Using ETFs to Hedge the S&P 500
Featuring John Kolovos
Published on: June 19th, 2019 • Duration: 17 minutesJohn Kolovos, CFA, CMT, chief technical strategist at Macro Risk Advisors, reaffirms his trade from early May where he suggested going long the S&P 500. He updates his original thesis and reviews the price action since he last appeared. Kolovos then suggests two ways to hedge a potential breakdown in his thesis through the ETFs $GLD and $TLT, in this interview with Justine Underhill. Filmed on June 18, 2019.
JUSTINE UNDERHILL: Welcome to Real Vision's Trade Ideas. Today, we're sitting down with John Kolovos of Macro Risk Advisors. It's great to have you here.
JOHN KOLOVOS: Thank you for having me.
JUSTINE UNDERHILL: So, you were here about six weeks ago, and you were quite bullish on the S&P 500. You saw it in this long term trend channel. You had a year-end target of 3065 and a stop loss at 2850. Since then, we've had a lot of things going on in the markets. We had the selloff in May. It's rebounded up past 2900. Can you give us a little bit of an update as to what your levels are right now?
JOHN KOLOVOS: Okay. Sure. First and foremost, thanks for having me again. And number two, I would say yeah, my objective for the S&P 500 is still the same. 3065, I could even say get as high as 3100. The pullback that we saw in May was just that. It pulled back, a minor correction. We saw an acceleration in downside momentum, but not enough to tilt trend. So, trend is still positive. And I still want to stay on the side of trend.
JUSTINE UNDERHILL: In terms of staying on the side of trend, what technicals are you looking at right now?
JOHN KOLOVOS: Sure. So, I'd say this market's strongest attribute here right now, besides trend is sentiment. And I would say that sentiment is so bearish right now, that is as bearish as it was back at the cyclical bear market low of 2016. And one indicator that I look at is the AAII bull-bear ratio. And that is, like I said, at the same level as it was back in 2016. We're only a couple percentage points away from a new all- time high. And sentiment is as if we were at a multiyear low. So, to me, I want to look at the other side and be contrarian. So, sentiment is quite compelling.
Also, on the sentiment front to put call ratio during the May pullback reached about three standard deviation levels, you want to be on the other side of that so on a put-call basis that was quite high. Also, the bond VIX, the move index, also hit about a three or four standard deviation level. When you have the combination of your put-call spiking and your move index spiking, you tend to have very positive for returns for the S&P 500. So, sentiment would be the other indicator that I've been looking at.
And the other category of indicators I'll be watching closely would be- or I'm watching closely is momentum. So, as we came down to around that 2700 level in the S&P 500 during the May pullback, the market always responded exactly what it was supposed to. I wrote in my reports that the markets move and as part of a three-act play. You have initial down move, which is Act One. Act Two would be the oversold rally, and then Act Three would be the lower low. And that's what corrections are, tend to be a three-part sequence.
And the way you measured it, a technician will come up the measured objective or whatever. And you get down to around this 2700 level. That's where we got to in the market, we spotted off of it. And then when we spotted off of it, it responded off with a very robust price momentum. And also, with a very strong advanced decline ratios. We had like a 90% right off the low, we were able to shoot up higher to about where we are right now. So, price momentum has been very, very strong.
And then lastly, how is this pullback, the one we had in May, different than what we saw back in 2018? And I think this is important to think about is that if you were to overlay, the pullback that started in May, actually the pullback to turn into a bear market- with an October's with what we see right here in May. They're almost one and the same. They both broke down from wedge formations. And they both went through this one, two, three- sequence at one, two and three.
What happened in 2018 is that we actually had breadth divergences like the AD line was already declining while the market was going up. Currently, when the market made a new high, all-time high breadth confirmed. So, the market was on a stronger footing now than it was then. So, I'm inclined to be buying this pullback versus what happened last year. So, I'm looking at breadth, I'm looking at momentum, and I'm also looking at sentiment.
JUSTINE UNDERHILL: Okay, and right now, do you see that rally potentially happening sooner than later? Or do you think for a while, we're just going to muddle through?
JOHN KOLOVOS: I think it's going to be a little bit of a muddle through. We have summer seasonality to deal with, we have a lot of catalyst ahead, we have G20 meeting, we still have the Fed coming up in a couple days. So, there's a lot of that going on. And we also have the July employment data that needs to come out and market has to figure out what to do with that. So, I think it would be muddle along but eventually will make the higher high and make a push up to 3065.
JUSTINE UNDERHILL: Is your stop loss still in the same area at 2850?
JOHN KOLOVOS: It is, it is actually, yeah. I have raised 2860 and adjust a little bit, but we'll call it 2850. It's fine enough.
JUSTINE UNDERHILL: And technicals there, is there a point that people should be watching for in the stock market to say I got to back out?
JOHN KOLOVOS: Yeah, I believe underneath 2860 will prove to the marketplace that the correction that we went through in May is still ongoing and that a break underneath that level will tell us, well, we need to go back down to around 2700 and test the level that I would have been calling as trend defining support. So, anything underneath that 2700 level, we start questioning the trend models I was referring to earlier that perhaps we need to become a little bit neutralish, if not come become a bit negative.
