War: Easy To Start, Hard To End

by Jim Welsh
“In the U.S. time is measured by quarters, but in China it is measured in decades. China’s leadership is not immune from short term considerations, but their focus is not centered on the next year or two but where things will be in 5 to 10 years and beyond. China has been taking steps to insulate and bolster its economy from any short term negative impact from trade. By stimulating its economy, China can weather the storm in the short term and achieve its long term goals. According to Chinese philosopher Sun Tzu,

“The supreme art of war is to subdue the enemy without fighting.”

It’s possible that Sun Tzu may possess more wisdom and negotiating prowess than the guy who wrote the ‘Art of the Deal’. In recent years China has expanded its military reach to a number of islands in the South China Seas despite Chinese President Xi Jinping’s 2015 pledge to President Obama that “China does not intend to pursue militarization” on the Spratly Islands. China’s military expansion reflects a mindset that is focused on the long term and an attitude that China will not be bullied nor dissuaded by any country. On July 31, 2018 the Trump administration said it was considering increasing the tariff on $200 billion of Chinese imports from 10% to 25%. Comments by a spokesman for China’s Commerce Ministry didn’t sound as if China is cowed.
“The U.S. unilaterally exerting pressure on China will get the opposite of what it wants.”Discussions haven’t even produced a plan for additional negotiations. The Commerce Ministry also issued a statement on August 2.
“China has been fully prepared and will have to retaliate to defend national dignity and the people’s interests.”The word dignity caught my attention since it indicates that for China the trade negotiations represent something much bigger. China wants to be treated as an equal to the U.S. and respected, and that’s something China is not willing to trade away.”

China’s response during the trade negotiations since last October and after Trump’s escalation in the Trade War on May 5 is instructive. China controls the media in China and uses it to shape public opinion. From the end of last September the frequency of the phrase ‘trade war’ declined to almost nothing by the end of April, which suggests the leadership didn’t want the Chinese people to be fully aware of the negotiations. By keeping the trade negotiations off the radar it would be much easier for China’s leaders to control the narrative after the trade negotiations ended, rather than having to reshape public opinion. After President Trump threatened and then followed through on 25% tariffs on $200 billion worth of Chinese imports, the frequency of the phrase ‘trade war’ soared.

It has also been reported that Chinese media is showing old movies of the Korean War to remind their people of another time when relations between the US and China were bellicose. Now China can easily cast the US as the aggressor that has instigated tariffs, increased the tariffs to untenable levels, and made unreasonable demands.

This last point was probably one of the sticking points that caused the negotiations to collapse. As you likely know, the US intended to keep some of the tariffs in place as leverage to encourage the Chinese to uphold any trade deal. China’s track record in adhering to the details of prior trade pacts has been not good, so seeking some assurance makes sense. However, the idea that the US would continue with tariffs after a trade deal was struck was incomprehensible and reprehensible to the Chinese, a point they likely made abundantly clear to the American trade delegation. Here’s a good analogy: A young couple is engaged and going to be married next Saturday. One of them tells the other,
“I love you very much and I’m going to hire a private investigator to follow you for the first year of our marriage to make sure you remain faithful.”

That would certainly make ones heart beat faster but not in a good way!

All eyes are now on the G20 meeting in Japan on June 28 and expectations are high that a trade deal can be resurrected before then. That’s not likely to happen especially if Treasury Secretary Mnuchin and US Trade representative Lighthizer don’t announce plans to travel to China to resume talks soon. Nothing of substance can happen at the G20 meeting unless negotiations restart weeks before the meeting. At best the G20 meeting will provide a photo opportunity for President Trump and Xi Jinping with the possibility of an agreement to resume negotiations. Given the message being delivered to the Chinese people by the state controlled media, the prospects of new ‘productive’ talks soon may be optimistic.

While negotiations were moving forward between last September and April, China allowed its currency to appreciate against the Dollar from 6.95 to 6.73. (chart above) That literally changed overnight and now the Yuan is approaching levels only seen in December 2016 and September 2018 at 6.95. Should the Chinese allow the Yuan to rise above 6.95 (depreciate), it would signal that China had decided to use the depreciation of the Yuan as part of the Trade War and reflect a toughening in their trade position. If the Yuan does trade above 6.95 for a few days, global financial markets are going to respond negatively.

It is becoming clear that the trade negotiations are just part of a larger realignment of power between the US and China, as both countries wrestle with non trade issues that have the potential to shape which country dominates the world in coming decades. With so much at state a quick resumption of talks seems unlikely.

“The takeaway is the S&P 500 is nearing an inflection point based on sentiment, its price pattern, and the loss of upside momentum. For conservative investors it’s time to become more defensive if the S&P 500 rallies above 2954 or closes below 2870.”

