ANSWERS TO P&F QUESTIONS -- THE FIRST SIGNAL IS ALWAYS THE BEST ONE -- TRY PERCENTAGE SCALES WHEN THERE ARE DISCREPANCIES -- THE DOLLAR HAS NO LONG-TERM LINK TO STOCKS -- CORPORATE BONDS DO
THE FIRST SIGNAL IS ALWAYS THE BEST ONE... Chart 1 is the point & figure chart of the S&P 500 that I posted on Friday to show that its trend is still upward, and made mention of the buy signal given at 935 during July. One of our readers pointed out that I did not mention the previous buy signal at 930 in June which was followed by a sell signal in July at 885. He then claims that "you would have lost a bundle" between the June sell signal and the buy at 935 a month later. First let's correct the reader's numbers. The May (not June) buy signal took place at 915 not at 930. The initial sell signal in June took place at 925 not 885. It's the first buy or sell signal that counts. That put the July buy signal ten points (or 1%) over the June sell signal. That's hardly "losing a bundle". In retrospect, the chart shows that a trader would have captured the vast majority of the rally off the March low.
Chart 1
TRY PERCENTAGE SCALES ... Another reader asked why the "traditional" p&f chart of the Nasdaq 100 looks so different from the chart of the QQQQ since they're essentially the same market. The problem has to do with the scaling of the two charts and the fact that they cover different time periods (one covers seven months and the other seven years). When faced with that type of discrepancy, it's better to switch to a "percentage" scale which makes each box the same percentage value (usually 1%). Charts 2 and 3 show the similarity of both charts on a 1% percentage scale. An initial buy signal was given in both during March and, except for one short-term whipsaw during July, have been in uptrends since then. When p&f charts of two markets that should look the same look different, try switching to a percentage scale. That should fix the problem.
Chart 2
Chart 3
YOU CAN'T ARGUE WITH THE NUMBERS ... When gold is in a strong uptrend, gold miners usually outperform the commodity. That's one of the historic realities that I wrote about years ago in my first intermarket book in 1991. One reader disagreed with my Friday comment that gold stocks were indeed rising faster than bullion. Since last October, the Market Vectors Gold Miners ETF (black line) has risen 87% while bullion has gained 25%. That means that gold miners have more than tripled the gain in bullion. You can't argue with those numbers. [In response to another question about natural gas stocks, it's also true that commodity-related stocks usually rise faster than the commodity].
Chart 4
LONG-TERM LOOK AT THE DOLLAR VERSUS STOCKS ... Since the start of 2008, an inverse relationship has existed between the U.S. Dollar and the stock market. Over the short-run, therefore, a falling dollar appears necessary to continue the stock market uptrend (while a dollar bounce could lead to stock profit-taking). One of our readers asked what a 20-year comparison would look like and if a rising dollar could co-exist with rising stocks. Chart 5 shows that the stock market (red line) has rallied with a rising dollar (1995 to 2000) and with a falling dollar (2003 to 2007). Both fell together during 2002. On a longer-term basis, therefore, the direction of the dollar has shown little correlation to the direction of the stock market. Other factors (like the direction of interest rates and commodities) have a more direct bearing on stocks. I suspect that the current inverse relationship between stocks and the dollar is a relatively short-term phenomenon which will disappear once the global economy is on a sounder footing. At the moment, a dollar "carry trade" appears to be in effect where global traders borrow cheap dollars (sell them short) and invest in higher-yielding commodities and stocks. I suspect that will end once U.S. interest rates start rising.
Chart 5
LINK BETWEEN CORPORATE BONDS AND STOCKS ... My Friday message expressed some caution about last week's high volume drop in the investment grade corporate bond ETF (LQD). A couple of readers asked if a drop in corporate bonds was an early warning of a possible correction in stocks. Charts 6 and 7 may help answer that question. I believe that the relationship between Treasury and corporate bonds tells us something about investor sentiment and the state of the stock market. The red line in Chart 6 is a ratio of investment grade corporate bonds (LQD) divided by the 10-Year Treasury Note prices (IEF). The green line is the S&P 500. The chart shows that corporate bonds outperformed Treasuries (rising ratio) while stocks were rising from 2003 to 2007. That makes sense. Corporate bonds depend to a large extent on the profitability of corporations while Treasuries are defensive in nature. Chart 6 shows the LQD:IEF ratio "double topping" during 2007 (as it retested its 2005 peak). In retrospect, that could have been viewed as an early warning of stock market problems ahead. Chart 7 shows the two lines dropping together from mid-2007 to last October as investors fled corporates and bought Treasuries. The ratio bottomed last October which was five months before the March stock bottom. Both lines have rallied together since March.
Chart 6
Chart 7
LQD:IEF RATIO BREAKS 50-DAY LINE... Chart 8 shows the LQD:IEF ratio breaking its 50-day average for the first time since April. Chart 9 shows the LQD testing its 50-day line (also for the first time since April). While no serious damage has yet been done to the uptrend (as long as the 50-day line holds), heavy downside volume bears watching. High yield corporate bonds have been rallying even more than investment grade corporates all year. Chart 10 shows the High Yield Corporate Bond ETF (HYG) retesting its September high. There again, heavy downside volume (and relatively light upside volume) should be watched closely as well. The reason being that I believe that there is a link between the direction of corporate bonds and the stock market. Any serious downturn in the former would be a warning for the latter.
Chart 8
Chart 9
Chart 10
S&P 500 SPDRS TESTS HIGH ON LIGHT VOLUME... I doubt that it's a coincidence that the chart of the S&P 500 SPDRs (SPY) is nearly identical to the chart of the junk bond ETF in Chart 10. Chart 11 shows the SPY testing its September high at 108 (1080 in the S&P 500 cash index). What's a little disburbing is the volume pattern over the month. The big red volume bars show pretty heavy selling at the end of September as prices fell, while the relatively small green volume bars show light volume on the recent rebound. In a strong uptrend, the volume pattern should be just the opposite. That is, lighter volume on pullbacks and heavier volume on rallies. That may mean nothing more that the fact that the market needs to mark time for a bit within its recent trading range. The general uptrend will remain intact as long as the early October intra-day low at 101.99 remains intact.
Chart 11
I AM NOT A SILENT BEAR ... One of our readers suspects that I'm a "silent bear". Well, I'm not. I've expressed the belief several times over the last seven months that the market has probably bottomed. That bullish view, however, doesn't rule out market pullbacks or retests of underlying support levels. My initial upside target for the current rally (given in March) was a 38% retracement of the entire bear market and a rally to 1000 in the S&P 500. When the 1000 barrier was broken over the summer, I upped my target. I have been too cautious during September and October, however, when I thought technical and seasonal factors would lead to an autumn pullback. I continually emphasized, however, that any meaningful pullback should be viewed as a buying opportunity. That's not a bear market view. Having said that, I would be remiss in not pointing out that the market is approaching another important test. Chart 12 is an updated version of a chart that I showed on September 18. The weekly bars show that 1120 marks a fifty percent retracement of the entire bear market. That also marks the spot where a major down trendline comes into play. That makes 1120 a very important barrier that the market will have to overcome at some point to dispel any lingering doubt about whether this is a legitimate bull market or just a huge bear market rally. Or, what is more likely, whether or not stocks will have to do some more work at lower levels as part of a bottoming process.
Chart 12
