The Macro Levels that Matter Most
Featuring John Kolovos
Published on: August 9th, 2019 • Duration: 15 minutesJohn Kolovos, CFA, CMT, chief technical strategist at Macro Risk Advisors, sees two distinct possibilities for equities over the coming months. In this interview with Justine Underhill, Kolovos breaks down those scenarios, and then provides his outlook for bonds and gold. He also provides specific trades on the Japanese yen and crude oil. Filmed on August 8, 2019.
JUSTINE UNDERHILL: Welcome to Real Vision's Trade Ideas. Today, we're sitting down with John Kolovos of Macro Risk Advisors. It is great to have you back.
JOHN KOLOVOS: Thank you for having me.
JUSTINE UNDERHILL: So, I'd like to get your take on the current market environment to start out with.
JOHN KOLOVOS: Sure. So, equities. Boy, what a pullback we've seen. I think we need to view this pullback within the context of a longer term uptrend. So systematically and objectively, the trend for the US markets, the S&P 500, is still positive. But the way in which the decline has occurred is a little bit troublesome. And we need to keep a very close eye on that.
JUSTINE UNDERHILL: Okay. So, then could you take us a little bit through that historical perspective versus what you see going on today, specifically in equities?
JOHN KOLOVOS: Sure. So, as we made all-time highs and approached this 3065 level that have been thrown out all year, I think it made sense to be a bit cautious as you were getting to the high, and anticipating some sort of pullback. Why? Well, seasonality it tends to be weak this time of year, from July into October. Also, after the Fed cuts interest rates for the first time, markets tend to act poorly for about a month later after the cut. So, as we're seeing the markets roll over here, we need to view it within the context of what is- I would typically say normal, weak seasonalities and weak performance after a Fed cut.
JUSTINE UNDERHILL: And so, is this every single time after the Fed did its initial cut? We usually see the markets-
JOHN KOLOVOS: Well, what usually happens is and what I did was I did an interesting study is this like all right, the Fed's cutting rates for the first time. And let's take a look at how equities performed after and let's separate it from an uptrend into a downtrend. So, if equities went on uptrend and the Fed cut rates for the first time, how did equities perform? Well, actually, three months later, stocks were higher. But over the short term, stocks were lower.
But what's interesting about that is it only happened four times at the 17 observations that I saw. So, it's very unprecedented to see the Fed cut rates when equities are so strong. So, as markets are coming in, they're behaving in a way that they should, according to that study, and again, with the seasonalities and some other divergences that I'm seeing, but we have to start to study, okay, are we diverging, if you will, from what would be typically normal?
JUSTINE UNDERHILL: It is a rather small sample size to have the Fed cutting rates in a strong market environment. Do you see this time being substantially a different environment though, than possibly previous times? We have $15 trillion of negative yielding debt. We have a global economy that's potentially on the verge of a recession, earnings are potentially slowing down. So, do you see this time as being something that could be potentially worse than previous setups?
JOHN KOLOVOS: Yes, I do. Back in early 2018, when we had fallen again, when the equity market came down, I was inclined to buy that almost blindly. We were coming from a very strong perch with the equity market, had good breadth, good statistics technically into that high, you wanted to buy that pullback. And then now, what we're seeing with this pullback, there are a lot of divergences going on underneath the surface, which has me a bit concerned.
What are the divergences that they are? Well, let's say the S&P is an all-time high, financials aren't, industrials are not in all-time high. Small caps are not on an all-time high. Global markets have rolled over significantly. Emerging markets are in a bear market, they can't get out of their way. Same with Europe. It looks like a big massive top formation. So, global breadth is weak as markets are coming down. So, it is concerning with this pullback. Say, okay, as we come down to the support levels, we need to be very respectful of them.
JUSTINE UNDERHILL: What do you see equity markets doing in the medium term? Is it a muddle through for the time being? Is that something that you want to be in, be out of?
