Written by Jim Welsh

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Macro Tides Weekly Technical Review 25 March 2019

Over the last two weeks, we have discussed technical indications that weakness could be developing in equity markets. Those fears seem to be materializing.

As discussed last week there were a number of technical deficiencies as the S&P 500 was rising to a new recovery high:

“The S&P 500, the Nasdaq 100, and the DJ Utility average have ‘broken out’, but the Dow Jones Industrials, Transports, and Russell 2000 have failed to exceed their February 2019 highs. This has created a negative inter market divergence. This type of divergence is evidence of vulnerability and often appears before a modest pullback. In addition the 21 day average of Net Advances minus Declines for the NYSE and the Nasdaq are well below the levels reached in February. This indicates that fewer stocks are participating and another sign that the market has become more vulnerable to a pullback. The S&P 500 has exceeded its high in February but the Equal Weighted S&P 500 has not. The relative strength of the Equal Weighted S&P has weakened significantly, which is at least a short term negative for the market."

As discussed in the March 11 WTR there were technical indications that the S&P 500 was expected to surmount the heavy resistance zone between 2800 and 2816. As expected once the S&P 500 closed above such an obvious level of resistance, technicians would sound the all clear which would be a short term positive. This burst of approval allowed the S&P 500 to modestly and briefly exceed the price target range discussed in the March 11 WTR:

“The price target for wave 5 of wave c of Wave (B) is 2834 to 2847 (Horizontal blue lines)."

The S&P 500 spiked up to 2860 on March 21 before selling off sharply on March 22 and closing at 2800.47.

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As noted last week, technical indicators suggested the market was vulnerable but the depth of any pullback will be determined by the degree of negative news that appears in coming weeks. The S&P 500 experienced a delayed reaction rally on March 21, after the Federal Reserve surprised markets (and me) by cutting the projected rate hikes in 2019 from 2 to none on March 20. The risk from this decision will be discussed in the April issue of Macro Tides.

A bucket of cold water was thrown on the party when investors were reminded that the global economy is still slowing as amplified by a sharp decline in Germany’s IHS Markit’s flash composite Purchasing Managers’ Index (PMI) for March. The sub-index for manufacturing fell to 44.7, well below the estimate of 48.00. The New Order index was even weaker which suggests a quick turn-around is unlikely. The weakness was pronounced enough that some manufacturers laid-off employees for the first time in three years.

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The lone bright spot was in services, which was well above 50.0 at 54.9. Germany derives 46% of its GDP from exports and is mired in trade disputes with the U.S. and China, and is suffering from the slowdown in growth in China and the European Union. The strength in services indicates that a recession in the near term is not likely, but the yield on the German 10-year Bund fell below 0% for the first time since 2016, while the yield on the 10-year government bond in Switzerland fell to -0.43%.

The expectation has been that the S&P 500 could experience a pullback to the March 8 low of 2723 or 2685 before rallying again into April or early May. If, after a pullback, the subsequent rally exhibits more technical deterioration, the S&P 500 will become vulnerable to a deeper correction that could test 2630. Market breadth needs to be quite negative during that the decline, and the number of new 52 week lows would be expected to expand dramatically.

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03

The percent of stocks above their 200-day average was lower when the S&P 500 pushed up to 2860 which was another sign that fewer stocks were participating in the rally. When the S&P fell sharply on March 22 the percent of stocks above their 200-day average dropped from 51% on March 21 to 45%, which is an unusually large decline in one day.

Since February 22 the Nasdaq 100 has handily outperformed the S&P 500. However, on Friday, March 22, there were more new 52 weeks lows (89) on the Nasdaq than new highs (67), which shows that even within the Nasdaq the strength in recent weeks was becoming more concentrated. On Monday, March 25 the number of new 52 week highs further contracted to 55. The number of new 52 week highs on the NYSE fell to 72 on March 25 from 149 on March 22, and barely exceeded the number of new lows (62).

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My guess has been that the S&P may experience a correction (2723 - 2685) and then a subsequent rally to a lower high before the market becomes more vulnerable to a larger decline. A 38.2% retracement of the rally to 2860 from the December low of 2347 is 2664. The 50% retracement of the 513 point rally in the S&P 500 would bring the S&P 500 down to 2604. The probability of the S&P 500 falling to 2630 - 2604 will increase if the S&P 500 closes below 2723.

Another sign will be provided if the relative strength of the Equal Weight S&P 500 falls below the rising trend line connecting the lows in October and December. So far it has held above the upward sloping lower trend line, but a break below it would usher in another period of weakness for the broader market and lead to lower prices for the S&P 500 as well.

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If the S&P 500 does fall to 2630 - 2604, the manner in which it declines will provide clues as to whether the potential for a decline below the December low of 2347 increases. Since late December the expectation has been that the Wave (A) low in December would be followed by a large Wave (B) rally, and a subsequent Wave (C) decline that would bring the S&P 500 below 2347.

