for more than half of new cases according to the CDC, and early research suggests it spreads 225% faster than the original COVID-19 virus. The good news is that research from Public Health England (PHE) recently showed that the Pfizer-BioNTech vaccine was 88% effective against symptomatic infection from the Delta variant after the second shot. The Pfizer-BioNTech vaccine was 94% effective after the first shot and 96% effective after the second shot in preventing hospitalizations from Delta. Since the Moderna vaccine uses the same technology, it is presumed to have the efficacy as the Pfizer-BioNTech vaccine.
More than half (55.4%) of the U.S. population has received at least one shot and 47.9% have been fully vaccinated. Of the most vulnerable in the U.S. more than 88% of adults older than 65 have received at least one dose with 79% having had one shot. There have been 33.7 million reported Covid-19 cases to the CDC. This data doesn’t capture asymptomatic cases which have been estimated to represent 30% of symptomatic reported cases. This suggests that in addition to the 183 million people who have received one shot there is another 44 million people who have gained natural immunity after contracting Covid-19.
News reports about the Delta variant have used data points to maximize fear by showing big percentage increases to encourage more people to become vaccinated. In early July the 7-day average of cases was 12,300 and on July 8 it had increased to 20,061. The increase since the low point is above 60% which certainly sounds alarming.
In early January the 7-day average was 278,000 so the number of cases is down 93% even after the recent surge. On February 4 the 7- day average of deaths was 5,145. Despite the increase in cases from the Delta variant, the number of deaths in the past 7 days is 257, or 95% less than the peak in January.
The number of Delta COVID-19 cases will continue to climb in coming weeks and potentially strain medical resources in some areas that have low vaccination rates. However, the level of immunity that has been achieved through vaccinations and natural immunity will prevent the U.S. economy from being derailed by the Delta variant. That may not be true in other countries that have low vaccination rates and lower medical resources.
The biggest challenge remains the increase in Core inflation that is expected to sow doubts about Powell’s transitory outlook for inflation. The Consumer Price Index (CPI) for June will be released on Tuesday July 13. The Consensus forecast is that headline inflation will be unchanged from May at 5.0% in June, and the Core CPI is expected to rise to 4.0% from 3.8% in May. The monthly increase is expected to drop to 0.4% in June from 0.7% in May, which might lead some people to assume the high in inflation pressures is past. Don’t think so.
Shelter comprises more than 40% of Core CPI inflation and will get a big boost if the moratorium on rent and mortgage payments is ended on July 31, after being extended from June 30 by President Biden. The coming increase in shelter inflation will continue to lift Core CPI for the next 6 to 9 months.
This is one reason Core CPI inflation is expected to hold above 3.0% through the end of 2021. The headline CPI is expected to fall in coming months as Base Effects are unwound. The expectation is that investor’s attention will shift to Core inflation and away from the headline number as Core inflation remains sticky. It is likely to take more than the June CPI to accomplish this, so stocks may rally if the June headline CPI dips from 5.0%, even if the Core rate climbs. Investors want to believe Powell will be correct and inflation will prove transitory, so they will continue to focus more on the data points that support that narrative rather than data that casts doubt.
The U.S. Savings Rate was 12.5% in May and 70% higher than the pre Pandemic average, and Credit Card balances are 10% below their pre Pandemic level.
As savings are drawn down, consumers will charge more, so consumer spending will remain healthy. Inventories are really low which means production must increase to restock depleted inventories. These factors will keep the economy motoring even as GDP growth slows in coming quarters.
The tightness in the labor market isn’t going to improve significantly until schools reopen and parents are able to work. Unemployment benefits will end on September 6 and encourage more than 4 million workers to rejoin the workforce. Wages are likely to increase in coming months as the labor market remains tight and employers scramble to get qualified workers. Many firms are resorting to offering signing bonuses of $500 or more to attract new employees.
Stocks
The rally in the Mega Cap stocks has continued for 7 straight weeks which has lifted the S&P 500 above the target range of 4294 – 4315 due to their 25% contribution to the S&P 500. The strength in the S&P 500 and Nasdaq 100 has masked the rotational correction that has occurred in many cyclical sectors. Basic Materials, Industrials, Financials, Midcap stocks, and the Russell 2000 topped in the first half of May and have trended lower, as investors interpreted the decline in Treasury yields as an indication of economic weakness. The net result is that the percentage of stocks above their 50 day moving average has fallen from 91% in early May to 54% last week.
The S&P has not experienced any meaningful correction but each modest pullback was preceded by a decline in the percent of stocks above their 50 day average to less than 60%.
Another sign of underlying weakness is the persistent decline in the percent of stocks making a new 52 high on the NYSE and the Nasdaq. The 21 day Highs – Lows percent average is the same as on April 5 when the S&P 500 was 7.5% lower. The Nasdaq 100 is up 11.6% from where its 21 day Highs – Lows percent average was on April 1.
