Written by Jim Welsh
Macro Tides Weekly Technical Review 26 July 2021
Delta, the Labor Market, and a Small Step Toward Tapering
The FOMC meets on July 27 and July 28 and will release the FOMC statement at 2pm E.S.T. on July 28, which will be followed by Jay Powell’s press conference. The FOMC statement and Powell’s remarks will emphasize three points. The Delta variant poses a threat to the economic recovery and increases the risk that the recovery could falter. This narrative plays into the Dove’s hands who want to maintain the current level of accommodation as long as possible. The voting district presidents in 2021 give the Doves a plurality of 7 votes to 4.
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The FOMC will reiterate its commitment to observing real improvement in the labor market based on actual data rather than FOMC projections. The headwinds of parents remaining home until schools reopen in September and employment benefits ending on September 4 for 70% of those unemployed means a clear understanding of labor market strength won’t be possible until early October when the September jobs report is released on October 8.
The FOMC seems resolute in its commitment of waiting for much stronger job growth and a far lower unemployment rate. The FOMC believes a tighter labor will benefit low wage workers and won’t materially lift inflation. Although the jury is out on this point, the FOMC is willing to take that risk and believes it has the tools to deal with higher than expected wage inflation. The FOMC certainly has the tools. Whether a consensus will ever develop to actually shrink its balance sheet and increase the federal funds rate is yet to be determined.
The FOMC believes its Forward Guidance is a powerful tool in shaping inflation expectations and managing financial market risks. The FOMC wants to avoid a sequel to the May 2013 Taper Tantrum and believes that can be achieved if the FOMC does a good job of communicating.
There is some date in the future that the FOMC will announce its schedule for tapering its $80 billion in Treasury bonds and $40 billion in Mortgage Backed Securities (MBS) it buys every month. In order to avoid waves in the financial markets the FOMC will make a number of small incremental steps towards the day of the Tapering announcement. This will allow the financial markets to gradually adjust to the coming reality and minimize the reaction when the announcement is made.
This approach suggests the FOMC will use every opportunity to nudge forward the awareness that tapering is coming. The FOMC statement and Powell’s press conference is just such an opportunity. My guess is that Powell will acknowledge that the FOMC is now discussing tapering, whereas a few months ago Powell said the FOMC wasn’t even talking about talking about any changes to monetary policy. He will emphasize that no time table has been set. The FOMC will continue to evaluate policy as additional data becomes available.
Financial markets may respond negatively to any nudge since most investors continue to embrace the inflation will be transitory narrative. If the Delta variant proves to be less of a drag on the economy than feared (my expectation), the outlook for the economy would be subsequently upgraded and put more upward pressure on Treasury yields going into year end. We won’t know if the Delta variant will fizzle out for another 3 to 5 weeks. In the short term, some states are requiring government workers become vaccinated. It wouldn’t come as a surprise if the mask guidelines from the CDC are changed in the next few weeks i.e. even vaccinated people should wear masks indoors. Cases have jumped significantly but hospitalizations and deaths are still down by more than 80% from the high in January.
The media is using the percentage increase in cases 175.7% to spur (scare) more people to get vaccinated, but rarely if ever highlight that the number of deaths has barely increased. To be clear, I strongly favor people getting vaccinated but heavy handed coercion is unwarranted.
The United Kingdom has been a few weeks ahead of the U.S. throughout the Pandemic. England’s cases peaked last week at 48,161 compared to the high of 60,000 last January. The number of people in the hospital last week was 5,001 just 12.7% of the 39,254 who were hospitalized in January, even though cases are 80% of January’s peak. In January the 7-day average of deaths was 1,200 but only 64 last week have passed in the last 7 days 94% lower.
On July 25 the number of new reported cases of COVID in England fell to 29,173, which suggests the worst is over. If the pattern holds cases should top out in the U.S. before the end of August. There are many reasons why inflation is likely to be more persistent than expected, even if headline and core inflation dip as discussed in the July 19 WTR. This topic will be discussed in more detail in the August Macro Tides.
Stocks
In recent weeks the underlying strength of the market’s internals have been weakening, which was expected to result in a correction. The 4 day sharp drop for the S&P 500 from an all time high of 4392 on July 13 to a low of 4233 on July 19 was over as the buy the dippers rushed in, just as it appeared to be getting started.
Although the S&P 500 has quickly rebounded to a new high, the internal weakness within the market has not improved and in fact has become worse. The S&P 500 recorded a new high on July 26, but its RSI is decidedly lower than it was on July 2 and July 12. The S&P 500 closed at 4352 on July 2 and 4384 on July 12. A negative RSI divergence developed in mid February and in early May as the S&P 500 was marching to a new high and both negative divergences were followed by a decline.
The NYSE Advance – Decline Line has failed to make a new high along with the S&P 500 for the first time since the March 2020 low. This shows that, as impressive as the rebound from the low on July 19 has been, the majority of stocks on the NYSE haven’t participated. The number of stocks that have advanced minus declines in the last 21 days hasn’t been good enough to lift the 21 Day Net Advances minus Declines above 0. In healthy markets this Oscillator would be near +400 (red horizontal line second chart below).
This kind of technical weakness at a new all time high is unprecedented. The number of stocks joining in the S&P 500’s new price high has been falling since peaking in early May (third chart below). The 5 day average (green) is also below the 21 day average which underscores just how narrow the recent rally has been.
