MCCLELLAN SUMMATION INDICES CONTINUE TO CAPTURE CURRENT RALLY -- INFLATIONARY PRESSURES BUILDING AS TIPS AND GOLD SURGE -- SHORT-TERM RATES HIT NEW LOWS AS LONG-TERM RATES FIRM -- DOLLAR COULD BENEFIT FROM RISE IN LONG-TERM RATES
MCCLELLAN SUMMATION INDICES CONTINUE TO CAPTURE CURRENT RALLY... Link for todays video. Even though stocks are overextended after a massive seven week run, we have yet to seen any evidence of weakness to signal the start of a correction or pullback. Many momentum oscillators are also at or near overbought levels, but cumulative indicators, such as the McClellan Summation Index, continue moving higher to capture the current uptrend. Chart 1 shows the Nasdaq Summation Index ($NASI) and the McClellan Oscillator. These two are related. Basically, the McClellan Oscillator equals the 19-day EMA of Net Advances less the 39-day EMA of Net Advances. Like MACD, it captures momentum by taking the difference of two moving averages. This indicator oscillates around the zero line as momentum shifts for Net Advances. The Summation Index is a cumulative McClellan Oscillator. As a cumulative indicator, it is smoother than the McClellan Oscillator and has fewer crosses above/below the zero line. It also trends. A 5-day EMA has been applied to identify the upturns and downturns. This may seem like a tight moving average, but the Summation Index is already smooth and short moving averages identify turns pretty well. Notice that the Summation Index moved above its 5-day EMA in early September and remains above this moving average. There is no questioning the uptrend in the Summation Index. As long as this breadth indicator remains above the 5-day EMA, I would expect the current rally to continue, even if conditions are getting overbought. A break below this moving average would signal weakness in breadth that could give way to a correction or pullback in the market. Chart 2 shows the NYSE Summation Index ($NYSI) with similar characteristics.
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Chart 1
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Chart 2
INFLATIONARY PRESSURES BUILDING AS TIPS AND GOLD SURGE... While there might not be signs of inflation in the Consumer Price Index yet, there are signs in the financial markets. John Murphy noted yesterday that the Inflation Indexed Bond ETF (TIP) was outperforming the normal 20+ year Bond ETF (TLT). Inflation is to bonds as sunlight is to Dracula. Normal bonds are not protected against inflation and will suffer at the first hint of inflationary pressures. We all know about QE2 and the Feds propensity to keep the monetary floodgates open. This propensity probably has something to do with relative weakness in the finance sector, which is getting hit again today. As noted on Wednesday, something is not right with the Finance SPDR (XLF) as the big banks continue to seriously lag the broader market. The Fed will do all it can to prevent another financial crisis. While easy monetary policy may indeed keep the banks afloat, the risk of inflation increases as long these policies remain in force. That tipping point may be sooner rather than later. Chart 3 shows the Inflation Indexed Bond ETF (TIP) and the Gold SPDR (GLD) surging over the last 2 1/2 months. This is just the latest surge in an ongoing uptrend. There is clearly a positive correlation between these two. And it makes sense. Both are sensitive to inflationary pressures.
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Chart 3
The indicator window shows the TIP:TLT ratio. The Inflation Indexed Bond ETF outperforms when the ratio rises and underperforms when the ratio falls. TIP was underperforming until late August. The price relative bottomed in late August and turned sharply higher the last few weeks. Relative strength in TIP favors inflation.
SHORT-TERM RATES HIT NEW LOWS AS LONG-TERM RATES FIRM ... In Wednesdays market message, I showed how the 20+ year Bond ETF (TLT) was starting to lag the 7-10 year Bond ETF (IEF). We can also compare the yield charts for signs of change in the fixed income market. Chart 4 shows the 5-yr Treasury Yield ($FVX) chart 5 shows the 10-year Treasury Yield ($TNX) and chart 6 shows the 30-year Treasury Yield ($TYX). Stockcharts.com users can also track 13-week ($IRX), 6-month ($UST6M), 1-year ($UST1Y), 2-year ($USTY2) and 7-year ($UST7Y) yields. These yields pretty much cover the whole yield curve. We can see differences when looking at the three charts below. While the 5-yr Treasury Yield broke below its 2008 low in late October, the 10-year Treasury Yield held just above it 2008 low and the 30-year Treasury Yield well above its 2008 low. Short-term rates declined more than long-term rates from April to October. Even though all three remain in downtrends since April, notice that the 30-year Treasury Yield formed a higher low in early October and surged this week. A break above the late September high would reverse the 6-7 month downtrend. This would be an important event in the fixed income arena.
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Chart 4
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Chart 5
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Chart 6
DOLLAR COULD BENEFIT FROM RISE IN LONG-TERM RATES... The Dollar is getting hit on all sides these days. The Fed is still busy printing money and this is diluting the Dollar. US interest rates are falling and this makes Dollar denominated bonds less attractive. Other countries are raising rates. I would also venture an educated guess that sentiment toward the Dollar is overwhelmingly bearish. While the current trend is certainly down for the greenback, an upturn in interest rates would be positive. Chart 7 shows the US Dollar Index ($USD) and the 30-year Treasury Yield ($TYX) over the last 14 months. The last three reversals in the 30-year Treasury Yield preceded reversals in the US Dollar Index by around two months. The first blue arrow show the 30-year Treasury Yield bottoming at the beginning of October and the US Dollar Index bottoming in late November (two months). The 30-year Treasury Yield peaked in early April and the US Dollar Index ($USD) peaked in early June (two months). Currently, the 30-year Treasury Yield bottomed in late August (about eight weeks ago). Should the current relationship hold, a bottom in the Dollar could be expected any week now.
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Chart 7
EURO ETF HITS KEY RETRACEMENT ... Weakness in the Euro will be required for any strength in the US Dollar Index. The Euro is still the dominant currency in the index and the US Dollar Fund (UUP). Current weightings for UUP are: Euro (57.6%), Yen (13.6%), Pound (11.9%), Canadian$ (9.1%), Swedish Krona (4.2%) and Swiss Franc (3.6%). We can pretty much concentrate on the Euro for clues on the US Dollar Index and UUP. Chart 8 shows the Euro Currency Trust (FXE) with two big surges since July. The second surge carried the ETF just above the 62% retracement mark. The overall trend is clearly up, but this could be a bear market rally for the Euro. First, the Euro broke its 2008 low with the decline below 123 this year. Second, the current advance, while strong, could be an ABC correction. Wave A was up from June to July, Wave B was the August correction and Wave C was the surge to 140. Third, this ABC correction retraced 62%. If the Euro is going to peak and reverse, this is as good a spot as any. We can also watch the momentum swings with StockRSI on the weekly chart. Surges above .80 signal the start of a bullish momentum swings. Plunges below .20 signal the start of bearish momentum swings. More aggressive traders can use .50 for signals, but this level is more prone to whipsaws. As far as the four month uptrend is concerned, I would mark support at 132. This stems from broken resistance and the trendline extending up from the summer lows.
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Chart 8