JUSTINE UNDERHILL: Okay, so if you were looking to trade this in the SPY, what levels would you be looking at?
JOHN KOLOVOS: So, SPY, that's approximately 310 on the SPY as a target and for the stop would be around 285.
JUSTINE UNDERHILL: Given that we are potentially going to see a muddle through period, would you consider putting a hedge on that trade?
JOHN KOLOVOS: Yeah, I would actually. And what's quite interesting when it comes to gold, for instance, I think is one hedge we can put on. One thing I've been telling the clients and even my written reports is this, if you were just to cover up the price, the label for gold on your Bloomberg chart or wherever, and say, oh, what is that? It's quite compelling. It's an interesting chart. We should be long regardless of what asset class it is. So, on a short term basis, gold looks very interesting to me. But it's only a tactical idea. It's only a hedge. It's not a strategic long term idea.
And the reason being is if you were to look at a long term picture of gold, it's been basing for about four or five years, okay, underneath this 1352 to 1375 resistance level. It's a base and technicians get very excited about these bases, but it's still a base until it breaks out and it hasn't broken out yet. So, from a tactical standpoint, I think we can push up and test those levels and maybe continue a little bit of the short term momentum that we've seen, but longer term, it's hard to become bullish on gold until we break out above that level.
And one last thing is that with gold, if you would look at the ratio of stocks to gold, the stock to gold ratio, that is actually giving a tactical cell signal. So, I do want to be hedged a bit when gold is outperforming stocks, which it is right now on a short term basis.
JUSTINE UNDERHILL: So, just to follow up on that chart that you mentioned of stocks versus gold, stocks are underperforming gold on a short term basis. But what about a long term?
JOHN KOLOVOS: Long term basis now, stocks are still outperforming gold. A great indicator that technicians have used for decades is to look at the stock to gold ratio on a monthly basis and you overlay with say, a 15-Month Moving Average. If that ratio is above trend, you're in a secular bull market. If below trend, you're in a secular bear market. So, while stocks have lost momentum relative to gold, the trend is not negative. So, I just want to make it clear that on a structural basis, stocks are still on an uptrend and down the road if things start to turn south for stocks, I'll be watching this quite closely to tell me whether or not maybe stocks are turning into more of a prolonged bear market or not.
JUSTINE UNDERHILL: And looking at the price chart of gold, you have mentioned in notes that even a gold rally up to 1700 would still mean that there's a secular bear market for gold.
JOHN KOLOVOS: Yeah, that's right. So, even last time I was here, and we talked about oil. And I think oil continue to move lower. Why? Because it's a secular bear market. And same with gold. Gold, I believe is in a secular bear market. So, if gold were to break out at say above this 1375 level, it counts to 1700. It's a nice rally, it's a strong move, but it still would keep gold within the definition of a bear market, secular bear market. A decade of just volatile sideways trading and it would be very similar to what we saw back in the '80s.
JUSTINE UNDERHILL: So, is this gold trade just a short term tactical trade rather than watching it get up to 1700?
JOHN KOLOVOS: Correct. Yes. I wouldn't be surprised to see it get up that high on a sustained breakout. But as of right now, I'm treating strength right now in gold as a tactical position.
JUSTINE UNDERHILL: Okay, so what would you be looking for to actually see it get up to something?
JOHN KOLOVOS: Okay, so there is actually an inverse relationship between gold and real interest rates. So, gold is bumping up against major resistance around this 1350, 1375 level. Real rates on the 10 Year, okay, has a strong support at around 30 basis points right now. So, for gold to breakout, real rates would really have to break down. And the market right now is supporting interest rates at that level. If the Fed does cut and say, they continue to cut, it's quite possible real rates head closer to negative. And that would be a tailwind for gold. But I want to wait for confirmation from gold breaking out to position better for the 1700 and also look for real rates to confirm the breakout.
JUSTINE UNDERHILL: And what about your stop loss?
JOHN KOLOVOS: So, for gold, I would say the stop- and actually I came prepared more to talk about the GLD, I would say the target for GLD would be around 137 to around 140 with the stopping at around 123.
JUSTINE UNDERHILL: And are there other asset classes that you would use to hedge?
JOHN KOLOVOS: I would be looking at bonds as well. In particular, I think individuals can be long the TLT. Just a small position. I think given the uncertainty that we're in right now, having some hedge on I think is totally fine. And the reason being is you think about it, the market only really gives us a tremendous buying opportunity once every couple years. And I believe that buying opportunity happened in December of 2018. Now, we're much, much higher. And now, you have a little bit more careful I guess about your spots and how you play it. But also, we're almost at a new high for the market. And I think the market's really going to test the participants' will, whether or not they're going to allow it to break out. So, I think it's a good idea just to keep a bit of a hedge in the TLT would be one.
JUSTINE UNDERHILL: So, what technicals are you looking at in TLT?
