EXPANDING ON THE RISK-ON RISK-OFF TRADE -- WHAT ARE BONDS TELLING THE MARKET? -- OIL AND GASOLINE POINT TO WEAK DEMAND -- BASE METALS ETF BACKS OFF RETRACEMENT RESISTANCE -- SILVER BREAKS TRIANGLE RESISTANCE
EXPANDING ON THE RISK-ON RISK-OFF TRADE... Link for todays video. John Murphy and I have been writing a lot on the movement away from risk in favor of relative safety. I showed a PerfChart on August 6th showing the beginnings of a shift from the risk-on trade to risk-off trade. Today I would like to expand on that chart by adding a few other assets to the mix. In general, the risk-on trade favors stocks, oil, base metals and Euros. These four assets perform well when the appetite for risk is strong. In contrast, the risk-off trade favors bonds, gold, US Dollars, Swiss Francs and Yen. These assets outperform when relatively safety drives the market. PerfChart 1 shows nine ETFs representing these assets in July 2010, when the risk appetite was strong. Stocks, oil, metals and the Euro were up because risk appetite was strong. The Dollar, Swiss France, Yen, gold and bonds were down.
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Chart 1
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Chart 2
Perfchart 2 shows these same nine ETFs from July 30th until August 24th. The appetite for risk did a u-turn in August as traders turned to relative safety. Notice that stocks, oil, metals and the Euro are down sharply the last four weeks. In contrast, the Dollar, Swiss Franc, Yen, gold and bonds moved higher. The surges in gold and bonds are especially pronounced. This environment is bearish for the stock market. Chartists can also divide the stock market into sectors that favor the risk-on trade (finance, technology, industrials and consumer discretionary) and sectors that favor the risk-off trade (healthcare, utilities and consumer staples). Simply enter these sector SPDRs symbol into a PerfChart and compare their performance against the S&P 500 ETF (SPY) (SPY,XLF,XLK,XLI,XLY,XLV,XLU,XLP).
WHAT ARE BONDS TELLING THE MARKET?... There is an awful lot of chatter regarding a bond bubble. Admittedly, bonds have been on a tear since April. Chart 3 shows the 7-10 Year Treasury ETF (IEF) moving straight up the last five months. IEF is up over 12% from its April low. This move is sharp, but not as sharp as the 10-week surge from early October to early December 2009 when IEF gained over 14% during this 10 week rocket to safety. The current advance is certainly steep, but has yet to reverse. Chart 4 shows the 20+ Year T-Bond ETF (TLT) surging 10% (low to high) over the last four weeks. TLT broke flag resistance at the beginning of August and never looked back. RSI moved to its highest level since December 2008. RSI has been overbought for three weeks now and could remain overbought. This is what happens in strong uptrends. Notice that RSI became overbought with the surge above 95 in November 2008. The indicator remained overbought another five weeks as TLT extended to 115.
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Chart 3
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Chart 4
Instead of asking if bonds are in a bubble, we may want to consider the alternative. What if bonds are not in a bubble? Are falling interest rates telling us something about the economy? Remember, interest rates fall as bonds rise. The bond market could be pricing in weaker-than-expected economic growth ahead. The Fed is not going to raise interest rates in the face of a sluggish economy. Interest rates at the short end of the curve (0-2 years) have little room to fall. Long-term rates, in contrast, still have some room to fall. In fact, the Feds quantitative easing program specifically targets long-term rates by purchasing bonds at the long end of the curve. Regardless of the rationale for the plunge in rates, the positive correlation between stocks and long-term interest rates bodes ill for stocks. Chart 5 shows the 10-Year Treasury Yield ($TNX) and the S&P 500 over the last 10 years. Generally speaking, these two have been positively correlated the last 10 years. Both fell in 2001-2002, rose from 2003 to 2007, fell in 2008, rose in 2009 and fell in 2010. Interest rates (pink) have fallen a lot further and faster than stocks in 2010. This means stocks may have some catching up to do. At the very least, we should not expect a meaningful bottom in stocks until interest rates reverse their downtrend.
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Chart 5
Chart 6 shows the 10-Year Treasury Yield falling from around 4% to 2.5% over the last five months. This is a huge move for interest rates. Sure, the 10-Year Treasury Yield is oversold and the 7-10 Year Treasury ETF is overbought, but both remain in strong trends. The next support level for the 10-Year Treasury Yield is around 2%, which leaves room for a further decline.
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Chart 6
OIL AND GASOLINE POINT TO WEAK DEMAND... The US Oil Fund ETF (USO) and the US Gasoline Fund ETF (UGA) broke down with sharp declines in August. These two commodities are driven by the perceptions for future supply and demand. Supply is largely dependent on OPEC. Demand is dependant on the economy. A strong economy favors strong demand. A weak economy points to weak demand. The rise in bonds and fall in long-term rates suggests weakness in the economy and this is extending to stocks and oil. Chart 7 shows USO breaking wedge support last week and continuing lower this week. Broken support around 34 marks the first resistance level to watch on any oversold bounce. The MACD-Histogram moved into negative territory at the beginning of August to indicate a bearish signal line crossover in weekly MACD. Chart 8 shows the US Gasoline Fund ETF (UGA) with a similar chart pattern.
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Chart 7
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Chart 8
BASE METALS ETF BACKS OFF RETRACEMENT RESISTANCE... The DB Base Metals ETF (DBB) is also subject to weakening demand from worse-than-expected economic growth. Chart 9 shows DBB with a double top support break in July and then a retracement rally. Notice that this bounce retraced 62% of the prior decline. In addition, DBB turned lower in the middle of the double top. A weekly bearish engulfing pattern formed three weeks ago and the ETF moved lower the last two weeks. Should interest rates and stocks continue lower, I would expect base metals to follow suit. The next major support zone is around 14. RSI is shown in the indicator window. This momentum oscillator broke below 40 in May and then met resistance in the 50-60 zone in late July-early August.
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Chart 9
SILVER BREAKS TRIANGLE RESISTANCE AND GOLD STAYS STRONG... Not all commodities are falling. Gold, a precious metal, has been moving higher throughout August. It appears that gold and stocks are negatively correlated this month. Chart 10 shows the Gold ETF (GLD) rising around 7% since late July. In contrast, the S&P 500 is down 6-7% since early August. GLD broke wedge resistance in early August and continued above 118 as stocks fell. There are no signs of weakness here. The next resistance zone is around 122-123. The indicator window shows gold, the Euro and the Dollar. The latter two have been relatively flat since late July (black arrow). Gold, on the other hand, has been rather decisive with a sharp move higher. Bloomberg reported that gold demand rose 36% in the second quarter as money moved into gold related ETFs. It is almost a self-fulfilling prophecy. Money goes into gold ETFs. The gold ETFs then take the money and buy gold. Gold goes up and the gold ETFs follow. What a business! Chart 11 shows the Silver ETF (SLV) playing a little catch-up with a triangle breakout today. This semi-precious semi-industry metal is largely positively correlated with gold. The indicator window shows both moving together throughout 2010.
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Chart 10
