Soaring Delta With Stronger Data

Written by Jim Welsh

Macro Tides Weekly Technical Review 09 August 2021

Markets Provide Clues

Markets have responded as Delta variant cases soared from 11,123 on June 20 to over 100,000 in the first week of August. Treasury yields fell to near their July 19 lows of 1.128% on the 10- year and 1.78% for the 30-year Treasury bond. Lower Treasury yields lifted the Mega Cap stocks enabling the Nasdaq 100 to hit new highs as cyclical stocks continued to falter.

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The Dollar backed away from its high of 93.19 on July 21, and Gold and Silver tested upside breakout levels. On August 4 ADP announced at 5:30 PST that jobs grew by a weak 330,000 in July and less than half the expectation of 680,000. On that news the 10-year Treasury yield dropped to 1.129% and the 30-year yield fell to 1.811%. The Nasdaq 100 futures rose while the Russell 2000 futures dipped. The Dollar pulled back to 91.82 and Gold jumped to $1830.09 up more than 1% from the prior close.

At 7:00 PST on August 4 the ISM Service PMI data was reported showing that the headline number reached a new record of 64.1. The percent of firms reporting higher Prices hit 82.1% and the Delivery Index was 72.0% indicating that supply chain issues are persisting.

Within minutes of the ISM report every major market reversed. The 10-year yield jumped to 1.215% from 1.129% and the 30-year Treasury yield rose to 1.879% before closing at 1.840%. Gold fell to $1806.90 as the Dollar rallied to 92.30. The reaction in the stock market was muted with the Nasdaq 100 up modestly while the S&P 500 and Russell finished lower, and on August 5 markets basically treaded water with little change.

On Friday August 6 the Labor Department reported that job growth accelerated in July with 943,000 new jobs, plus job growth for April and May were revised higher by 190,000. The Unemployment Rate dropped to 5.4% from 5.9% in June and much lower than the 5.7% forecast. Average Hourly Earnings (AHE) rose 4.0% from July 2020 even though more than one-third of the jobs created in July were Leisure and Hospitality. These jobs are normally lower paying jobs which in the past would have brought AHE down. The fact that a surge in Leisure and Hospitality jobs didn’t underscores that wage pressures are widespread.

In response to the stronger labor market data, the 10-year Treasury rose to an intra-day high of 1.300% and 1.946% for the 30-year Treasury bond. The Dollar popped to 92.84 and Gold fell below its support at $1790 and closed at $1763.20. Cyclical stocks strengthened modestly on August 5 and followed through to the upside after the employment report. The Russell 2000 gained 0.53% while the Nasdaq 100 lost -0.44%. Higher Treasury yields really lifted Financials (XLF) +2.02% and Regional Banks (KRE) +2.98%.

In response to the better than expected economic data, Treasury yields rose which gave the Dollar a nice boost as currency traders anticipate the FOMC will need to address tapering its bond purchases sooner rather than later. Gold, Silver, Gold Stocks were hammered by the prospect of higher rates as stop loss orders below recent lows were triggered. The reaction in Gold and Silver is interesting since the ISM Service report and Employment report suggest that inflation will remain higher for longer.

On July 29 the Commerce Department announced its first preliminary report for second quarter GDP (there will be two more, August 26 next), and estimated that GDP grew 6.5%. This was well short of the estimate of 8.4% and sparked concern that the economy might be slowing more than thought, which would allow the FOMC to postpone any taper decision.

The knee jerk reaction to the headline overlooked what contributed to the ‘big miss’. The government spent less in the second quarter than in the first which lowered Q2 GDP by -0.27%. It appears that Congress will soon be passing the $1 trillion infrastructure bill that will boost government spending in 2022 and beyond.

U.S. consumers bought more goods from overseas so net imports rose. Imports are deducted from GDP since it is designed to measure Domestic production. Stronger imports reflect strong demand which is hardly a negative reflection overall U.S. demand. Commerce lowered Q2 GDP to reflect higher imports by -0.44%.

When inventories are increased it adds to GDP, but in the second quarter inventories fell. Inventory liquidation subtracted -1.13 in Q2. This decline indicates that production levels in coming months will be increased to restock depleted inventories, and lead to better growth, not less in coming quarters. In total these 3 categories lowered Q2 GDP by -1.84% which accounts for most of the shortfall relative to forecasts.

The perception that GDP was softer than expected contributed to Treasury yields falling in early August and weakness in the Dollar. This is another example of investors looking for any headline that may allow the FOMC to postpone the inevitable decision on tapering.