As I discussed last week there were a number of technical indicators suggesting the S&P 500 had a good chance to rally above 2870 after it had closed below 2870 on May 13. I recommended selling into any rally above 2870:

“If you didn’t become more defensive last week I would recommend selling into a rally if the S&P 500 does manage to rally above 2870 in the next few days.”

The S&P 500 rallied above 2870 on Thursday May 16, trading as high as 2892 and less than 1 point above the intra-day spike high of 2891 on May 10.

When the S&P 500 was trading at 2877 at 7am on May 16 I lowered the exposure in the Tactical U.S. Sector Rotation Model Portfolio from 100% to 50%.

Based on the technical deterioration I’ve discussed in recent weeks, and the poor prospects for a quick resumption of trade talks, the downside risks in the market have increased. Sooner or later the S&P 500 is expected to fall below 2780 and test 2650. If after the G20 meeting President Trump does slap China with a 10% tariff on the remaining $300 billion in Chinese imports, the odds of the S&P 500 falling to the lows of December (2347) in coming months will increase. A few weeks ago this outcome seemed remote, but that has changed and I’m not sure investors appreciate the magnitude of the fissure.

Although the risk of a break down below 2780 is higher than a week ago, there is a chance the S&P could rally above 2892 before it tests 2800. The Call / Put Ratio is approaching 1.0 so any additional weakness would cause it to drop below 1.0 in coming days.

Click on any chart below for large image.

The indicator that combines the Trading Index with the Call / Put ratio has held below 1.0 for a number of days which is supportive a bounce in the near term.

However, the market’s internals are not oversold as measured by the 21 day average of Advances minus Declines. At most solid trading lows this measure of internal breadth usually drops under -400. As of May 20 the 21 day average of Advances minus Declines was -69 and nowhere close to being oversold. This suggests the S&P 500 could easily drop below 2800 before the market would truly be oversold.

I noted that the majority of the major market averages were oversold on May 13 which supported the potential for a short term rally above 2870. The rebound that lifted the S&P 500 up to 2892 also lifted the S&P 500’s RSI to 49 on May 16 from 31 on May 13. The rally effectively used up the oversold energy which leaves the S&P 500 vulnerable to another selloff.

The intra-day trading pattern in the S&P 500 suggests investors are more worried about missing a rally if a trade deal is reached, than concerned about the downside risk if a trade deal doesn’t occur. After the S&P 500 topped on May 1, investors jumped in to buy after the S&P 500 gapped lower on May 2, May 5, May 9, May 10, and May 15. Investors jumped in on May 17 after the S&P 500 fell 27 points on the open only to watch the S&P 500 fade into the close. The same thing happened on May 20.

This is a subtle change in the pattern and could signal that investors are becoming wary and weary from buying gap down openings but not being rewarded for the risk. Despite all the dip buying the S&P 500 recorded the third lowest close since May 1. However, for many investors hope springs eternal and a strong rally is likely to follow should Treasury Secretary Mnuchin announce he’s going to China for more trade talks.

As long as the S&P 500 holds above the intra-day low of 2815 on May 13, the S&P 500 has the potential to rally and slightly above 2892. I would recommend becoming more defensive should the S&P 500 rise above 2982. Aggressive investors can establish a 33% short position above 2892. If the S&P 500 drops under 2815 a decline below 2800 could quickly follow and create a more definitive oversold condition that would be enough to support another multi-day rally.


The expectation has been that Gold will drop below $1250 before a significant rally develops. The Commitment of Traders report for May 14 increases the probability of this outcome. After bottoming at $1266 on April 23, Gold rallied a whopping $35 to a high of $1301 on May 14. During this modest rally of 2.7% Large Speculators (green line middle panel) increased their long position from 37, 375 contracts to 124,536, which is a big jump relative to the magnitude of the rally. Managed Money (blue line bottom panel) flipped their position from being short -33,829 to being long 52,546 contracts.

Large Speculators and Managed Money are trend followers who get in as the Gold goes up and out as Gold drops. More often than not they have their largest long position near a top and smallest long position or largest short position near a low, which was the case last August and September. The willingness of Large Speculators and Managed Money to turn bullish so quickly suggests that Gold will have to drop below $1250 to curb their bottom fishing enthusiasm.

The Commercials (red line middle panel) are considered the ‘smart money’ and usually have their largest short position near tops in Gold and at lows have only a very small short position. During this modest bounce of 2.7% the Commercials increased their short position from -57,396 contracts to -137,183 contracts. I suspect the Commercials will aggressively reduce their short position if Gold does fall below $1250.

Gold may still mount a rally to above $1301 to complete an a, b, c rally from $1266, especially if the S&P 500 briefly falls below 2800. The expectation has been that Gold has the potential of falling $81 after it completes the rally from $1266. If the high at $1301 stands, Gold could fall to $1220 – $1230 before Wave e of the triangle from the high in July 2016 would be complete.

