Weekend Strategy Review March 24, 2019

Posted by OMS  at March 24th, 2019

Global markets fell hard on Friday, after Germany and France announced a slowdown in factory output.  The announcement caused traders to dump stocks and buy Bonds driving yields below zero on Germany’s 10 year note.  Factory output in Germany fell by the largest amount in over five years.  Markets in the U.S. followed Europe lower with the Dow dropping 460 points, closing at 25,550.  The Dow was down 347 points for the week.  The NASDAQ fell 196 points on Friday and was down 46 points for the week.

Friday’s decline also caused the yield curve on U.S. 10 year note to invert.  So now the 3-month rate is less than the 10 year rated for the first time since 2007.  An inverted yield curve is a sign that the economy is slowing.  This is probably what caused the Fed to terminate its rate hikes for the rest of 2019.  A rate hike in this environment would likely cause the market to tank.

Anyhow, it’s apparent that world economies are slowing. This is an entirely different picture the Fed was painting as recently as December.  Now they’re talking about a slowing economy, with little inflation and a slower GDP growth.   As investors, we always need to pay attention to what the Fed does, not what it says.  And the fact that they have stopped their Quantitative Tightening (selling) program even though they only reduced their balance sheet from $4.5 trillion to $4 trillion in the last 18 months tells me their worried.  Heck, with the kind of junk they have on their balance sheet (tons of mortgage backed securities from 2007-2008) they probably would have liked to sell their entire portfolio.  But doing this in the current economic environment would have been reckless.  Please understand that the Fed did not stop selling out of the goodness of their heart.  They stopped selling because if they continued dumping $50 Billion a month, it would only exacerbate the decline in their holdings.  This is why they stopped!

On Friday, I mentioned that the Banking Sector had appeared on the Weak Sector List. This is another sign that the economy is slowing.  It’s tough for Banks to make money when short term rates are higher than the rates on longer term money.  BTW, the last time the 3 month note was higher than the 10 year was in the summer of 2006, just before the equity market crashed in 2007-2008.  The yield curve also inverted in 2000, just before the market crashed in 2001-2002.  Another way of looking at this is that since 2008, the yield curve has been positive leading to a rising stock market.  But now, the yield curve is inverted again.  Students need to factor this into their planning.

BTW, the fact that the yield curve is negative doesn’t mean that equity markets will crash immediately.  It usually takes several months before the effects of a negative yield curve begin to filter through the economy and into equity prices.  But it’s like an avalanche that starts slowly but eventually destroys everything in its path.

This is why I’m spending so much time talking about yield curves this morning.  Things have changed!  The investment climate is no longer positive for equities.  As long as the yield curve remains inverted, we need to take steps to protect ourselves.

As many of you know, for the past several weeks I have been somewhat defensive because of two things:  The fist was an unclear pattern, especially on the upside.  The pattern since last October’s decline suggested the rally on the Dow that began on 8 January, was likely Wave 1 up of Major Wave 5 up.  The subsequent pullback that started in late February suggested Wave 2 was forming. So far, we’ve seen wave ‘a’ down and wave ‘b’ up complete.  Yesterday’s decline was likely the start of wave ‘c’ down of Wave 2 down.  If this is what’s happening, wave ‘c’ down should drop the Dow down to the 24,500 level, maybe slightly lower, before it completes.  After that, Wave 3 up should take the markets to new all time highs.  Again, IF this is what’s happening.  This is the Bullish Scenario.

IF this is NOT what’s happening, and the Bearish Scenario is occurring, the market will continue falling to the 23,000 level before bouncing.  The bounce will likely take the Dow back to the 25,000+ level before falling again.  The after a series of violent up-down moves, the markets will begin to break below the 23,000 level, testing 22,000 before bottoming near 20,000.  This is the Bearish Scenario that we need to be concerned about now that we are dealing with an inverted yield curve.  Again, forget what the Fed and everyone else might be saying.  We must pay attention to the fact that the yield curve is now inverted.