The Consumer Price Index (CPI) for July will be released on Wednesday August 11 and the Producer Price Index on Thursday. Wall Street expects the monthly change to show a drop from 0.9% in June to 0.5% in July. If correct it will generate more talk that Powell is right, Inflation is transitory! Whether that over shadows the ISM and Employment message of strength remains to be seen. Soon strategists will cite the decline in Gold as the Gold market telling them inflation won’t be a problem. Of course in 2011 Gold zoomed to $1920 but inflation didn’t materialize. Don’t expect to hear that history mentioned now.

Treasury yields

As noted last week, technical confirmation of a low in Treasury yields was still missing:

“Technical evidence of a reversal higher in yields has yet to develop. The 10-years’ RSI has yet to breakout above the green trend line, and the red 5 day moving average is still below the 13 day average.”

The increase in Treasury yields on Friday after the Employment report and follow through today has satisfied what was anticipated. The 10-year’s RSI jumped above the green trend line on Friday and the red 5 day MA crossed above the 13 day MA today. A test of the upper channel line should happen soon. A close above that line is expected to lead to an acceleration in the 10-year Treasury yield.

The 30-year Treasury yield closed above the RSI trend line on Friday, the 5 day MA closed above the 13 day MA today, and today’s close was above the upper channel line.

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 as expected.

Dollar

The Dollar was expected to drop to 91.50 but the strength in response to the strong ISM Service data and solid Employment report calls that into question. As noted in recent weeks, the Dollar was expected to rally above the July high of 93.19 and above 95.00 in coming months, so the strength isn’t a total surprise. The Dollar’s momentum is strong and the Dollar is likely to exceed the March high of 93.43 soon. The CPI report could provide a boost if inflation doesn’t fall enough to outweigh the ISM and Employment reports.

Gold

The $1790 support level in Gold has been highlighted in recent WTR’s and last week:

“As long as Gold doesn’t close below $1790 it is expected to rally to $1860 – $1880.”

The decline in the last two days underscores one of the challenges in trading any ETF that is dependent of prices in the futures market. Gold traded under $1796 7 times in the 12 days after July 12, so traders put their stop losses around $1790. When Gold broke below this level after the jobs report, a lot of stop losses were triggered. Margin calls play a big role in futures trading as traders are forced to come in with more money immediately or face liquidation of positions. The prospect of margin calls on Monday August 9 was an overhang that likely contributed to a big decline in thin trading on Sunday night.

At the low Gold traded down to $1693.2, down $70 from the close on Friday after Gold lost $40 on Friday. When Gold traded under the June low of $1752 on Sunday night, even more stop loss orders hit an illiquid market. Although Gold closed down $34 on Monday at $1729, it was $35 off the intra-day low during Sunday night’s session.

The intense selling in Gold since the close on Thursday ($1811.60) was triggered by economic news but exacerbated by technical stop loss selling. There is a risk of reading too much into the decline but I don’t want to minimize it either.

Gold’s RSI fell to 24.47 today so Gold is clearly oversold. Each time Gold’s RSI dropped to 30 (November, March, June), Gold subsequently rallied – 10.7% after November low, 14.1% after March low, and 4.6% after the June low. This suggests that Gold has the potential to rebound to $1770 -$1790 as it tests the area of the breakdown at $1790.

In the worse case, Gold could approach the March double bottom at $1677 as additional margin selling occurs in the next few days. If Gold does test $1680, Gold can be expected to bounce off the support near $1680, given how oversold Gold already is.

From the high of $2070 in August 2020 Gold dropped $393 to $1677 the low in March. If the decline from August to March is the first part of a major correction, an equal $373 decline from the June high of $1915 would bring Gold down to $1522. This is why dismissing the sharp drop since Thursday could be a big mistake.

Although unlikely, it would be positive if Gold were able to close above $1750 quickly. My bias is to suggest selling a portion of the Gold position if it trades above $1775 for those who still hold IAU.

Traders were long the Gold ETF (IAU) at $34.125 and had a stop of $34.00. IAU opened at $33.75 on Friday and closed at $33.50 for a loss of -1.83%, rather than .37% based on the stop.

Silver

As noted last week:

“Silver needs to close above $25.76 and then $26.71 if it is going to test the August 2020 high of $29.75. Traders are long the Silver ETF SLV at $24.515 and use a close below $22.90 as a stop.”

On Friday SLV closed at $22.52 for a loss of -8.1%. SLV is more oversold than at any time since March 2020. Stop loss orders played a role in Silver’s decline but not as much as with Gold.

