Weekly Economic Update 01-27-2017

Finally, we are seeing things line up as I have expected. Interest rates, or Treasury yields are slowly trending down indicated that 2.6% may be the peak. Treasury bond prices are firming right on their long term bullish trend line, meaning a potential break out to the upside in price within the next week or two may be in the cards. Gold and gold miners are finally starting to pull back; for a moment, I thought the train might have left the station, but it didn’t. Traders bought into gold anticipating a “Trump Dump” in stocks, but since that didn’t happen gold and gold miners are slowly starting their way back down to my target buy points.

The Dow finally reached 20,000 with all major indices hitting new highs purely on optimism and forward earnings projections. Analysts are quickly increasing their forward outlook for corporate profits in the coming year, like what they did at the peak of the dot com boom. Hedge funds and short sellers have been afraid to enter the market since the market continues to move up even on bad news. The sentiment is that bad news is just another problem Trump will quickly fix.

It makes me wonder what investors hope to gain with cyclically adjusted price-to-earnings ratios at the third highest level in history and the economy about to enter the third longest expansion in history. Not to mention the VIX, or volatility gauge which measures fear of a market corrections is at the second lowest level in five years. This behavior matches what we would see after a recession, not late in the business cycle. In the meantime, short term momentum is clearly on the side of equities, but the long-term trend broke mid-2015 supporting that stocks are overvalued by 10% across the board.

This week I got to watch an interview on an expert on stock market momentum. Why this is interesting is because his research and target buy points match mine. Pretty cool, right?! His firm provides research analytics on market momentum, in addition, his first job as a trader was in the gold market. As you can imagine I was very interested.

His research attempts to determine when momentum has changed from bullish to bearish or bearish to bullish. Compared to other strategies, such as technical analysis that often misses the top and bottom 20% of a market move, his research shows momentum is the only way to gauge the true long-term direction of the market. While I can’t replicate his proprietary charts, I can replicate charts of the long-term trends and integrate it into our research. I’ll comment on this as we go through the different positions we are in or targeting.

10-Year Treasury Yields (TNX)

Yields have failed to break their below their 50-day moving average twice, as we have seen in the charts. The 50-day moving average is a critical point that if crossed will signal the early stages of a change in momentum. Keep in mind it often takes several attempts before a break occurs, then once it does, we know the trend has shifted.

I previously identified that yields would get to the high 2.4% to mid-2.5% and they have, with a strong barrier at around 2.51-2.52% Yields have moved there and run into a stiff wall of resistance. Failure to hold around those levels would have yields retesting the recent highs. While I don’t believe we will see yields retest their recent high, we can’t rule out the possibility.

On a longer-term momentum basis, looking at the 50 & 100-day moving averages over the past 20 years, it supports that once there is a change in directions yields should fall to around 1.874%. At that point we will find out if we have entered a rising interest rate market or if this recent spike in yields was a just a temporary blip before continuing their downward trend. Keep in mind that historically when we enter a recession that yields set a new low, meaning bond prices would in turn set a new high

Knowing the probabilities are high that we are heading into the recession and the Fed has stated they are raising rates to combat the next economic downturn, it is more likely that yields will establish a new all-time low before we enter a secular cycle of rising interest rates. Plus, we know that institutional managers have placed huge bets in the futures market that yields will rise, which they are starting to back off on. Another indication that yields are more likely to fall in the short term.

iShares 7-10 Year Treasury Bond (IEF)

Prices here have been trending along the bull market channel line for the past few weeks, which has been supported by increasing volume. Increasing volume with an increasing price trend is a very bullish indicator for bond prices. We’re also seeing late day buying, which is also a good sign. I’m not ruling out that prices drop a little more, but if they do that does not change the bullish picture. I expect to know if prices are headed up or further down within a week. As of Friday, January 27, the outlook for prices continue to move up is good!

Based on short-term momentum, if prices break out over $105 they will quickly move to $107-108, where if they break over that level, then the long-term momentum price targets quickly come into play.