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As weak as the breadth has been on the NYSE, it is far worse for the Nasdaq. The Nasdaq Advance – Decline Line is near the lows of the past 3 months as the Nasdaq 100 is reaching a new high. The 21 Day average of Advances minus Declines was -252 on July 26. In the months prior the A-D Oscillator was usually near the red horizontal line at +400. In February the 21 day average of Nasdaq stocks making a new high was 405, but on July 26 it was +10. More stocks made a new 52 week low on July 23 and July 26 as the Nasdaq posted a new high.
This is ugly.
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Trend line resistance for the S&P 500 is between 4430 and 4450 which is expected to contain the advance. The underlying weakness in the stock market suggests another selling wave is coming which likely bring the S&P 500 below last week’s low of 4233.
Aggressive traders can establish a 33% short position in the S&P 500 if it trades above 4430 and use 4475 as a stop. The inverse ETF SH is an easy way to go short without using leverage.
Treasury Yields
The low in Treasury yields was likely recorded on July 19 when the 10-year Treasury yield spiked down to 1.128% and the 30-year fell to 1.780%. After falling below the channel the 10-year and 30-year have climbed back into the channel. This is the first sign that yields have bottomed. The 10-year’s RSI (bottom panel) is close to breaking above the green trend line which would represent a breakout and further indication that the trend in yields has reversed. Additional confirmation will be provided when the 5 day MA (red) crosses above the 13 day MA (green) and the 10-year yield closes above 1.45% and the 30-year yield closes above 2.05%.
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In recent weeks traders established a 100% position in the inverse Treasury bond ETF (TBF) at an average price of $16.68. TBF is expected to rally above $18.49, if Treasury yields exceed their March peaks
Dollar
As the Dollar pushed higher in the last two weeks, its RSI reached progressively lower highs. This is usually a warning sign of a coming pullback. The Dollar fell on July 26 and is expected to drop to 91.50 and possibly lower in the next few weeks. Once this pull back is complete the Dollar is expected to rally above its July high of 93.19.
Gold
The modest decline in the Dollar should provide Gold a lift. The nearby chart inverts the Dollar’s value so it is easier to see the inverse movements (look at the Dollar’s chart if you start to get dizzy). Since last December Gold and the Dollar have had a remarkably tight inverse relationship. As the Dollar rallied from a low in December, Gold fell until the Dollar topped in late March. Gold rallied into late May as the Dollar was recording what has been expected to be a significant low.
Since the end of June Gold has held up even as the Dollar kept pushing to higher highs. The improvement in Gold’s relative strength to the Dollar suggests any decline in the Dollar should remove a weight from Gold and allow it to rally. As noted in prior WTR’s the seasonal pattern for Gold is normally positive in August and another reason why Gold has a good chance to rally in the next 4 to 6 weeks.
After bottoming on June 29, Gold rallied from $1752 to $1832 before pulling back to $1793 last week and holding above $1780. An equal rally would target a rally to $1873 which is expected (1860 – 1880). Whether Dollar weakness and favorable seasonality will propel Gold above the serious resistance at $1920 remains to be seen.
Traders are long the Gold ETF (IAU) at $34.125 and should use a stop of $33.85.
Silver
The recent decline in Silver suggests wave 5 of the triangle extended with wave c of wave 5 completing on Jluy 21 rather than a few weeks ago. As noted last week Silver needed to hold above $24.71 and the low last week was $24.79. Since last September Silver has made 4 higher lows and held the trend connecting them. This is good but Silver needs to get going. Once the Dollar rolls over, Gold should get a lift which is expected to help Silver potentially rally above last August’s high of $29.75. The metals have been a disappoinment given the inflation news.
Traders are long the Silver ETF SLV at $24.515 and use a close below $22.70 as a stop
Gold Stocks
GDX has been underperforming Gold since mid May (upper panel GDX chart). However, the downtrend in relative strength as shown by the blue trend is on the verge of being broken to the upside which would begin to show that GDX’s relative strength is improving. As GDX was falling its RSI registered a positive divergence which suggests selling pressure was lessening despite the lower lows. In the short term GDX needs get above $33.85 and then $35.20 to confirm that a low is in place.
Gold stocks have been reacting to weakness in the equity market more than the strength in Gold. This has to change if stocks experienced another sinking spell.
Traders are long GDX at $34.93 and should use a stop of $32.00. If Gold rallies as expected GDX should rally at least to $36.73 to close the gap from July 16 and potentially test the blue trend line near $37.40.
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 strength in the S&P 500 has been concentrated in the Mega Cap stocks that comprise 25% of the S&P 500. The ‘buy the dip’ mentality isn’t going to disappear anytime soon, and the rotation between cyclical stocks and Mega Cap stocks was expected to support the S&P 500 in the short term. However, the broad market continues to display more underlying weakness which is expected to lead to another decline that takes the S&P 500 below 4233 and possibly near to 4165. If the S&P 500 closes under 4150 then a decline to 4000 becomes possible.
The S&P 500 could drop to 3800 in the fourth quarter as investors lose faith that inflation will be transitory and if Treasury yields rise to 1.90% or higher. The increase in Treasury yields would likely cause Mega Cap and cyclical stocks to fall together, although cyclical stocks are expected to show better relative strength.
The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.
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