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Gold Stocks The $35.20 level on GDX has been discussed for weeks and last week too:

“A close above $35.20 should be followed by a move up to $36.73 to close the gap from July 16. Raise the stop to $33.50 from $32.90 if Gold closes above $35.20.”

GDX looked like a close above $35.20 was happening when GDX traded up to $35.82 on Wednesday after the weak ADP jobs estimate. GDX closed at $34.78 after the ISM report led to weakness in Gold. GDX traded down to $32.87 on Friday and closed at $33.24, but closed at $32.47 today for a loss of -7.0%.

GDX’s RSI may be providing a small positive, as it was 34.16 today and above the 27.4 on June 29 when GDX closed at $33.64. This positive is not clearly bullish since today’s RSI is below the 35.6 level on July 19 when GDX close at $33.19.

GDX is going to follow Gold and should rebound if Gold bounces to $1775 – $1790. The risk is if Gold does fall to $1522 GDX could drop under $28.00. GDX fell from $45.78 in August 2020 to $30.64 in March 2021. If GDX experiences an equal drop from $40.13, GDX could decline to $24.99.

Inflation was expected to exceed projections and it has. Gold was expected to benefit as traders responded to higher inflation. Chart analysis wasn’t able to manage risk as well as expected due to the swiftness of the decline in Gold and Silver in trading before the market opened on Friday morning and overnight trading on Sunday night. I expected the Dollar to bottom and rally but believed Gold would respond more to the inflation news than to Dollar strength.

Inflation is expected to persist longer and hold at a higher level than investors realize. Whether Gold, Silver, and Gold stocks will eventually catch fire is still possible. However, if selling was driven more by technical stop loss trading than fundamental selling, Gold still needs to prove itself.

Stocks

Last week traders were advised to

“Establish a 33% short position if the S&P 500 trades above 4430 or closes below 4360. If the S&P 500 rallies above 4430 first, and then closes below 4360, traders can increase the position in SH from 33% to 66%, using 4475 as a stop. The inverse ETF SH is an easy way to go short without using leverage.”

Weakness in the Advance – Decline Line and the number of stocks making a new 52 week high suggested the market was likely to top soon. Higher interest rates was expected to cause the Mega Cap stocks to decline and cyclical stocks weren’t expected to be able to offset the weakness in technology stocks. This is still the expectation.

But the strength in cyclical stocks after the strong ISM Service and Employment reports suggests another rotation out of technology and into cyclical stocks may develop. If this rotation develops, the Advance – Decline Line would improve since there are many more cyclical stocks than technology stocks. The number of stocks making a new all time high would increase. In other words, the technical reasons for expecting a correction would be reduced or eliminated if cyclical stocks take off.

Rather than covering the Advance – Decline and New Highs minus New Low charts, a review of technology and cyclical sectors will help monitor whether cyclical stocks are breaking out even as technology stocks pullback.

Technology Sectors

Most technology sectors have been making new highs but their RSI’s have been negatively diverging by recording lower highs. Negative RSI divergences are usually seen right before a correction. (Bottom panel under prices) The Relative Strength of most technology sectors to the S&P 500 has been trending sideways rather than making new highs as prices do. It won’t take much weakness to cause the Relative Strength to the S&P 500 to begin to decline (Upper panel above prices). The 5 day MA will cross below the 13 day MA on drops of 1.5% or less (red 5 day MA green 13 day MA on price charts).

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Cyclical Sectors

Most cyclical sectors are hovering below their recent highs and under a resistance trend line. If cyclical sectors are going to become leaders they must en masse breakout above resistance and hold above the resistance trend line. Banks as measured by Financials XLF, Regional Banks (KRE) broke out on Friday as Treasury yields confirmed the uptrend in rates after the employment report. The red 5 day MA should cross above the green 13 day MA and stay above it to show that the breakout is following through.

If the majority of cyclical sectors fail to breakout and reverse lower and Treasury yields continue climbing, a correction that engulfs most stocks should ensue.

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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 near term weakness in the A-D Line and the falling percent of stocks above their 200 day average from 92% in June to 68% last week, suggests the stock market could fall by 5% to 8% in the short term. However, if cyclical stocks breakout, breadth will improve which will negate some if not most of the weakness in the A-D Line and the percent of stocks below their 200 days average. Unless cyclical stocks start to run higher, the S&P 500 is expected to drop below the July 19 low of 4233 and potentially test the June 18 low of 4165.

The primary 10 sectors for the S&P 500 with the Russell 2000 and Midcap included.

Caption graphic photo credit: Image by Darby Browning from Pixabay.

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