STOCKS RETHINK FED POLICY STATEMENT -- XLF AND XLY GAP DOWN FROM RESISTANCE -- HEAD-AND-SHOULDERS REAPPEARS IN QQQQ -- SHORT-TERM RATES HIT RECORD LOW -- HOW LOW FOR THE 10-YEAR TREASURY YIELD? -- MOVING FROM RISK-ON TO RISK-OFF
STOCKS RETHINK FED POLICY STATEMENT... Link for todays video. After bouncing yesterday afternoon, stocks opened sharply lower on Wednesday morning in what looks like a rethink of the Fed policy statement. The prospects of further quantitative easing and even lower interest rates may seem promising on the surface, but one wonders why the Fed must resort to such moves. The answer can be found in the Feds policy statement, which alluded to a weaker-than-expected recovery. This might not have been a problem when the S&P 500 was trading around 1020 in early July. However, the S&P 500 was trading around 1120, which is some 10% above its early July lows. The market had already priced in expectations and the Fed just dashed these expectations. Chart 1 shows the S&P 500 hitting resistance near the June high. Also notice that the index retraced 50-62% of its April-July decline. Admittedly, this is the perfect spot for a counter-trend rally to fail. With todays developing long red candlestick, the index filled the August 2nd gap and is about to test first support at 1088. A move below this level would forge a lower low and reverse the uptrend of the last 5-6 weeks. The indicator window shows MACD on the verge of moving below its signal line (red). Chart 2 shows the Nasdaq with similar characteristics. The index hit resistance near the 50% retracement, stalled for a couple weeks and declined sharply today. Notice that the Nasdaq is already on the verge of breaking its late July high. CCI turned momentum bearish with its deepest move into negative territory since early July.
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Chart 1
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Chart 2
XLF AND XLY GAP DOWN FROM RESISTANCE... There are eight sectors in the S&P 500, but some are more important to overall market performance than others. I consider consumer discretionary, finance, industrials and technology as the offensive sectors that are vital to overall market performance. Healthcare, utilities and consumer staples are the defensive sectors that perform best during adverse market conditions. Materials and energy perform best when the Dollar is falling, commodity prices are rising and stocks are rising. Of the four offensive sectors, the consumer discretionary and the finance sectors stand out. Consumer discretionary represents consumer spending, which drives some 2/3 of GDP. Finance represents the health of the banking system. Chart 3 shows the Consumer Discretionary SPDR (XLY) hitting resistance near the 50% retracement and gapping below the July trendline. Support from the late July low has yet to be broken, but the gap down is bearish until filled. Chart 4 shows the Financials SPDR (XLF) breaking below the July trendline and late July low with a gap down. Again, this is bearish as long as the gap remains unfilled. Also notice that the price relative hit a new low as XLF continues to underperform. Chart 5 shows the Industrials SPDR (XLI) gapping down to form an island reversal over the last nine days. Chart 6 shows the Technology SPDR (XLK) hitting resistance near the 62% retracement and gapping down today.
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Chart 3
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Chart 4
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Chart 5
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Chart 6
HEAD-AND-SHOULDERS REAPPEARS IN QQQQ... Chart 7 shows the Nasdaq 100 ETF (QQQQ) with a head-and-shoulders pattern evolving on the weekly chart. Head-and-shoulders patterns were identified in mid June as well, but stocks had other plans with the July rally. Despite this advance, QQQQ is meeting resistance near the prior high. Even though the week is still incomplete, QQQQ has a bearish engulfing pattern working this week. Also notice that CCI is meeting resistance near the zero line for the second time since June (red arrows). Turning back to the head-and-shoulders, neckline support resides around 42.5 and a break below this support zone would target further weakness towards the mid 30s. The height of the pattern is subtracted from the neckline break for a target (50 - 42 = 8, 42 - 8 = 34). A 50-62% retracement of the March-April advance also extends to the 35-37.5 area. Some readers are probably wondering about the asymmetrical nature of this pattern. Perfect patterns are the exception rather than the norm. I think the current chart pattern captures the essence of a head-and-shoulders reversal.