Gold Stocks

On May 2 GDX closed at $20.17 and its RSI was 28.8. By May 17 GDX had rallied to $20.75 and its RSI was up to 45.8. Although the rally of 3.0% is OK, the fact is GDX’s RSI has already burned off the oversold energy as it was trading just above $20.00. The price pattern since that low appears to be a triangle for wave 4 (red), which would be complete after one more rally above $21.02 for wave e. From the high at $23.70 on February 20, GDX lost $2.30 in wave 1 (red). This opens the possibility that GDX could fall $2.30 in wave 5 (red) before the correction from the high on February 20 is finished.

As noted last week, the challenge in forecasting a path for GDX is the changing level of relative strength it has displayed in recent months. If Gold follows the script described – a decline below $1250 and possibly as low as $1220 – Gold stocks could prove vulnerable to a deeper correction. If the relative strength of the Gold stocks remains poor, which seems like the more likely outcome, GDX could easily fall to $19.50 (black horizontal trend line), and in a worse case under $19.00.

In the April 8 WTR I recommended a 33% position if GDX fell below $21.60, and recommended increasing the position to 66% if GDX traded below $20.60. I am not comfortable holding this large of a position if GDX has the potential to fall under $19.00. Last week I recommended selling half of the position at $21.05, but GDX could only make it up to $21.02 on May 15. Sell half of the position if GDX trades up to $21.00 and the remaining half if GDX trades at $21.17. Use a stop of $20.40 on half of the position if GDX fails to trigger the sell at $21.00.

Treasury Bonds

Not much has changed since last week. The weekly chart suggests TLT may rally above the September 2017 high of $129.56. From the November low of $111.90 TLT moved up $11.96 and an equal rally from the February low of $118.64 would target $130.60. TLT rallied $8.05 from the low in February and an equal rally from the April low of $122.11 would target $130.16. Once the current rally is complete TLT may finish the corrective rally from the low in March 2017 for Wave (B) in red. This corrective rally would have taken the form of an a, b, c in green. If this pattern analysis is correct, TLT has the potential to decline below $105.00 by early 2020 for Wave (C), if Wave (C) is equal to Wave (A) (143.62-116.49 = 27.13).

The 10-year Treasury yield is likely to drop under 2.30% and could breach 2.20% if TLT does rally to $130.00 or higher. The 30-year Treasury yield is likely to drop under 2.77% and could breach 2.60% if TLT does rally to $130.00 or higher.

A decline below 2780 by the S&P 500 in coming weeks could provide the motivation for Treasury yields to fall to these targets. From the momentum low in December 2016, TLT rallied until early September 9 2017 or just over 8 months. A comparable rally in time from the low in Treasury bond prices on October 5 would target June for the next high in Treasury bond prices.


Since reaching 97.71 in mid November, the Dollar has traded in a choppy pattern which has made reading its chart difficult. Although the Dollar could still push up to 100.00, sentiment and positioning argue strongly that an intermediate high in the Dollar is near. Although the Dollar and Gold often don’t trade inversely a push higher in the Dollar may be one of the factors that contribute to Gold dropping below $1250

Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking

The MTI generated a Bear Market Rally (BMR) buy signal on January 16, 2019 (green arrow) and climbed above the green horizontal trend line on February 26, as it did on March 30, 2016 confirming the uptrend.

In the April 29 WTR I noted that there was an important negative divergence between the S&P 500 and the NASDAQ 100, and the majority of the other major market averages, as well as a loss of internal momentum:

“The S&P 500 pushed to a new closing high and a new intra-day all time high on April 29, along with the NASDAQ Composite and NASDAQ 100. The New York Composite Index is -1.7% below its September 2018 high and -4.4% under its January 2018 all time high. The Russell 2000 is -7.9% below its all time high while the DJ Industrial average is -1.2% short and the Transports are -4.1%. The fragmentation between the major market averages is not a sign of strength. Despite the new high by the S&P 500, internal strength as measured by the 21 day average of Advances minus Declines has continued to weaken (blue arrows). This confirms what the divergences between the market averages indicate: Fewer and fewer stocks are lifting the S&P 500 higher, while the majority of stocks tread water or fade.”

In the May 6 WTR I noted that the MTI had flattened out as the ascent in the S&P 500 had slowed which provided another warning that the S&P 500 was at risk for a pullback. The key is the S&P 500 holding above important support at 2780. The progressive weakening in the technical structure of the market led me to reduce exposure. When the S&P 500 was trading at 2877 at 7am on May 16 I lowered the exposure in the Tactical U.S. Sector Rotation Model Portfolio from 100% to 50%.


The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Russell 2000 Index is a small-cap stock market index of the bottom 2,000 stocks in the Russell 3000 Index. The Nasdaq 100 is composed of the 100 largest, most actively traded U.S. companies listed on the Nasdaq stock exchange. All indices, S&P 500, Russell 2000, and Nasdaq 100, are unmanaged and investors cannot invest directly into an index.
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