Looking at the long-term momentum, bond prices should move up to $108-109.50 price range that I have previously identified. It is at that point that we will find out if the longer term bullish trend is intact. If it is, I expect bond prices to break out to new highs later this year. If it isn’t, then we have entered a cycle of rising interest rates and the Treasury bond positions will need to be liquidated for bonds that appreciate in a rising interest rate market.

S&P 500 (SPX)

The S&P 500 is overvalued by nearly every metric available. What it has going for it right now is short term momentum or “animal spirts.” Analysts are now saying we are at the bottom of a 20-year bull market for equities and that corporate earnings can only go up. The logic behind this is that we didn’t enter a recession last year, even though we should have, so that must indicate we are at the beginning of the next secular wave for stocks. As you may know I don’t buy that for a second. What I do expect is pullback in the range of 2,200 to 2,240. If it holds those levels, get ready for even higher highs. If doesn’t, get ready for a much larger move down.

The long-term momentum broke mid-2015 and on two separate occasions the S&P 500 almost entered a bear market. The long-term momentum trends put the S&P 500 at 2,100. If it falls to that point and holds, the market will make another attempt at the recent highs. If it fails, the trend will have changed and we will be in a bear market. What I find interesting is that I have been pointing out for several months that the S&P 500 won’t be fairly valued until it reaches 2,100. It’s nice that his research validates mine.

SPDR Gold Trust (GLD)

In the past, as I have pointed out, bond prices usually start moving up before gold prices. In the past few weeks we’ve seen the opposite, but I believe some of that had to do with the expectation that a Trump inauguration would crash the market. It didn’t; so now traders are backing off their gold positions as there’s no perceived immediate concerns. I’ve been sitting on a target buy price of $111-112, or about $1,175/oz. A hold there confirms the bullish trend that we are seeing in bonds and we move in. There’s also the possibility that prices will hold near its current level until bonds move up, which would shift our buy point up a bit.

Gold tested prices at $1,178/oz and moved up from that today, but volume has been flat or weak. Based on volume analysis it supports that prices may drop a little more. The good news is that gold prices are slowly going down, which suggests there is price support at these levels.

If you’re wondering why I didn’t try to target the bottom of gold, that’s because nobody knows where a bottom or top is until after it’s formed. You also must keep in mind that many people thought (and still do) that gold was headed to $800/oz. Based on momentum, that’s not very likely.

The longer-term momentum trends show that gold should move to $1,309/oz, which is about +8% from current price. If prices break above $1,309/oz, strap on your seatbelt, gold momentum gets very strong and puts it up at $1,700/oz or a +40% move from current prices.

Vaneck Vectors Gold Miners (GDX)

Gold mining stocks started leaving the station early, but something with that didn’t feel quite right. They ran into a stiff wall based on short term momentum this week as the train crashed into its long-term 50-day moving average and abruptly started to pull back.

Looking at short term price movement, prices are trying to push back over their short-term momentum control line which is the 100-day moving average. Failure here will likely force a retest of my target $20-21 range. A break over this line would force my hand and trigger an immediate move in, as prices are likely to move up. Volume on Friday was very weak, so I think it is more likely we will see a move down than up.

Since gold miners move with gold, they get caught in the same momentum. Meaning short term price movements, provided gold moves to $1,309/oz, takes gold miners up nearly 40-50% from my target buy point. Long term momentum suggests they could move over 100%, upwards of 200% should gold hit $1,700/oz. (Some believe even higher if there is a financial crisis.) Buying at these levels is like getting on the elevator at the second floor of a high-rise hotel and riding to the top.

Wrap Up

I was hoping to keep this short, but it didn’t turn out that way. Provided all the research is correct, this will have us investing at the bottom of trends instead of the top. Keep in mind, some of the most successful investors in history have made their clients big returns buy chasing the “belly” of momentum movements. Not trying to time the top or bottom, but trying to catch the big wave in the middle. That’s where we are at with gold and gold miners. That is my long-term goal; to catch trends as they start and invest with the smart money.

And if you’re worried about equity markets going to infinity, we should remember Bob Farrell’s (former head of Merrill Lynch’s research department) rule number 2: Excess in one direction will lead to an opposite excess in the other direction.