Sleep Walking

Macro Tides Weekly Technical Review 16 August 2021

Inflation and Delta

The first line in the July 19 WTR was “There is a good chance that inflation peaked in June.” This was a relatively easy call given the 12 month rate of change calculations (Base Effects) and the outsized contributions from a few categories in June 2021. In June new car prices were up 2.0% from May while used car prices soared 10.5%.

Please share this article – Go to very top of page, right hand side, for social media buttons.

As I noted at that time:

“These increases are unsustainable. The Mannheim Used Car Index Vehicle Index is still up 42% from two years ago, but is likely to moderate more in coming months.”

In July Used Car prices were up 0.20% versus 10.5% in June.

In coming months Used Car prices are going to fall and subtract from headline inflation. In July the Consumer Price Index (CPI) was up 5.4% at an annual rate and unchanged from June. As noted in the July 19 WTR:

“It is easy to see the headline CPI dropping to 4.0% to 4.5% from 5.4% in the next few months, and the Core CPI can be expected to fall to near 3.5% in coming months.”

The Core CPI rose 4.3% in July and down from 4.5% in June, so the gradual descent to below 4.0% has started.

Although the year-over-year change in the headline and Core CPI were small, the focus was on the sharp deceleration in month to month changes. The headline CPI was ‘only’ up 0.5% compared to a 0.9% increase in June. The Core CPI fell from an average of 0.8% during April, May, and June to 0.3% in July. These smaller changes in the monthly increases generated headlines proclaiming ‘Inflation has Peaked!‘ Investors assume that lower annual increases in inflation will delay tapering. This perception is very likely wrong.

In the past week a number of Federal Reserve District presidents have stated strongly that the FOMC should announce it is tapering its monthly purchases at the September meeting and start actual tapering in the fourth quarter. Raphael Bostic stated that the inflation goal had already been met and ‘substantial future progress’ on employment will be achieved in the next two months. Bostic said tapering should begin in the fourth quarter and he supported starting sooner. Bostic is a voting member in 2021.

Boston Fed President Rosengren said the Fed should announce the taper in September 22 meeting and begin to cut back on purchases this fall.

On August 11 Esther George, president of the Kansas City district, spoke at the National Association for Business Economics and said:

“Today’s tight economy … certainly does not call for a tight monetary policy, but it does signal that the time has come to dial back the settings. I support bringing asset purchases to an end.”

Dallas Fed President Robert Kaplan stated the economy would meet the criteria the FOMC has established for inflation and the labor market by the September meeting. Kaplan not only wants to start tapering in October but thinks the FOMC should reduce its purchases by $15 billion a month:

“You want to be gradual, but gradual for me means eight months, and I’m open-minded to faster than that. I think eight months would be giving the markets enough time to adjust.”

He justified cutting purchases by more than in the aftermath of the financial crisis by noting that a shortfall in demand “went on for years“, which isn’t the case now:

“There’s no issue about lack of demand. We don’t have a demand problem, so I don’t want to use the playbook from 2009 to 2013. This is a supply issue.”

There is clearly a vocal chorus advocating for the FOMC to announce tapering at the September meeting and to start tapering quickly, rather than waiting until January 2022.

Although Bostic is a voting member this year, Rosengren, George, and Kaplan are not. However, in an interview on CNBC on August 2, Federal Reserve Governor Christopher Waller said if the next employment report shows more than 800,000 new jobs were created in August, he would support tapering at the September meeting and starting in October:

“There’s no reason you’d want to go slow on the taper. We should go early and go fast, in order to make sure we’re in position to raise rates in 2022, if we have to.”

The Doves outnumber the Hawks 6 to 5, if Waller is included with the Hawks. (See graphic above.)

The August employment report will likely sway the vote if job growth is good. The Labor Department collects the data for the monthly employment report by the 12th of each month. Delta cases grew significantly after July 12 so the August employment report will indicate how much of a drag Delta was on hiring in August. If the number is good it would show that Delta had a minimal effect on hiring and would increase the odds of a decision at the November meeting.