In recent weeks the primary goal was to identify the initial top from the December low and then let the S&P 500 clarify whether the odds of a correction to 2630 - 2604 followed by a rally to a new high, outweighs the probability of a failed rally and subsequent drop below 2347. It appears that the S&P 500 did peak as expected just above the target range.

Treasury Bonds

In the March 11 Weekly Technical Review entitled ‘Are Treasury Yields About to Decline?’ I discussed why the chart patterns in the 10-year and 30-year Treasury bonds as well as the Treasury ETF (TLT) might be related with the expectation that the S&P 500 was also nearing a decline.

“It is interesting that the chart of TLT and S&P 500 are suggesting that potentially some bad news may be right around the corner."

Since March 11, the yield on the 10-year Treasury bond has fallen from 2.643% to an intra-day low of 2.377% on March 25, while the 30-year Treasury yield fell to 2.830% from 3.033%.

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The important feature of the rally from the high in Treasury yields in November is that the 10-year yield has closed well below the red trend line connecting the July 2016 low and the September 2017 lows, and has remained below this long term trend line. (See chart of the 10-year above) The failure to climb back above this trend line, and the pattern in TLT, suggests the recent decline in yields may be the first leg of a larger decline as the weekly TLT chart illustrates. (Treasury yields fall as TLT rises and vice versa.) As noted in the March 11 WTR:

“The rally from 111.90 to 123.86 is thus the first part of a rally that has the potential of lifting TLT to 129.56 or a bit higher."

A rally to 129.00 or higher would complete the rally that actually began in March 2017 and would be unfolding as a counter trend rebound after TLT fell from $143.62 in July 2016 to $116.49 in March 2017.

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In the short term TLT did not provide the buying opportunity on weakness I expected and hoped for. The following instructions were provided in the March 11 WTR:

“The recent high of $122.23 may be wave 1 of the move to 129.56, or it could be wave d of a developing triangle. A 33% position in TLT is recommended if TLT trades down to $120.20 which can be increased to 66% if TLT trades below $118.64."

As it turned out, the move up to $122.23 was wave 1 and the low for wave 2 was $120.92.

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TLT appears to be in wave 3 of the advance from the low at $118.64 and should push higher.

Dollar & Euro

After Mario Draghi downgraded GDP growth in the EU from 1.7% to 1.1% on March 7, the Euro dropped sharply which boosted the Dollar. The Dollar seemed to have broken out on the news only to reverse and fall back into the trading range it has been in since mid October.

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After the Fed indicated that there would be no rate hikes in 2019, the Dollar fell sharply which boosted the Euro. The Euro looked like it had broken out of the channel it’s been in since early January, only to fall back into the channel. Until the Dollar closes below the lower trend line, the triangle pattern I discussed a few weeks ago may still be valid. If so, the Dollar has the potential to rally to 100.00. A close above 97.20 would increase the odds. Conversely, a close in the Euro above 1.140 would suggest the rally to 1.17 is getting under way. Until the next break out occurs, the Dollar and Euro are trendless.

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British Pound

As noted last week, the British Pound appears to have formed an inverted head and shoulders pattern since last July. A close above 129.10 on the British Pound ETF (FXB) would complete the pattern. The distance from the bottom of the head (121.10 and the neckline at 129.00) is 7.9 points and projects a rally to 135.80 - 137.00 once FXB closes above 129.10.

Last week I recommended:

“A 50% position is recommended below 129.00 which can be increased to 100% if FXB drops below 126.80. A stop of 125.40 is suggested."

On March 19 FXB opended at 128.77 and dropped below 126.80 on March 21.

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Gold

Since Gold fell to $1282.00 on March 5 it has rallied in a choppy fashion which suggests the move higher is a correction of the previous decline. Although Gold has moved above the initial target of $1310, the pattern still suggests that Gold will drop below $1282 and potentially under $1250.

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Gold Stocks

The relative strength (Gold GDX Ratio) of the Gold Stocks continues to improve which is a longer term positive, and the Gold stocks have rallied more than expected in the short term. If Gold ultimately falls below $1282, the Gold stocks will experience another selling wave before a good buying opportunity develops.

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Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking

The MTI generated a Bear Market Rally (BMR) buy signal on January 16, 2019 (green arrow) and climbed above the green horizontal trend line last week, as it did on March 30, 2016. This increases the probability that a bull market has been confirmed. This does not negate the potential of a pullback to 2720 - 2680 in coming weeks. Corrections of 4% to 7% are common in a bull market, which would allow the S&P 500 to fall to 2630.

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My guess is that the S&P may experience a correction during the next few weeks (2680 - 2723) and then a subsequent rally to a lower high before the market becomes more vulnerable to a larger decline that carries the S&P 500 down to 2630.

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