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Chart 7
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Chart 8
Chart 8 shows the S&P 1500 ETF (ISI) with a similar pattern at work. The S&P 1500 ETF is a broad-based ETF composed of stocks from the S&P 500 (large-caps), S&P 400 Midcap Index and S&P 600 SmallCap Index. Notice that the Commodity Channel Index (CCI) surge to overbought levels in late April 2009 and this heralded the start of an extended advance. CCI stayed above -100 until late June, which is when it became oversold for the first time since early March 2009. This plunge to oversold levels is a sign of weakness that could herald an extended decline. The zero area now becomes resistance.
SHORT-TERM RATES HIT RECORD LOW ... Short-term rates continue to fall like a rock. 3-month T-Bill rates are near .015%, which is essentially zero percent. 1-year Treasury rates are at .025%, which is still close to zero percent. Chart 9 shows the 2-Year Treasury Yield ($UST2Y) breaking below its 2009 lows in June and continuing to record lows in August. 5 is the equivalent of 5% on this chart. .50 is the equivalent of .5% or half a percent. Nominal yields cannot go below zero percent so there is not much room left to fall. Real yields (nominal yields less inflation) can turn negative. Notice how short-term yields and the stock market are positively correlated for the most part. Both fell into 2002-2003, rose from 2003 to 2006-2007, fell from 2007 to 2008 and rose in 2009. Things started changing at the end of 2009 when the 2-Year Treasury Yield failed to break its prior highs and then moved to new lows. According to this positive correlation, stocks should follow rates lower at some point. Chart 10 shows the 5-Year Treasury Yield ($UST5Y) breaking down over the last few weeks. The 5-Year Treasury Yield ($UST5Y) broke support at 2% and looks poised to break its 2008 low.
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Chart 9
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Chart 10
HOW LOW FOR THE 10-YEAR TREASURY YIELD?... Long-term rates have the most room to fall. Chart 11 shows the 10-Year Treasury Yield ($TNX) breaking support in late June and moving below 2.75% (27.5) this week. The support break and downtrend clear the way for a support test around 20 (2%). A 10-Year Treasury Yield of 2% is hard to fathom, especially with the borrowing needs of the US government. Weakness in the economy, deflationary pressures and a flight to safety are pushing yields lower. These same reasons are enough to push stocks lower. Notice that the 10-Year Treasury Yield bottomed ahead of the stock market in December 2008 (four months earlier). The 10-Year Treasury Yield peaked at the beginning of April (about four months ago). Stocks were moving down along with yields in May-June, but decoupled with a rally in July. It may be time for stocks to catch up to falling yields.
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Chart 11
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Chart 12
MOVING FROM RISK-ON TO RISK-OFF... I featured PerfCharts depicting profiles for the risk-on trade and the risk-off trade on Friday. The risk-off trade was in force from late April until early July. Stocks, oil and the Euro declined as the Dollar, gold and bonds advanced. The risk-on trade was in force from early July to early August. Stocks, oil and the Euro advanced as the Dollar, gold and bonds fell. Trading on Friday morning showed a preference for the risk-off trade. We are also seeing a clear preference for the risk-off trade on Wednesday. Stocks Europe got things started with the German DAX ($DAX), French CAC 40 ($CAC) and London FTSE ($FTSE) losing over 2% each. The Euro was also down sharply, which means the Dollar was up sharply in a flight to relative safety. With stocks and the Euro positively correlated the last five months, a breakdown in the Euro would be negative for stocks. Chart 13 shows the Euro and stocks rising into April, falling together in May-June and then rising into early August. The Euro ETF and S&P 500 ETF are both sharply lower in early trading on Wednesday.
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Chart 13
Chart 14 shows the Euro ETF (FXE) backing of resistance in the 132.5 area. The surge to 132.5 retraced just over 38.2% of the prior decline. This is the minimum retracement expected. There is also resistance in the 132.5 area from broken support. With a long red candlestick developing this week, it looks like the Euro is reversing at this resistance zone. Also notice that RSI hit resistance in the 50-60 zone. 20-60 is typically the bear market range for RSI. Chart 15 shows FXE with the Commodity Channel Index (CCI) breaking its late June low and moving into negative territory.
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Chart 14
