We have regularly discussed our multi-month topping thesis in the last three months (and a few times last year – prematurely as it turned out), and price action in recent weeks has done nothing to change our core view. In fact, when we look at some important markets, it seems to us that important battle lines are being drawn between the bulls and bears.
First, let’s have a quick look at the US equity market with chart 1 below showing the S&P 500 since the start of the last leg of the post crisis bull market in early 2016. What is clear is that the price correction since late January is by far the largest since early 2016. At the very least, this suggests a change in character in the market. Gone are the days of relentless advances with minimal correction, which was highly unusual, if not unique.
We have marked what we consider to be developing support in the 2565 to 2580 zone (closing prices only – to try and eliminate the intra day noise). We get the sense that the bulls were getting quite excited early last week as price found support at the 200 day moving average. Let’s face it, buying corrections to this moving average worked very well in June and November 2016; why not now? Well, the two recoveries in 2016 from the 200 day average were real V-shaped affairs, whilst this time the market seems to be making several tests of the average; again, a change in market character perhaps?
However, by the end of the week, price was heading back down towards the support zone and the 200 day moving average. The media is convinced that the swings in the market are being driven by the waxing and waning fears over a potential trade war. However, there are other factors at play here such as fed policy and potential regulation of large cap tech stocks to name just two. Fact is, market moves creates the headlines, not the other way round. It would be very big news we think if the S&P 500 breaks below the defined support level.
Chart 1 – Daily chart of the S&P 500 with 200 day moving average (purple)
Moving on, we are very intrigued by the oil market at the moment, specifically US WTI oil. Chart 2 below shows the price of oil alongside the net positions held by speculators on the futures market. As can be seen, as price has rallied over the last two years or so, speculators net long positions in futures have moved from a relatively low level to a record high.
From a fundamental perspective, what has clearly helped oil to recover in the last two years is the combination of production cuts, synchronised global growth, geopolitical rumblings in the Middle East and steady buying by speculators. We think that all but the geopolitical rumblings are at risk of stalling or even reversing.
What intrigues us is that as price has plateaued in the last 10 to 12 weeks, speculators have continued to hold their nerve. Our thesis is that if price begins to roll over, the pressure on those bullish speculators to liquidate will increase quite dramatically. From our perspective, short term price action is already showing signs of weakness, so we may well soon get to test our bearish thesis on the oil market.
Chart 2 – US WTI Oil price along with futures positions data for speculative trading accounts
Having discussed Gold last week, we thought we would take a look at Silver, as we did mention that it may be more attractive.
As can be seen in chart 3 below, speculators are currently holding a record net short position in Silver, which is a bullish contrarian signal. Also, the Silver/Gold ratio shown in the lower panel is at a level that is historically cheap. We have indicated on the chart (purple dashed vertical lines) when both Silver is cheap relative to Gold and speculators are either net short or holding a relatively small long position. The four previous times this setup was in place, Silver either enjoyed a nice rally, or embarked on a significant bull run.
The price of silver itself appears to have been in a base building process for the last two years or so, and although it may take some time, a break out above $17 and especially $17.70 would give the appearance of a new bull market emerging.
Chart 3 – Silver with Net positions held by speculative accounts on the futures market and the Silver/Gold ratio
The FX markets are finely balanced at the moment. Chart 4 below shows the EUR/USD exchange rate which is typifying quite a lot in FX at the moment, in that price has been stuck in a narrow range for over two months now.
We have spoken recently about the battle that is taking place in FX. On the Dollar bearish side are those worried that the US is losing its reserve status (thing Sterling post WWI), and on the bullish side are those championing the Administration’s economic policies and the interest rate advantage that can be gained by holding US Dollars. Frankly, we are agnostic on this battle at the moment, and will simply wait for a new price trend to emerge from the current consolidation.
Chart 4 – Daily EUR/USD exchange rate with 50 day moving average
To try and bring these individual battles together, what we think they illustrate is that markets are setting up for some large moves and these will likely occur with higher volatility than that seen in 2016 and especially 2017. From where we sit, we see little that invalidates our multi-month topping thesis in risk assets (equities, corporate bonds and industrial commodities). In terms of timing, we still think that if a bear market does begin in earnest, the worst will not be seen for several months yet.
But the big point to make here is that markets appear to have changed character compared to the almost unique environment seen last year (low volatility and always bullish risk assets). Perhaps this is just a high level consolidation in an ongoing structural bull market, in which case nothing to worry about for long term investors. However, a change in character is also always the first part of a multi-month topping process and if price action turns bearish later this year, then investors should now be focusing on selling rallies rather than buying dips.
Stewart Richardson
RMG Wealth Management