Friday’s decline caused my market timing signal for the Dow and SPX(SPY) to turn Neutral.  The decline also caused the timing signal for the Russell 2K to turn Negative. The same timing signal for the NASDAQ remains Positive.  Another down day will likely cause the signals for the Dow and SPY to turn Negative, joining the RUT.

The Dean’s List has turned neutral with DXD and RWR, the inverse index ETFs for the Dow and RUT on the List.  The Tide remains Neutral.  The Hi-Lo indicator is the only breadth indicator that remains positive. 

The Sector Ratio fell slightly after Friday’s session.  The Ratio is now at 17-7 positive. However, nine of the Strong Sectors now have a RS rating of 1 or zero, so another down day or two will likely put these sectors on the Weak List. This would turn the Sector ratio negative.  BTW, the Sector Ratio has been positive since early January supporting the rally.  If the Ratio turns negative, pay attention!

The Strong Sectors continue to be led by Household Products, Semiconductors, Technology, Computers, and Utilities.  The Weak Sectors are Autos, Banks, Food Drugs, Media, and Leisure. I noticed that SKF, the inverse 2X leveraged ETF for the Banks is moving up on the Dean’s List. 

Gold and mining stocks rose slightly yesterday. GLD rose 0.29 cents to 123.97.  The pattern still suggests that wave ‘b’ up of Wave 2 down on GLD is nearing completion.  If this is the case, wave ’c’ down could take gold (the metal) back down to the 1250 level before wave ‘c’ down completes.  This would mean that GLD could trade back down to the 120 level before Wave 2 down completes.  The 120 level is approximately where the 200-day moving average is located.

Crude Oil (UCO) fell slightly in Friday’s market decline.  UCO dropped 0.64 cents to 20.66.  The CCI on UCO had fallen out of the Trend Mode, and the volume position of my VTI-volume indicator has turned negative.  So, without a trend in Crude Oil, I see no reason to hold UCO in the Model Portfolio in the current environment. A slowing economy will put a damper on crude oil prices.

Model Portfolio:  There were No Changes to the Model after Friday’s session.  The Model is currently holding a half position in Crude Oil (UCO). The remainder of the theoretical $100,000 portfolio, $88,936, remains in cash.

BTW, yesterday’s trading action put the Model’s overall gain at $2,675.22 without taking commissions into account.  The Model was started on 26 February.  Since inception, the Model has gained 2.64 percent vs. a gain of 0.16 percent for the S&P.

The Model Portfolio is being shown for educational purposed only.  The Buy/Sell actions in the Model Portfolio are made based on technical indicators that can and do change frequently and should NOT be considered as recommendations for trading an actual portfolio.  Any gain or loss in the Model Portfolio should not be used to predict future performance of the Model.

Bottom Line:  It appears the equity markets are starting to turn negative.  It’s still early, but with two Scenarios on the board that suggest lower prices for the short term, the Model will begin to step into a few short (inverse) positions.  With an inverted yield curve and Banks on the Weak Sector List, the Model Portfolio will be buying a few shares of SKF on Monday.  Again, Banks are usually one of the sectors hardest hit by a slowing economy and an inverted yield curve.  So, the Model will be buying half positions in SKF and TWM, the inverse ETF for the Russell 2K.  The Model will use the funds normally allocated for the NASDAQ for this purchase.  But because the NASDAQ is still on a Buy Signal, while the RUT is on a Sell, the purchase of TWM and SKF appear to be a better use of the funds. 

The Model will also consider buying a partial position of DXD on Monday, IF the conditions allow.  DXD is on the Dean’s List but the market timing signal for the Dow remains neutral.  But again, with market conditions starting to turn negative, a half position in DXD appears justified.

That’s what I’m doing,

h

Market Signals for

03-25-2019

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All of the commentary expressed in this site and any attachments are opinions of the author, subject to change, and provided for educational purposes only. Nothing in this commentary or any attachments should be considered as trading advice. Trading any financial instrument is RISKY and may result in loss of capital including loss of principal. Past performance is not indicative of future results. Always understand the RISK before you trade.