The other determining factor will be whether the surge in the Delta variant tops in the next few weeks and provides reassurance to the FOMC that the economic threat from Delta is past. If the U.S. continues to follow the pattern in the U.K., cases in the U.S. should peak by the end of August since cases topped on July 20 in the U.K. For the first time in the current Delta surge, the infection rate peaked and began to fall in 40 states last week. If the infection rate continues to decline, hospitalizations can be expected to top within the next two weeks.

As expected the large increase in cases since mid July has led to changes in behavior. In late June the number of diners inside restaurants had reached levels last seen just before the Pandemic, according to data compiled by Open Table. Since mid July the number of people eating in restaurants has fallen by 10%.

Consumers were happy to get to get on a plane when Covid-19 was in retreat, and by June spending on air travel had exceeded the high in early 2020 just before the onset of the Pandemic. With Delta dominating the news, more people have decided to shelve flying for the time being, so spending on air travel is off by about 10% from the June levels. The Hotel occupancy rate has fallen from 72% to 68% in the last 3 weeks.

All the downbeat news hit Consumer Confidence hard in early August as the University of Michigan’s Sentiment Index fell from 81.2 in July to 70.2. This was the lowest level since July 2011 and the third largest one month drop in the last 43 years. This sharp drop is likely due in part to fatigue as most Americans thought Covid-19 was in the rear view mirror.

Unless Delta fades and economic data rebounds from its recent dip, the Doves on the FOMC will not agree to tapering purchases at the September 22 meeting.

Stocks

On Wednesday August 11 the S&P 500 closed at 4447.70 and closed at 4479.71 on August 16. As the S&P 500 and Nasdaq 100 have recorded a new high on each of the last 3 trading days, the NYSE Advance – Decline Line has dropped by a net of -1331 issues and -3611 issues on the Nasdaq, as declining stocks outnumbered advances. The NYSE A-D Line remains comfortably below its July 2 high. The Nasdaq A-D Line fell to its lowest level since the end of 2020.

The 5-day average of Advances minus Declines on the NYSE fell from +428 on August 11 to -252 on August 16, and to -924 from +64 on August 11, which was not strong either. It is extraordinary to witness the S&P 500 and the Nasdaq 100 (QQQ) grind higher almost daily with market breadth extremely weak. There is a degree of Sleep Walking going on as every dip is bought at increasingly shallow levels, irrespective of any and all news. There is a wake-up call coming and the reaction is likely to be abrupt as traders respond.

The 5-day (red) and 13 (green) day averages for the S&P 500 and Nasdaq 100 are still positive. The first indication that a top has been made will occur when the 5-day average falls below the 13-day average. From a price perspective the S&P 500 has not fallen below a prior low for months. On August 9 the S&P 500 dipped to 4424 and today’s low was 4437. A decline below 4424 will represent the first crack in the S&P 500’s chart.

Investors were prompted to establish a 33% short position when the S&P 500 climbed above 4430, which it did on August 10. The 1 to 1 inverse S&P ETF SH was recommended and was trading at $14.87. The stop at 4475 was triggered today when the S&P 500 traded above 4475 and SH was trading at $14.72 for a loss of -.34%.

Treasury Yields

Treasury yields rose after the CPI and Producer Price Index (PPI) were released on Wednesday and Thursday. The 10-year tagged the upper channel line on August 12 and then reversed after the Consumer Confidence report on August 13. The 10-year yield rose 0.25% from the low of 1.129% to 1.379%. The 61.8% retracement of the 0.25% increase would bring the 10-year down to 1.224% (0.25 * .618 = 15.5 basis points). The low on August 16 was 1.225% so the counter trend decline in the 10-year may have reached its target today.

The 30-year Treasury yield broke above the upper channel line on August 6 and despite the dip in yields since August 12 remains above the line. The 61.8% retracement of the 0.254% rise in the 30-year yield would target a drop to 1.877%. The low on August 16 was 1.887%. As long as the 30-year fails to fall below the upper channel line, the trend is for higher yields. Although not expected the Delta variant could reverse this trend if cases fail to top in the next two weeks and continue to climb.

In the short term failure to increase the Debt Ceiling will handcuff the Treasury and allow FOMC purchases to exceed issuance. The Fed has absorbed almost all of the T-bond supply for the past 3 months. This could limit any increase in yields until the Debt ceiling is raised.

