WEAK ECONOMIC NUMBERS PUSH BOND YIELDS AND DOLLAR LOWER -- SOME MONEY IS MOVING BACK INTO BONDS FROM OVERBOUGHT STOCKS
BOND YIELDS FALL SHARPLY ... An unexpected drop in September consumer confidence and a drop in manufacturing activity have raised fears of an economic slowdown. That's pushing bond prices higher and bond yields lower. Chart 1 shows the 10-year T-note yield falling to the lowest level in a month after failing a test of its 200-day moving average. [That's weakening the dollar and boosting gold shares]. As you would expect, bond prices are rising today. That's happening at a good time for bonds.
Chart 1
BOND ETF BOUNCES OFF CHART SUPPORT ... Chart 2 plots the 7-10 Year Treasury Bond ETF (IEF for the last two years. During September, the IEF broke through the January highs near 82. On the subsequent pullback, the price has bounced off that new support level and its 50-day moving average. [Broken resistance levels become new support levels]. That's keeping the uptrend in bond prices intact. Bond prices usually rise (and bond yields fall) when investors start to sense a weaker economy. Money moving into bonds usually comes from the stock market. That rotation may also have some other technical underpinning.
Chart 2
BOND:STOCK RATIO BOUNCES OFF MAY LOW ... There's usually a tug-of-war going on between bonds and stocks. When investors are confident, stocks do better than bonds. When they're less confident, bonds usually do better. One of the best ways to monitor the relative strength between the two asset classes is with a ratio. Chart 3 is a ratio of the Bond ETF (IEF) divided by the S&P 500. Bear in mind that the ratio has been falling throughout the four year bull market in stocks as stocks have outperformed bonds. During the stock market correction in May, the ratio turned up as nervous money flowed into bonds. Since the August bottom in stocks, the ratio has fallen as money moved back into stocks. Notice, however, that the ratio is starting to bounce off its May bottom. The presence of the May low in the bond/stock ratio (potential chart support) suggests that this is a logical spot for some money to start rotating back into bonds. That could come at the expense of an overbought stock market.
Chart 3
S&P 500 STILL LOOKS OVER-EXTENDED ... A few weeks back I applied long-term Bollinger bands to the S&P 500 to make the case that it had moving into over-extended territory. I simply plotted the bands around a 400-day moving average (the equivalent of a 20-month average). I explained that, in the past, moves over that upper band were usually followed by downside corrections. Chart 4 shows that the S&P 500 is still above the upper band and is still over-extended. The two accompanying indicators show the same picture. The 14-day RSI (top of chart) had climbed over 70 (overbought territory) for the first time in a year and is starting to weaken. The PPO Indicator (along the bottom) is a normalized variation of the MACD lines, and has also moved into overbought territory over 1.0. Let's take a closer look at the PPO.
Chart 4
MACD USED AS AN OSCILLATOR ... The Moving Average Convergence Divergence (or MACD) lines are one of my favorite indicators. Trading signals are given when the shorter average crosses the longer. Another version of the MACD is also available and is called PPO (Percentage Price Oscillator). The PPO gives the same signals as the MACD, but allows us to identify overbought and oversold zones more easily. Chart 5 plots the PPO below the S&P 500 for the last two years. The most important value on the PPO chart is the zero line. Moves over the zero line are bullish; moves below it are bearish. The last time the PPO crossed over zero was during July. Two other important lines are +1 and - 1. They mark overbought and oversold levels respectively. The last oversold reading was given during June just prior to a market bottom. The PPO is now in overbought territory for the first time in nearly a year. That doesn't have any long-term significance. But does support the view that the market is over-extended and in need of a period of consolidation or correction. If the latter were to occur, initial support is likely at the 50-day moving average or the spring high at 1325. Meanwhile, the Nasdaq is struggling near its spring high. That's a logical spot to expect some profit-taking.
Chart 5
OVERBOUGHT NASDAQ MAY STALL AT SPRING HIGH ... I keep coming back to the Nasdaq market because I believe it holds the key to the short-term direction of the market. It's the only one of the three major stock indexes that hasn't cleared its spring high. Chart 6 shows the Nasdaq Composite right up against potential resistance at its spring high near 2378. Given the overbought state of the market, that puts the Nasdaq in a logical spot to stall. If it stalls, the rest of the market will probably stall as well. That's because the Nasdaq has been leading the rest of the market higher since the August bottom. That can be seen in the rising relative strength (blue) line overlaid on Chart 6. That makes it a crucial part of the market rally. The RSI and PPO lines also show the Nasdaq in overbought territory.
Chart 6
BOLLINGER BAND WIDTH NARROWS ON NASDAQ ... The blue lines in Chart 7 are daily Bollinger bands plotted around a (red) 20-day average of the Nasdaq. The 20-day line has acted as support for the last three months. Any close below that support line (now at 2338) would signal a short-term downturn. If that were to occur, the downside target would be to the lower band (now at 2290) which is 70 points (or 3%) from today's price. One sign that a correction may be due is the downturn in the black line which measures Band Width (the difference between the two bands). Expansion of the bands (a rising black line) is usually associated with a strong market. Contraction of the bands (a falling black line) is normally associated with a consolidation or a pullback. The black line has fallen to the lowest level in a month which increases the odds for some short-term selling.
Chart 7
ADX LINE TURNS DOWN FOR THE DOW ... Another indictor that's helpful spotting market turns is the Parabolic SAR. They're the rising green dots applied in Chart 8 to the Dow Industrials. The rising dots are used like spotloss points. The Dow hit its SAR price yesterday which is usually viewed as a sign to take some short-term profits. The three lines below Chart 8 also show weakening in the Dow's uptrend. The positive DI (green) line is still trading above the negative DI (red line) which means the trend is still up. The two lines are converging, however, which indicates a weakening uptrend. The black line is the ADX line which measures the strength of the uptrend. The ADX (Average Directional Index) line, which has been rising since August, is starting to turn down from overbought territory over 40. If a pullback does materialize, the Dow could test its (blue) 50-day average which is 350 points (or 3%) from its current price. Two things that could cause that to happen are some weak economic reports and new bond buying. Both of those are occurring today.
Chart 8
