S&P 500 VIOLATES IMPORTANT SUPPORT LINES TO ENTER DOWNSIDE CORRECTION -- THE MARCH LOW IS NEXT DOWNSIDE TARGET -- HIGH YIELD BONDS CORRECT ALONG WITH STOCKS -- FALLING DOLLAR BOOSTS COMMODITIES AND FOREIGN STOCKS
S&P 500 VIOLATED MAJOR UP TRENDLINE... Thurday's message showed the S&P 500 threatening two important support lines. Unfortunately, both have been broken. Chart 1 shows the SPX closing below its 100-day average (green line) for the first time since last August. The weekly bars in Chart 2 show the SPX ending well below an up trendline drawn under its August/March lows. Those downside violations leave little doubt that the market has entered a downside correction. The most logical downside target at this point is a drop to the March low near 1250 which also happens to coincide with the 200-day (40-week) moving averages which are the red lines in the two charts. There are at least three reasons why the March low is so important. First, it's the next major support level (and represents the bottom of Wave 4 in an Elliott Wave sequence). Second, it coincides with the 200-day moving average which is a major support line. Chart 3 shows another reason. The 1250 level represents a test of a two-year up trendline drawn under the 2009/2010 lows (see arrows). That means that prices need to stay above that level to keep the two-year bull market intact.
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Chart 1
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Chart 2
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Chart 3
HIGH YIELD BONDS ENTER CORRECTION... The 10-Year T-Note Yield (green line) dropped again on Friday following a weak employment report, while Treasury prices (price bars)) rose. [Bond prices rise when yield falls]. Investors usually buy Treasuries when the stock market starts to weaken and when they sense economic weakness. Not all bond groups rose however. I've explained before that high-yield corporate bonds are closely tied to the direction of the stock market. And, not surprisingly, that bond category suffered a bad week along with stocks. Chart 5 shows the High Yield Corporate Bond ETF (HYG) falling to a two-month low and violating its 50-day moving average in the process. The line above Chart 5 is the S&P 500 and shows a close correlation between the two markets. So if you're buying bonds as protection against a weak economy, don't buy junk.
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Chart 4
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Chart 5
FALLING DOLLAR BOOSTS COMMODITIES... Chart 6 shows the The US dollar Index (UUP) falling sharply on Friday on weak economic numbers. Normally, that would be bullish for stocks since they've been trending in opposite direction. In this case, however, that relationship may be changing. If the dollar is falling on economic weakness (and lower US interest rates), that may not help stocks over the short-run. The falling dollar, however, appears to be giving a boost to commodity markets. [While there's historically no close link between the dollar and stocks, there is a clear inverse relationship to commodities]. That may explain why commoditiies rose on Friday while stocks fell. Chart 7 shows the DB Commodities Tracking ETF (DBC) closing just below its 50-day average (blue line). A decisive close above that resistance line is needed to turn the commodity trend higher. The commodity that usually benefits the most from a weaker dollar, falling interest rates, and weak stocks is gold. Chart 8 shows the SPDR Gold Trust (GLD) trading near a monthly high.
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Chart 6
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Chart 7
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Chart 8
WEAKER DOLLAR HELPS FOREIGN STOCKS... If the US Dollar continues to weaken, another possible beneficiary may be foreign stocks. I recently explained that foreign stocks usually do better than the US when the dollar weakens. That may explain why foreign shares held up much better than ours this past week. Chart 9 shows EAFE iShares ending the week on an upnote and well above the May low. The EFA/SPX ratio (below chart) also surged this week. The same is true of emerging markets. Chart 10 shows Emerging Market iShares (EEM) having a relatively strong week versus the US. With so much talk of the US economic recovery faltering, it would make sense for investors to shift more funds overseas. So not only does the US now have the world's weakest currency. It may also now have one of the world's weakest stock markets.
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Chart 9
