UTILITIES AND FINANCE SECTORS LAG IN OCTOBER -- INDUSTRIALS SPDR HITS CHANNEL RESISTANCE -- VOLATILITY INDEX MOVES HIGHER EVEN AS STOCKS GAINS -- DETRENDING THE VIX TO IDENTIFY EXTREMES -- NON-CONFIRMATIONS IN NASDAQ AND NYSE BREADTH
UTILITIES AND FINANCE LAG IN OCTOBER ... Link for todays video. The sector performance picture shows relative weakness in two interest-rate sensitive sectors. PerfChart 1 shows the relative performance for the nine sector SPDRs since September 30th. Keep in mind that this is not absolute performance. On an absolute basis, all nine sectors show gains over the last four weeks. Relative to the S&P 500, however, we are seeing relative weakness in utilities and finance. These two sectors are also sensitive to interest rates. As noted earlier this week, the 30-year Treasury Yield ($TYX) has been moving higher since late August and the 10-year Treasury Yield ($TNX) has been moving higher since early October. Rising rates could be weighing on the performance of both sectors. Utilities have large debt burdens. Financials depend on rate spreads for their loan business.
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Chart 1
INDUSTRIALS SPDR HITS CHANNEL RESISTANCE... From the PerfChart above, we can also see that the Industrials SPDR (XLI) is showing relative weakness over the last four weeks. This relatively recent because industrials were holding up quite well until mid October. Chart 2 shows XLY hitting the upper trendline of a rising price channel. I drew the lower trendline first and the second (upper) trendline parallel from the August high. The extension confirms resistance in the 32.5 area. The ETF stalled over the last few weeks with support clearly marked at 31.5. A move below this level would argue for a correction of the August-October advance. The indicator window shows the price relative (XLI:SPY ratio), which measures the performance of XLI relative to SPY. This indicator confirms the findings on the PerfChart. Notice how the price relative peaked in mid October and moved lower the last two weeks. XLI is starting to show relative weakness.
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Chart 2
VOLATILITY INDEX MOVES HIGHER EVEN AS STOCKS GAIN... The CBOE Volatility Index ($VIX) has been acting a little strange lately. Normally, this indicator declines when the S&P 500 advances. Recently, however, both the VIX and S&P 500 advanced five times (days) in the last three weeks. Chart 3 shows the VIX moving lower since May with a clear downtrend. VIX bottomed the second week of October and moved higher the last three weeks. Stocks also moved higher as the S&P 500 advanced from 1170 to 1184. Admittedly, the VIX gains came with a surge from 18.78 to 20.88 (+11.18%) the last four days (Monday to Thursday). There is probably a good explanation for this abnormal rise. Just look at next weeks event calendar. The mid-term elections are Tuesday, the Fed makes its policy statement on Wednesday and the employment report is on Friday. Throw in several key economic releases and next week promises lots of fireworks. Oh, by the way, the Fed is also expected to make it big announcement on QE2 Wednesday. Overall, the VIX remains in a downtrend and volatility is falling, which is positive for stocks. Falling volatility means less risk (standard deviation). The abnormal behavior over the last 2-3 weeks should be watched, but it has yet to translate into a breakout that would reverse the overall downtrend in volatility.
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Chart 3
DETRENDING THE VIX TO IDENTIFY EXTREMES... In the above example, I showed how the VIX acts as a coincident indicator. Normally, the VIX reacts to the stock market and moves counter to stocks. The CBOE Volatility Index can also be used to identify sentiment extremes and anticipate stock market reversals. Picking tops and bottoms is, of course, the exact opposite of trend following. To see extremes, we have to detrend the VIX by showing it as the difference of two moving averages. Enter the Percent Price Oscillator (PPO). Chart 4 shows the PPO (10,50) of the VIX. This momentum oscillator shows the percentage difference between the 10-day EMA and 50-day EMA. PPO is high when the 10-day EMA is far above its 50-day EMA. PPO is low when the 10-day EMA is far below its 50-day EMA. Over the course of 2010, the VIX PPO seems to trough around -10% (red line). The red dotted lines show when the PPO moved back above -10%. PPO turned up in January, April (twice), early August and now October. Three marked tops in the S&P 500. The April 1st upturn turned out to be early. The PPO for the VIX is flashing another bearish signal with an upturn this week.
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Chart 4
NON-CONFIRMATIONS IN NASDAQ AND NYSE BREADTH... While the Nasdaq moved to a new high this week, the Nasdaq AD Line flattened out and failed to keep pace. Chart 5 shows the Nasdaq AD Line with the Nasdaq in the indiator window. The inability of the Nasdaq AD Line to make a new high amounts to a non-confirmation. The AD Line is cumulative of Net Advances (advancing issues less declining issues). Net Advances increase as advances outnumber declines, but decrease when declines outnumber advances. Failure to make a new high suggests that fewer stocks are participating in this latest advance. While this non-confirmation looks relatively small, note that prior non-confirmations foreshadowed pullbacks in late June and August.
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Chart 5
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Chart 6
Chart 6 shows the NYSE AD Volume Line with similar characteristics. The AD Volume Line formed lower highs as the NY Composite flattened in mid June, early August and now late October. The lower highs show weakness in the AD Volume Line, which is built on Net Advancing Volume. This tells us that the volume of advancing stocks is dwindling and the volume behind declining stocks is increasing. Prior instances foreshadowed pullbacks in the NY Composite.
SMALL-CAPS FAIL TO KEEP UP WITH LARGE-CAPS ... After leading large-caps for three months, small-caps are starting to show signs of relative weakness that could foreshadow a pullback in the market. Chart 7 shows the Russell 2000:S&P 100 ratio, which measures the performance of small-caps relative to large-caps. This ratio rises when small-caps outperform and falls when small-caps underperform. Notice that small-caps outperformed until mid May, underperformed from mid May to mid August and have outperformed since mid August. The overall trend remains up, but the ratio peaked in mid October and formed a lower high this week. As with the AD Line above, this amounts to a non-confirmation. We have yet to see an actual trend reversal, but the non-confirmation tells us to be alert for a possible trend change. A break below support would reverse the uptrend and signal relative weakness in small-caps. This would be negative for the overall market.
