1. The S&P 500 just had its worst week in two years
Is this the beginning of a deeper selloff or just a short-term shake out? Lets first step out of the forest to see the trees; the S&P 500 is still up 3% on the year. What caused last week’s selling? It's difficult to pinpoint one main catalyst but here are a few. First and foremost, we discussed a trend line on last Monday’s Morning Express at the 2850 area that would be critical to keeping this immediate-term uptrend intact. In fact, we went as far as to say traders should go short below here and we completely neutralized a Bullish Bias that we have had for months. Second, in last week’s Tradable Events we discussed how last year’s State of the Union caused peak exuberance and added how this year’s address, an FOMC Meeting, earnings from the top tech firms and Nonfarm Payroll all in the same week could do the same (though selling picked up earlier in the week than we had initially thought because of the trend line violation). Third, the S&P traded up as much as 7.5% in January coming into the last couple days of the month. Such an extreme melt-up at such high levels sparked a drastic portfolio cash imbalance between stocks and bonds. This forced institutions such as pension funds and insurance companies that must maintain a certain balance to sell stocks in favor of bonds to rebalance at the end of the month.
Another is political upheaval, we can all agree that some events this week in Washington did not help to bottom out stock market weakness. While all of these have contributed to the selling, one undeniable catalyst is the rise in yields. The 10-year treasury yield notched its best weekly gain since the election finishing at 2.85%, the highest since January 2014. This rise in yields becomes attractive for some investors to move money out of the equity market and into bonds. Furthermore, as yields rise, debt becomes more expensive to service. Now, where do we go from here? During weakness that felt foreign on Friday, our downside target, a key technical level at 2798 was taken out. This opens the door to our next major three-star support at 2748.25. This level on Friday aligned with a trend line at 2752, however, this trend line is higher for tomorrows session and comes in at the 2757 area. We believe that while buyers were on the sidelines awaiting a clearer picture late last week and this will be different in the first half of this week. We are watching for price action to test 2748.25 but a close maintaining 2757 will be key; this will help the bottoming process. The bad news is that the tape will not be neutralized until a close back above the 2798-2800 area. Furthermore, if the S&P closes below 2748.50, the next stop is 2690-2700. This lower level is roughly a 10% correction and aligns several proprietary technicals. Unfortunately, a close below here would cause a windfall of selling.
2. Fed speak and rates
Now that the FOMC Meeting is in the rear-view mirror, Fed officials are now clear of their quiet period. This week brings several key members to the podium to discuss their views on the economy. While the Fed is quiet on Monday, maybe they wanted to avoid a Super Bowl hangover, European Central Bank president Mario Draghi is due at 10:00 am Central. St. Louis Fed President Bullard speaks Tuesday at 7:50 am CT. Wednesday will be key with NY Fed President Dudley at 7:30 am Central, December rake hike dissenter Chicago Fed President Evans at 9:15 am CT and San Francisco Fed President Williams at 4:20 pm CT. On Thursday we have Philadelphia Fed President Harker at 7:00 am Central. Also, on Thursday is two-time rate hike dissenter Minnesota Fed President Kashkari at 8:00 am CT. The 10-year yield closed at the highest since January 2014 on the heels of the FOMC Meeting and a solid jobs report. Verbiage from these Fed officials will be key for all aspects of the markets. We want to add that ISM Non-Manufacturing will be a pivotal read on Monday. Other key influences in yield activity this week will be a three-year auction on Tuesday, 10-year on Wednesday and 30-year on Thursday. We expect these auctions to show strong demand, potentially putting in a near-term bottom on the longer end of the treasury complex (10 & 30 years).
3. Crude oil
WTI crude finished Friday’s session down 30 cents and 85 cents from its high of 66.30. On a technical basis, there is solid resistance building above $66 per barrel with the second lower peak from an ironic high of 66.66. For at least a month, we have had major three-star resistance at 66.87, our only major three-star resistance level since $60 was taken out. The energy complex is beginning to tire as it heads into a seasonally weaker time of year. Gasoline technically broke down from an ascending wedge (bearish pattern) early in the week before a surprise drawdown in inventories helped lift prices. For us, the upside has remained very limited, however, the market has defied probabilities in 2018 as U.S. production has grown to flirt with 10 mbpd. One major catalysts in this leg above $60 per barrel is the weaker U.S. dollar, which has lost more than 5% since late December. We believe the immediate-term downside in the dollar is now very limited. In fact, we expect a recovery in the Dollar from oversold territory. This could be the straw that breaks the camel’s back; Crudes record long position is a sitting time-bomb. Managed Money increased their long position to a record number of contracts in the week ending Jan. 30. This is just about 1,000 net-long contracts below the record from two weeks ago. We believe that a move below $63 would create a mass exodus and force a quick move to $60.
4. Central Banks and data
The Bank of Japan, ECB and Federal Reserve headlined last two weeks. Now it is up to the Reserve Bank of Australia on Monday and the Bank of England on Thursday to deliver policy decisions and outlooks. A major focus of ours has been fading the rally in the Australian dollar, especially as it reached and took out the 200-month moving average and nudged last year’s peak while in extremely overbought conditions. Price action in the Aussie began to retreat to close out the week, now trading back below the 200-month moving average at .8050 as traders readied for Monday night’s policy announcement. The Reserve Bank is expected to keep interest rates unchanged. Three hours before their decision on Monday night at 9:30 pm Central, is Trade Balance and Retail Sales data. The Bank of England’s decision is at 6:00 am Central on Thursday. Markets are pricing in a near coin flip on whether they will hike rates. We believe they will stay steady at 0.5% after hiking in November. With the Brexit still a headwind, they are likely to pave the way for a hike in March rather than moving this week. Other key data points this week are Services PMI data out of the Eurozone and U.S ISM Non-Manufacturing Monday morning. U.S Jolts Job Opening and Canadian Trade Balance and Ivey PMI Tuesday. Chinese Trade Balance overnight Wednesday into Thursday. Chinese CPI and PPI Thursday night. U.K Manufacturing and Canadian Employment data Friday.
About the Author
Bill Baruch is President and founder of Blue Line Futures, a leading futures and commodities brokerage firm. Bill has more than a decade of trading experience and focuses on developing trading strategies for both long and short-term trading approaches. Prior to Blue Line, Bill was the Chief Market Strategist at iiTRADER. Bill is a featured expert on CNBC, Bloomberg and the Wall Street Journal as well as other top tier publications. Blue Line Futures offers five research reports each day with the Blue Line Express