Written by Jim Welsh

Macro Tides Weekly Technical Review 24 December 2018

I hope your Christmas is spent with your family and that Santa stopped for cookies at your home. Today's report is shorter than usual so I can finish wrapping presents.

From its low in February 2016 at 1810 to the September 2018 high of 2940, the S&P 500 rallied 1130 points. A 50% retracement would target 2375 which was exceeded on December 24.

The 61.8% retracement is 2242. The red trend line connecting the March 2009 low with subsequent lows in October 2011 and February 2016 comes in near 2300.

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The unrelenting nature of the decline confirms that the S&P 500 is falling in wave 3 which shows no signs of being complete. Once wave 3 completes, wave 4 could lift the S&P 500 150 - 200 points as wave 2 allowed the S&P 500 to rally from 2603 to 2815. Once wave 4 is complete wave 5 is likely to draw the S&P 500 below the low wave 3.

The 21 day Net percent of Advancing stocks minus Declining stocks closed at -29.1 on December 24, one of the lowest readings since the 1987 crash, 1998 Long-Term Capital Management selloff, September 2001 after 9/11, July 2002, and financial crisis in 2008. In each case, the S&P 500 experienced a rally and then a subsequent decline to a lower low that recorded a less oversold reading.

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For weeks I've cited the lack of fear as measured by the Trading Index (TRIN) as an indication that the market was vulnerable to more weakness. As of December 24, the 10-day and 21-day moving averages are finally above 1.30.

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I have also noted that the Call/Put Ratio did not show the level of pessimism that is often a sign that a trading low is developing. As of December 21st, the Call/Put Ratio has fallen reaching a level that is commensurate with a trading low.

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The TRIN readings and the Call/Put Ratio suggest the S&P 500 is in the zip code and close to finishing wave 3 soon. After wave 4 carries the S&P 500 up by 150 - 200 points, a decline to a lower low is likely to follow in wave 5. Wave 4 could take the form of a triangle as investors sell rallies but buy above the wave 3 low. Triangles are extremely choppy but end with a thrust down to conclude a larger selloff.

Once a 5 wave decline has finished, a significant rally is likely to take hold that lasts from 1 to 3 months and retraces 50% to 61.8% of the decline and would likely reach 2600. Markets often rebound back to the scene of the crime i.e. the level they broke down from. In this case, 2600 was a major support for the S&P 500 so a rally that at least tests this level is coming in the first few months of 2019.

If this roadmap is roughly the way the market path unfolds, it is too late to sell.

In the November 5 WTR, I recommended moving 100% into cash when the S&P 500 was trading at 2771. I also recommended a 50% short position in the S&P 500 when it traded at 2790 and 2805 on November 7.

Half of the short position was covered when the S&P 500 fell below 2650 on November 20 (+5.0%) and reestablished at 2730 on November 28 and covered at 2664 on December 11 (+2.4%).

The remaining half was covered when the S&P 500 broke below 2485 December 20 (11.4%). The 50% short positions added a net portfolio gain 4.7%. (+5.0%+2.4%+11.4% / 4 = 4.7%)

Dollar

The Dollar has confirmed that a top has formed after closing below 96.40 and the rising uptrend line. The expectation is that the Dollar Index can fall to 94.00 in coming months.

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Treasury Yields

Last week I wrote:

"If the S&P 500 plunges below 2400, the 10-year yield could drop below 2.74% before reversing higher".

The S&P 500 fell below 2400 on December 24 and the 10-year yield closed at 2.749%.

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"If the S&P 500 plunges below 2400, the 30-year yield could drop below 3.00% before reversing higher."

The 30-year yield dropped to 2.957% on December 21 and 2.998% on December 24.

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Gold

Last week the expectation was:

"If the Dollar pulls back as expected Gold has the potential to trade up to $1265 or a bit higher in the short term".

Gold traded up to $1269 on December 24.

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Gold Stocks

Last week I said, "This near strength suggests GDX can trade up to $21.35 and test the red horizontal trend line at $21.40. This may mark a short-term high". GDX traded up to $21.47 before reversing and trading down to $19.90.

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Emerging Markets

Establish a 33% position in Emerging Markets ETF EEM if it trades below $38.00. Increase the position to 66% if EEM trades under $37.57 and to 100% if EEM trades down to $37.05.

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

The Sector Relative Strength Ranking is based on weekly data and used in conjunction with the Major Trend Indicator (MTI). As long as the MTI indicates a bull market is in force, the Tactical Sector Rotation program is 100% invested, with 25% in the top four sectors. When a bear market signal is generated, the Tactical Sector Rotation program is either 100% in cash or 100% short the S&P 500.

The MTI crossed above its moving average on February 25, 2016, generating a bear market rally buy signal. Based on the buy signal, a 100% invested position in the top 4 sectors was adopted. The MTI confirmed a new bull market on March 30, 2016, which is still in effect.

Past performance may not be indicative of future results.

The MTI has weakened significantly since early October. The U.S Sector Rotation Portfolio was moved 33% into cash/money market at 2738.30 on November 6, 66% into cash/money market when the S&P 500 opened at 2774.13 on November 7 and moved 100% into cash/money market fund as the S&P 500 moved above 2800. The average exit price was 2770.81.

The U.S Sector Rotation Portfolio established a 33% short position in an inverse S&P 500 ETF (SH) at $28.35, when the S&P 500 traded above 2800 on November 7. Half of the position was covered when the S&P 500 traded under 2650 and SH was trading at $29.97. When the S&P 500 exceeded 2730 on November 28, the 25% that was sold when the S&P 500 traded under 2650 was bought with SH trading at $29.03. This position was closed at the open on December 11 when SH opened at $29.60. The 16.5% position established on November 7 when SH was trading at $28.35 was closed on December 20 when SH was trading at $31.81.

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One of the reasons I thought the S&P 500 was vulnerable to more weakness in recent weeks was the herding mentality that led investors to crowd into Utilities and Consumer Staples. Investors thought they could hide out in these sectors since they are defensive in nature and would not get hurt.

One of the signs that a trading low might be developing would come once Utilities and Consumer Staples were sold. This would indicate that investors were actually beginning to become concerned about additional weakness in the overall market.

On December 17, the Utility average lost 3.2% wiping out more than 2 weeks of gains in one session. On December 24 the Utility ETF fell -4.2%. The decline in the Utilities is occurring against the backdrop of lower Treasury yields so institutional investors are finding no place to hide. This is another sign that wave 3 is almost complete.

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It took more than 6 months for the Consumer Staples ETF to rise from $49.00 to $57.00 and less than 6 weeks to erase the entire gain.

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