JOHN KOLOVOS: Okay, so on a longer term basis, I'm still positive on the equity markets. 3065, I think is the central tendency for this year, I think we can still work up there. But this is where it gets- we have to thread the needle a little bit. I will maintain that bullish view so long as the June 3rd lows on the S&P 500 holds, or you want to keep it real simple, that's approximate where the 200-Day Moving Average is, that is huge. I'm going to maintain my positive view for equities so long as we stay above it, say the 200-Day Moving Average, is a very simple proxy for trend, but it's incredibly useful. So, as long as you stay above it, I still think the trend for the market will stay higher. But what's incredibly important to consider with it to break the 200-Day Moving Average, if we do break below it, we tend to go into an environment lower for longer, it doesn't necessarily mean we're going to crash or something like that, but it does mean that we need to base out and to go sideways a little bit and get our bearings before we start pushing up higher. JUSTINE UNDERHILL: Okay, so then in terms of the equity markets, maybe it's something that you're a little bit cautious of right now. JOHN KOLOVOS: Yes, I am cautious on that. And there's one other scenario- I know I forgot to mention about why this is a little bit different than other pullbacks in the past. The S&P is following a pattern very similar to what we saw in the 1970s. I call it the bell bottom blues chart. Named after a great song from the Derek and Dominoes, nearly sound hound with Duane Allman and Eric Clapton, great song, but it's a bit worrisome and the analog is quite striking to me.
Back in the '70s, we saw higher highs and we saw lower lows. We're seeing that now with the S&P 500. It almost looks like a megaphone, if you will or broadening formation. They represent extremes in bullishness and bearishness, extremes in sentiment and how people feel about the environment. And what that means is, is that they tend to be trend killers, they tend to put an end into an uptrend and the implication of which- if I am correct in saying that this 200-Day Moving Average is important, if it gets violated, my suspicion is, will undercut the December lows around 2350 in a hurry.
So, we could be down peak to trough 20% by November if we do not hold these levels. So, it's incredibly important that we maintain the June low or the 200-Day Moving Average, very, very important. It's also interesting in my mind with that analog, it's not just the visualization of it. Think about what was going on in the '70s and what's going on right now. And I think the most important one would be the love affair that everyone has now with growth stocks, and you had it back then in the '70s. You had the Nifty Fifty then, now, you have the growth socks and the Fangs and what have you. That to me, it's just staring me right in the eye.
And the other thing would be is that back in the '70s, we had a President that was going after the Fed. Today, we have a President that is very critical of the Fed. Also, there were issues with OPEC back in the '70s. Of course, we got them right now. And instead of having a cold war with Russia, we're having a bit of a cold war, at least in a trade front, with China. So, there's not just the visual similarity, but I think from a society or social standpoint, there's also that those comparisons.
JUSTINE UNDERHILL: How do you see the bond market faring in that scenario?
JOHN KOLOVOS: Okay, so I think the trend for rates is lower. And I think we have to stay with the trend for lower rates. But I'll put a big asterisk on that. And this is hugely important as well, because equity markets and interest rates have correlated with each other on a 26-week basis since 2000. So, if interest rates go down, stocks should go down and vice versa. So, this decline that we just saw in interest rates has brought them to the most oversold level since 2002 on a weekly basis. And maybe like the 15th most overall interest rates have been since 1980.
So, what that's telling me is this, we're getting close to an important inflection point for interest rates, we could go down a little bit lower, I have an objective somewhere around 160, I wouldn't be surprised if we drift a little bit lower towards 150. But over the next eight to 12 weeks, we should see interest rates start to plateau and start to move up higher.
JUSTINE UNDERHILL: So, then in this potentially risk on environment, what do you see happening to gold?
JOHN KOLOVOS: So, gold- there's two things going on with gold. There's a long-term breakout for gold which implies 1800 on gold. Big base, breakout, technical breakout, everyone likes it. And it's true, it's a good breakout. But on a short-term basis, I think gold can pull back and consolidate here right now. And same with silver. Silver actually, I have more conviction on silver pullback than on the gold, silver has lagged the price action of gold up to this point. And if you look at the longer term chart of silver, it's bumping up against resistance here right now in an overbought state and in an environment where everybody is so risk off and so on edge that I think a pullback here makes it makes a bit of sense.
JUSTINE UNDERHILL: Okay, so with all that being said, where do you see the opportunity for a trade in this market?
JOHN KOLOVOS: Okay, so a couple things I have my eye on. I think it still makes sense to be cautious on the near term. And I think it always makes sense to protect yourself. And I think one interesting trade out there, particularly given that a currency volatility is very, very low right now, I would look to be long the yen here.
JUSTINE UNDERHILL: Okay. And so, that would be because of strength in the yen or potentially weakness in the dollar, what side are you looking at?
