Trading Plan and Overall Market Outlook for Monday, March 25, 2019
Mar 24, 2019 Trading Blog
What an ugly day on Friday. The question now is whether this was just a temporary pullback or the start of something serious. It’s probably too early to tell, but by the end of this coming week the answer should be pretty clear.
The real key to watch here is the TLT. I posted a chart a couple of weeks ago saying watch that 123 level, which has been an important market level since mid 2017. The market gapped up to 124 and closed the day at 124.86. That is a huge move taking out an almost 2 year resistance level with absolute ease. You can’t ignore the significance. If you want to know why the stock market dropped, that’s the answer. Lower rates should have fueled this market to new highs, yet it didn’t. The key here is WHY rates are dropping. The severity of the gap in TLT combined with the drop in the SPY clearly shows concern that the economy is slowing and recession could be approaching, and that’s likely the ‘WHY’ supporting the FED’s dovish move.
Sitting here looking at charts this morning and the most concerning group of stocks to me is the drop in the Financials since the FED announcement on Wednesday. JPM ran right into the 200 day moving average at 108 and has moved straight down closing at 99.76 on Friday. I just don’t see how the market is going to move up without the financials. The problem obviously is the expected lower rates, which aren’t much help to bank profits. The underlying question though still remains: Why are rates going down and what really caused the FED to take a very drastic and somewhat absurd move of lowering rates into a stock market that was headed to all time highs? On the face, their conduct doesn’t make sense, but if you dig deeper and consider that they most likely see a recession coming, then their conduct starts to make A LOT more sense.
No central bank should ever be lowering rates into a stock market approaching all time highs. It’s just a waste of ammunition and there’s no reason to do it, other than to manipulate and blow a bigger bubble. Unfortunately, I think they are caught between a somewhat manipulated stock market and an underlying economy that is going the other way. The market and the economy have clearly diverged and have been for a couple years. I think it’s possible that the FED has been forced to shift their position to protecting against the slowing economy, at the risk of blowing a bigger stock market bubble. They simply have no choice at this point. If that’s the real reason, then the move of lowering rates in the face of an all time high stock market doesn’t look quite as absurd.
The second most concerning group of stocks are the commodity stocks, things like X, AA, FCX, CLF, etc. When rates drop, these component stocks of the XME usually respond by going up, and they did on Wednesday and Thursday, but Friday they got crushed. This is a clue about the ‘why’ rates are dropping (TLT rising). When these commodity stocks drop on lower rates, it’s because the economy is slowing and I think these commodity stocks offer a real clue as to why the market fell on Friday in the face of a very dovish FED. These commodity stocks are more supply/demand driven than other types of stocks. A slowing economy can shift the supply/demand dynamic quickly. The market should have run on lower rates, yet it didn’t.
Utilities are another group offering clues. They moved up on lower rate expectations as they normally do, but the move in the XLU was to all time highs on the weekly chart. That’s not just a rate move, that’s more than likely a flight to safety and dividend preference move. When investors would rather buy Utilities instead of bonds or tech, that’s a red flag. The Consumer Staples operate on a similar theme, but not quite as purely as utilities. The XLP held up well Friday, closing down just 7 cents, although it is looking toppy on the weekly chart. But when you compare Utilities/Staples to Financials/Tech, the market is sending a signal.
Which brings us to the oil sector. If this TLT/SPY correlation on Friday is for real and is on concerns of a slowing economy, energy stocks are going to get absolutely crushed over the next couple months. Oil stocks moved in line with commodity stocks on Wednesday/Thursday, and then followed them down Friday. If the economy slows, the supply/demand characteristics of commodity and oil stocks will show quickly. Oil has already been dealing with supply issues and if the demand side of the equation starts to also become an issue because of a slowing economy, there’s probably nothing that OPEC, nor anyone else, can do stop the coming price collapse.
If the slowing economy theme starts to pick up speed, oil could quickly find itself back in the 40’s and I really don’t think any of the E&P’s could survive that drop in their current condition. They are already struggling with WTI almost 60 and I’d hate to see the carnage at WTI 40.
So what to watch this week? I posted this week’s Decision Tree on Twitter (on the right side of the blog). I think the most important watch is the TLT to see if it pulls back to the 123 level and if it holds that breakout point on a retest. If it doesn’t even bother to pull back for a retest of 123, that’s going to be an even clearer signal of the danger in the stock market. Next, keep an eye on the financials to see how they respond to the TLT action and whether they can diverge from the current TLT up / XLF down correlation. Another watch is the DXY to see if it picks up strength or if it just moves sideways. With the dovish FED and lower rates, it should be weakening, but it really isn’t.
So how to trade energy this week? I think the best trade opportunity is going to be on the short side. The XOP should try to bounce early in the week, along with the SPY. At some point, the market could fail again and that’s going to be the short entry for the XOP. I’d stick to the XOP rather than the XLE if shorting is the plan. The XLE should be able to weather the collapse better with XOM and CVX sometimes being stocks that money flows to for safety. It doesn’t always happen, but I’ve seen it happen before. No sense in trying to short them when the XOP is a much softer target.
As for exact levels on the XOP, I’m really not sure how far it could bounce Monday. The E&P’s closed at 30.05. The 50 day moving average is 30.18, 20 day moving average at 29.98 and 8 day moving average at 30.37. The 30.50-30.65 level is the first supply and 31.00 is the second supply. If this market is truly weak, it shouldn’t be able to take out 31.
On the downside, the level for me is 29.61. That has been a solid demand level since early January. If that breaks, then 28 is obviously the next demand level. If the 28 level breaks, then things will get really ugly, really quickly and 24 could be the result.
From the Decision Tree (posted on Twitter Feed), the four most likely XOP paths this week:
1. Total breakdown. 29.61 breaks without much resistance and then the market makes a run at 28 and also breaks that level.
2. Market breaks down below the 29.61 level, drops to 28 and then bounces back to 29.61 for a test of that level.
3. On the retest from below, the market breaks back above 29.61 for a run back toward 31.
4. On the retest from below, the market fails at 29.61 and heads back down to 28 for a fourth test of that level, at which point it probably breaks down.
Two paths that could occur but I don’t see as likely:
A. The market tests 29.61, holds and then rips right back to the top of the range at 31.50.
B. The market simply drifts sideways in the 29.50-30.50 range all week.
That got longer than I intended. I’m off to have a couple bottles of good wine in the warm sun this afternoon, hope you guys have a great Sunday.