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. Use a stop of $15.90 on half of the position.

Dollar

The Dollar rallied on the CPI and PPI reports and tested the prior high of 93.19 on August 11, and then fell sharply after the Consumer Confidence report on August 13. This weakness increases the odds that the Dollar could drop below the recent low at 91.78 before making a bottom. The Dollar will rip higher once it closes above 93.19. So a short term pullback followed by higher highs in coming months.

Gold

During overnight trading on August 9 Gold plunged from $1763 to $1693 in a matter of minutes. In Asian trading and before trading opened in Europe an order to sell 24,000 contracts slammed Gold. No experienced trader would intentionally hit the Gold market with such a large order when trading is far less liquid than during trading hours in Europe and especially the U.S. This raises the potential that this was a fat finger trade. (No not that finger.) Rather than selling 2400 contracts the fat finger added a zero so a normal trade became a market moving experience.

If this is true, Gold should be able to reclaim $1800 and hold above $1750. A close below $1750 would open the door to more weakness, possibly as low as $1522 as discussed last week.

“This suggests that Gold has the potential to rebound to $1770 -$1790 as it tests the area of the breakdown at $1790. My bias is to suggest selling a portion of the Gold position if it trades above $1775 for those who still hold IAU.”

The stop on IAU was triggered last week, but some subscribers are still holding Gold. If you want to give Gold the benefit of the doubt, use a 8 close below $1750 to lighten up. If you’re nervous, selling some now as Gold has traded above $1775 as was discussed last week. Cash Gold traded up to $1788.60 on August 16.

Silver

When Gold sold off in overnight trading on August 9, Silver was collateral damage. If correct Silver should be able to trade above $24.50 and then hold above $23.80.

Gold Stocks

GDX’s Relative Strength topped on August 3 and has been trending lower ever since. If the GDX closes below last week’s low of $31.90, more weakness is likely. Gold has rebounded nicely and as expected, but GDX continues to lag. It is important that Gold closes above $1800, and it’s just as important that GDX begins to trade much better than it has relative to Gold.

In 3 of the last 4 days the, the high for GDX was $32.90, $32.96, and $32.94 today. In the short term GDX must close above $33.00. The next hurdle is $33.70 and the most important level is $35.20.

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.

Some Cyclical sectors are edging closer to a breakout as they tested resistance last week before fading on Thursday and Friday. Discussion of the sectors is below.

The ongoing weakness in the A-D Line, contracting number of stocks making a new 52 week high, negative RSI divergences as the S&P 500 and Nasdaq 100 hit new highs, and sharply declining volume suggest the risk of a correction of 5% to 8% is high.

The 5-day average of NYSE volume on the NYSE has fallen from 924 million shares on July 30 to 723 million on August 16. Yes these are the dog days of summer but a 21.7% decline in volume as the S&P 500 is recording record closes is not a sign of strength. However, until something convinces investors that selling is a good idea the S&P 500 and QQQ can continue to grind higher.

Core inflation will not grab investor’s attention in the next few months. But if core inflation continues to hold well above 3.0% into the first quarter of 2022, there will be increased 10 discussion about whether the FOMC will be forced to increase the fed funds rate before the end of 2022. This will be the biggest hurdle facing the market in 2022.

Mega Cap versus Cyclical Sectors

Cyclical sectors are likely the key to the market in coming weeks as strength would offset the expected weakness in Mega Cap stocks and Technology sectors. Cyclical sectors have moved higher and some have exceeded short term resistance lines. Most have not pushed above the trend line connecting 2021 highs, so there isn’t a definitive breakout in place. This leaves open the potential of another pullback in cyclical sectors.

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 many technology sectors to the S&P 500 continues to weaken, which suggests the stage is being set for an outright decline. 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).

Cyclical Sectors

Some cyclical sectors have exceeded the upper channel trend line (usually blue) but are below their recent highs and under a black resistance trend line. If cyclical sectors are going to become leaders they must en masse breakout above resistance and hold above the blue resistance trend line. Banks as measured by Financials XLF, Regional Banks (KRE) broke out on August 6. 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.