JOHN KOLOVOS: I see more of the yen gaining flows for safe haven, purposes, for more of the risk off. So, to protect myself, maintain being long the yen, thinking we get down to about $103.50 on the intermediate term basis. But no, I would maintain being long the yen in this environment here right now.
JUSTINE UNDERHILL: Okay. And that being a safe haven asset, how do you justify that with the idea that we might be in a risk on environment?
JOHN KOLOVOS: Well, I think it's just good like a hedge. I think it just makes sense. So, the way that, again, I keep going back into how the equity market had declined very quickly. That's the markets message of telling us, hey, something's going on, and let's pay attention to it. One interesting study I did recently was to take a look at when the S&P 500 declines through the 50-Day Moving Average and then did so when the yuan recreated change was already 5% or worse. And what I found there is that while returns are slightly positive, going forward for the next three months or so, the downside risks are very, very high.
So, what that means is, from a trend standpoint, we could be reversing. So, I think a yen trade would make sense in the context of also low currency volatility. So, if we get into a trade war with China, currency volatility is going to rep and accelerate, I think the yen is a good way to play it.
JUSTINE UNDERHILL: Interesting. So then, what would be your time horizon on this trade? And can you review your levels again?
JOHN KOLOVOS: So, the timeframe for the yen would be about two or three months, thinking about $103.50 is my initial objective there.
JUSTINE UNDERHILL: Are there other sectors or other commodities or other areas that you're looking at to trade right now?
JOHN KOLOVOS: Oil. I think oil is in a secular bear market, I think so long as oil stays below $60, I think it's a sell, they're looking to selling it, here pressing shorts below $50. Ultimately thinking that we do get underneath the December lows, $38 or so over the next six months or so.
JUSTINE UNDERHILL: Would you put a stop on that?
JOHN KOLOVOS: 60 bucks. $60. I'll just maintain the bearish view on it. So long it'd stay below $60. And then the only risk there to that would be what's going on in the Gulf with Iran. I think there's that risk that there's an accidental war or something along those lines where oil could spike. But you just look at the secular trend, it's down. So, even in the '90s, when we had the Gulf War then, oil did spike, but it still was within the context of a secular bear market from that era. I would still view oil, even we do get a spike- hope not for that reason- but it would still be within the context of a secular bear market.
JUSTINE UNDERHILL: And what is your time horizon for that trade?
JOHN KOLOVOS: So, the trade would be six months plus, it's more of a longer term view. If you want to say six, that's fine, but yeah, longer term, making new lows on oil.
JUSTINE UNDERHILL: And would you be doing this through the futures market or?
JOHN KOLOVOS: Futures. You can also use the USO, which is an ETF, that could also be a good way to play it. And then akin to that would be the energy sector, XLE. I think oil makes that sector un-investable on a relative basis.
JUSTINE UNDERHILL: All right, can you review your general market thesis as well as specifically your view on oil and the yen. 30 seconds.
JOHN KOLOVOS: Yeah, for 30 seconds. You got it. All right, so for equities, I think on a long term basis, you need to maintain your positive view so long as we stay above the June 3rd lows or the 200-Day Moving Average to keep it really, really simple. Still looking at around 3065 as your potential upside objective, all bets are off underneath that level, we want it falling into that bell bottom blue scenario where we have a quick decline lower on stock. So critically important there.
In terms of the yen, since currency volatility is very low and there's high risk of lower risk assets, if you will, I think it makes sense to be long the yen down to about $103.50. And then finally, when it comes to oil, oil secular bear trend is in place, momentum has reasserted itself to the downside, would look to play oil to the downside to at least $50, if not lower to new all-time lows to about $38 or so.
JUSTINE UNDERHILL: Great. John, thank you so much for joining us, and we'll have you back soon to give us a little bit of an update as to where things are going.
JOHN KOLOVOS: Thank you for having me.
JUSTINE UNDERHILL: So, John is bullish on the yen. Specifically, likes buying at current levels with the target of 103.50 over the next two to three months. Since the interview was recorded, John has updated his stop loss to 108. Additionally, he likes shorting oil at current levels with a target of $38 over the next six months and a stop loss at $60.
Just remember this is a trade idea and not investment advice. Make sure to do your own research, consider your risk tolerance and invest accordingly. For Real Vision, I'm Justine Underhill.