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In contrast the Russell 2000 is up only 0.7% since April 5, the Value Line Composite is up 3.1%, and the DJ Transportation index is flat. The majority of stocks on the NYSE and Nasdaq are badly lagging behind the Nasdaq 100 and the S&P 500. Since cyclical stocks have been correcting for 2 months after peaking in early May, it’s certainly possible that these sectors could get a second wind. The underlying technical weakness suggests it is more likely to be followed by a 7% to 10% decline. The difference is that it may begin from 4420 rather than 4315.
The reversal in Treasury yields last week suggests the Mega Cap stocks could top soon if Treasury yields follow through and increase more in coming weeks. The correlation between the QQQ’s (Nasdaq 100 ETF) and the Treasury bond ETF (TLT) is the highest since at least 2005.
If Core inflation surprises investors and holds above 3.0% for the balance of 2021, Treasury yields will jump and the QQQ will fall.
Treasury Yields
As noted in last week’s WTR:
“The 30-year Treasury bond futures could approach the June 21 overnight high 163.06 before the rebound from the March high in yields is complete. The 30- year yield could dip to 1.95%.”
On July 8 the 30-year Treasury yield recorded an intra-day low of 1.878% before closing at 1.91%, and 1.993% on July 12. The quick reversal suggests that the spike lower in yields was due in part to short covering by traders who were short Treasury bonds in anticipation of higher yields.
Now that buying and support has been used up, so yields can move up more quickly, if investors question Powell’s assessment of inflation. This seems like a layup after reviewing the broad list of inflation inputs. Grocery stores have been maintaining inventory that is 15% to 20% above normal since they expect more price hikes. I don’t remember this happening in the last 20 years or more.
The spike lower in the 10-year Treasury yield tagged a trend line that has identified the trend since the top in March. The low in the 10-year Treasury yield would be confirmed if the 10-year yield climbs above the rising trend line near 1.45%. It closed at 1.363% on July 12.
In the June 14 WTR I recommended taking a 50% position in the 1 to 1 inverse Treasury bond ETF (TBF) at $16.82. TBF traded down to $16.8197 on June 17. Last week traders were advised to increase the position to 100% if TBF trades down to $16.54, which it did on July 8. If Treasury yield exceed their March highs, TBF is expected to move above $18.50 before the end of 2021.
Dollar
The Dollar was expected to make significant low and it has provided additional confirmation of having done so. After bottoming at 89.54 on May 25, the Dollar rallied in 5 waves to its recent high of 92.84 on July 7. A 5 wave rally should be followed by a pullback to 91.50 or just above 91.00, before a stronger rally begins.
Gold
Gold held important support near $1750 and has rallied. Gold should get a boost if the Dollar pulls back as expected, and needs to show more upside energy. Gold dropped from $1915.40 on June 1 to a low of $1752.20 on June 29. In the near term Gold needs to get above last week’s high at $1817.50 and ideally above $1854 which is the 61.8% retracement of the recent decline.
Gold will enter a period of seasonal strength in August and September which could deliver more gains in those months. The 5 wave drop from the June 1 high is a concern which would be neutralized if Gold was able to exceed the June 1 high of $1915.40. The next few weeks could provide important clues as to expectations for the balance of this year.
Silver
The price pattern in Silver is differnet than Gold and has traced out looks like a 5 legged triangle, which usually appears right before a thrust higher. If this pattern analysis is correct, Silver will rally above the August 2020 high at $29.75 and could stretch up to $32.00.
Gold Stocks
The relative strength of the Gold Stock ETF (GDX) continued to improve after bottoming in March. The uptrend in relative strength was broken on June 3 after GDX traded down $38.00, and it has continued to weaken. GDX has the potential to dip under the recent low of $33.30 before the next rally commences. Irrespective of near term moves, GDX’s relative strength to Gold needs to improve and break above the down trend line. GDX is expected to close the gap at $36.73 and potentially test the blue trend line near $37.40. Ideally GDX’s relative strength will break above the downtrend line during the next rally.
In the June 22 WTR traders were advised to take a 50% position in IAU, SLV, and GDX on the opening on June 23. IAU opened at $33.96, SLV $24.38, and GDX opened at $35.01.
Last week traders were advised to increase the positions to 100% on July 6 by buying IAU below $34.30, SLV under $24.92, and GDX at $34.95 or less. GDX was purchased at $34.85, IAU at $34.29, and SLV at $24.65. The average price for each is GDX $34.93, IAU $34.125, SLV $24.515.
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.
Although the S&P 500 exceeded the target of 4315, the underlying weakness in the overall market suggests the S&P 500 is nearing a top. Once the high is confirmed the S&P 500 is expected to fall 7% to 10%. Since the S&P 500 ha traded higher than expected the downside targets may not be reached. We simply have to play it as it develops. The S&P 500 is expected to decline to at least 4000 and could drop to 3725 in the third quarter if Treasury yields spike higher to 1.90% or higher as expected.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
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