Has the Business Cycle Trapped the Fed and the Bulls?
The US Federal Reserve’s first interest rate cut in 10 years sent risk assets pummelling as many global equity markets fell 3% or more. Despite all the central bank interventions, the business cycle is alive and well. TRI believes the down leg of the business cycle is well underway, where the weakening global economy triggers cascading declines in output, employment, income and sales. Ultimately leading to re-pricing of risk assets lower while sovereign debt becomes a safe-haven play. The US or shall we say global trade war is creating additional economic headwinds.
TRI’s June 2019 scenario of a bear and then bull traps for investors is playing out well. The bear trap beat the bears up pretty good, as the S&P500 rallied over 10% out of the June daily and weekly cycle lows. Now the setup appears to be complete for bull trap, right as the Fed’s cut interest rates. The Fed now appears to be trapped as well, as its credibility is in question, and lower interest rates are on the horizon.
As of August 2, the S&P 500 is on a bearish daily and weekly cycle trend. This week’s price swing high and turn down in our weekly Cycle Turn Indicator puts us on the alert that the weekly cycle has topped out in only 7 weeks. We have a left-translated weekly cycle which means lower prices into October-November cycle low timing band. All bounces higher should be countertrend, ultimately resulting in lower prices, as the S&P500 has likely topped for this cycle.
Emerging Markets Don’t Look Healthy
Emerging market price action, as represented by EEM ETF does not look healthy. The EEM has re-traced and failed at the 50% Fibonacci level of the 2018 high and 2019 low.
EEM ETF is on a daily, weekly and monthly bearish trend as of Aug 2. Emerging Markets have likely topped for this cycle and now risk re-testing the 2016 4-year cycle low. The trends are for lower prices, but we will be aware of sharp countertrend bounces higher over the next 12 months.
The monthly chart also shows a bear flag setting up. If fulfilled the bear flag aligns with TRI’s target of prices likely testing at least the low $30’s. The turn down in the business cycle is especially painful for emerging markets.
Canadian Financials Now Turning Down
In spring 2019, TRI observed the Canadian Financials represented by the XFN ETF risk-reward profile was materially tilted to the downside. XFN was trading at $37.00 per share in Mar 2019 triggering a weekly sell signal, only to rally higher and make a new higher high. Since the original weekly sell signal, the XFN has bounced as high as $39.15 only to now sink back and retest the mid $37.00 range again. Price is now only marginally higher than at TRI’s original post.
Today we have a daily, weekly and monthly bearish trend on the XFN as it sits upon short term support at $37.00. TRI fears a break of $37.00 will lead to lower prices with next support at $33.00 and $27.00 below that. We urge extreme caution with Canadian Financials XFN ETF as Canada is in the midst of its first credit cycle in over a generation.
TRI Process Learning Opportunity
TRI’s XFN call is a perfect example where the Total Return Investor process was early and required more patience. As the first weekly cycle out of the Dec 2018 monthly cycle completed, confirmation of the cycle top comes with structure and phasing of the following cycle. The XFN’s first weekly cycle of 2019 was right-translated and bottomed with a weekly sell signal. The right-translation statistically means XFN is more likely than not to make a new high, which it did. That new high was made in 5 weeks, before prices rolled over to test the first cycle low. That test held and moved prices up again, but prices failed to make new highs before a weekly swing high formed. TRI should have waited for this structure to confirm change in trend from bullish to bearish.
Nonetheless, from a risk management perspective the TRI process provides valuable insights on price action, structure and risk parameters. The USD is another example which we discuss next.
USD – Fed Cuts, USD Rallies
The USD is on a daily, weekly and monthly bullish trend signal the previous daily and weekly cycles extended lower than expected into June 2019. USD has now broken above its June 2019 highs as the US Fed reserve cut interest rates. Many investors believe that the USD will weaken as the Fed cuts interest rates. The TRI assessment of the business cycle and cyclical price action is pointing towards higher USD.
The USD last weekly cycle extended to include and additional daily cycle lower. TRI originally believed the USD dollar bottomed in early June 2019, but it extended into late June.
The USD will trend higher until we see failed or left-translated weekly cycle that moves below the previous weekly pivot points. The phasing of the business cycle also supports a higher USD as global economic growth weakens.
Fixed Income – Interest Rates Following the Business Cycle Lower
The US 3-month T-bill rate is moving lower, following the business cycle. The Fed is also following the business cycle and market rates lower. Central banks cannot stop the business cycle which are part of market-based economies. The business cycles can expand or contract, just like price cycle of risk assets. Eventually excess increases in price of the cost of goods and money leads to slower economic growth, which leads to lower cost of goods and money which will spark the next economic recovery and growth phase.
TRI expects the 3-month T-bill to continue lower into at least Spring 2020. Will the Fed go back to ZIRP as the market drives down short-term rates? In past rate cut cycles, the Fed has tended to cut rates by more than 3%…. so is ZIRP a pit-stop before potentially negative rates?
Lower US Yields Across the Curve
US treasury bond yields are moving lower after the TRI’s support levels broke in June. Yields are now over 40 bps lower.
How much longer before we see a 1-handle on the US 10-year Treasury bond yield? US2, 10 and 30-year T-bonds are all on daily, weekly and monthly bullish trends (yields bearish/lower yields).
Meanwhile Canada Yields Broke Support… again
In Canada, Gov’t of Canada 10-year yields have broken down below the 1.4% level. Like US rates, TRI analysis points to lower interest rates from here …. as the Canadian economy looks increasingly vulnerable. The Can 10-year bond is on daily, weekly and monthly bullish trend (bearish/lower yields).
TRI Cycle & Trend Signals*
The TRI Cycle and Trend Signals are shown below. These signals are as of market close on Aug 2, 2019. Please see the TRI Overview document for further information.
Source: Fieldhouse Capital Management
* TRI Cycle and Trend Signals are dynamic and may change on a daily, weekly and monthly basis, without notice. The indicators are at a point in time and do not imply that the current trend will persist and should not be considered investment advice.
Disclaimer: This material has been provided solely for information purposes for the use of the recipient and Fieldhouse Capital Management Inc. (FCMI). This material does not constitute an offer or an invitation by or on behalf of FCMI to any person to buy or sell any security. It should not be assumed that the methods, techniques, or indicators presented in these pages will be profitable or that they will not result in losses. Any reference to past performance is not necessarily a guide to the future and the value of investments may fall as well as rise. FCMI accepts no liability for any direct or consequential loss arising from investments made in accordance with the attached material. The research and analysis contained in the attached material has been procured from sources which are believed to be reliable and accurate.