JOHN KOLOVOS: TLT, honestly, first and foremost is just the price trend for the TLT. It is just compelling. It broke out of a small base about a month and a half ago. And it's just been trucking along beautifully since then, just like gold, if you will just to hide the ticker on your screen and try to guess what stock that was, you would think it was a tech company or a biotech company. No. It's bonds. So, it's very, very strong. So, really, it's trend to momentum that's keeping me on the long side of bonds.
JUSTINE UNDERHILL: Okay. So, talk about some of your levels, what's your entry and your target and stop loss?
JOHN KOLOVOS: Sure. For a short term perspective, I would look at around 134.5 with the TLT. There is scope to get to 140. I know that's a bit aggressive. But I would say somewhere around 134.5 would be the initial level to look at. As for stops, I would say 130.25 would be a good stop or longer term, the 50-Day Moving Average. I think the 50-Day Moving Average for the TLT could be a good trailing stop over time.
JUSTINE UNDERHILL: And in terms of timeframe for both TLT and GLD, what are you looking at?
JOHN KOLOVOS: I would say just over the course of a couple of months honestly. Like I said, this is a tactical concern. And as we just back up a little bit and just think about what other things I'm looking at for bonds, interest rate should, in theory, try to find a floor around here at least temporarily, around 2% on the 10 Year. And I'm saying this before a Fed meeting. But when I look at the price and I use the chart of copper. Copper is testing a major support level. As I mentioned earlier, gold is testing a major resistance level.
So, my process tells me to respect my levels. I'm going to assume that support is going to hold, I'm going to assume that resistance could very well hold. And when you combine the two, copper and gold, you have the copper gold-ratio, and the copper-gold ratio actually correlates pretty well with interest rates. So, if the copper-gold ratio is oversold in that support, then interest rates should be oversold in that support, and therefore, rates go up. And then bonds should eventually find its way lower. So, that's why I think it's more of a tactical issue being long bonds than a longer term view because like I said the longer term support levels are legit for copper.
JUSTINE UNDERHILL: Gotcha. Now, you mentioned the Fed and we have a big Fed meeting coming up, what would be your response either way, let's say the Fed is more hawkish or comes out more dovish, how would you react to that?
JOHN KOLOVOS: I say I would wait until the dust settles. We're dealing with an all-time high for the stock market. I think the market's going to really test the will of its participants. That's what it's going to do. I wouldn't be surprised to see the market be following in both directions. Both on the upside and the downside. I think the algos will go wild the minutes after the statement gets released, I wouldn't act on that immediately, I would wait. Look at your levels, be mindful of your levels and then act accordingly after the event happens. It's not a good idea usually should you just acting right away. You have to think about- and again, I always tell everybody just watch your levels. Be mindful of them.
JUSTINE UNDERHILL: And in terms of G20 meeting, how do you see that potentially impacting your hedges or potentially, the markets?
JOHN KOLOVOS: Well, if it's a positive outcome, we should see gold come in. We should see bonds come in and then the stock market move up. One thing that I tried to do, and I advise our clients is that you got to be incremental. There's no rule out there that says on day one, you have to be 500 basis points overweight a position on day one, you can incrementally change your positioning. So, if the outcome is positive, yeah, we take back our hedges and then we stay with our core long positions. If it turns out to be a negative event, even with the Fed, what was a hedge could eventually evolve into a strategic longer term position. So, it's all incremental. It doesn't have to be a binary. Okay, I'm long stocks today. And I want to be short bonds tomorrow.
JUSTINE UNDERHILL: All right, can you summarize your entire trade thesis in 30 seconds?
JOHN KOLOVOS: Sure. I can. So, for the S&P 500, I would be looking for 3065 to 3100 as the upside objective, with the stopping at around 2860. I do want to just make it clear as well that that trend defining support level is somewhere around that 2700 level. So, if markets do rollover, that will be in a very, very important spot to be mindful of on an intermediate term basis.
For the second trade, it will be GLD. 137 to 140 would be the upside objective, with support being at 123. And as for bonds, the TLT, we have a short term objective at 134.5. 140 is possible with a stop at 130.25 and 127 being the 50-Day Moving Average.
JUSTINE UNDERHILL: Great. John, thank you so much.
JOHN KOLOVOS: Thank you for having me.
JUSTINE UNDERHILL: So, John is still bullish on the stock market. He suggests buying the SPDR S&P 500 ETF at current levels with a stop loss at 285 and a target price of 310 by the end of the year. In addition, he's also bullish on bonds and gold and likes buying them as hedges. Specifically, he likes buying the iShares Treasury bond ETF, ticker symbol TLT at current levels with a stop loss at 130.25 and 127 and a target price of 134.50 over the next few months. He thinks it could go as high as 140. And finally, John's just buying gold for a tactical trade. Specifically, he likes buying the SPDR gold ETF, ticker symbol GLD at current levels with a stop loss at 123 and a target price of 137 over the next few months.
Just remember this is a trade idea and not investment advice. You should do your own research, consider your risk tolerance and invest accordingly. For Real Vision, I'm Justine Underhill.