OVERSOLD GERMAN STOCKS ARE TRYING TO STABILIZE -- GERMAN ISHARES ARE ALSO TESTING SUPPORT AT THEIR 2010 LOWS -- FOREIGN ETFS INCORPORATE DOLLAR TRENDS AND, IN MY VIEW, ARE BETTER TO CHART -- NASDAQ COMPOSITE STALLS AT 2600 RESISTANCE
GERMAN DAX STABILIZES NEAR LONG-TERM SUPPORT ... A couple of Thursdays ago (September 15), I included in my market message a story about the German DAX Index trying to bounce from oversold territory after having reached a potential support level. The weekly bars in Chart 1 show that's still the case. The oversold reading comes from the 14-week RSI which had dipped below 30 for the first time since the bull market began in spring 2009 (green circle). The potential support level came from the DAX having retraced 62% of the bull run from 2009 to this spring. [The 62% retracement level (which is the lowest horizontal line) often functions as an important support level during market declines]. Having lost 30% of its value this year, the DAX remains in bear market territory. Because it's the largest market in Europe, however, any signs of stabilization is encouraging and may be helping to stabilize other global markets. That's especially true since other markets are being heavily influenced by events in Europe. The daily bars in Chart 2 show the DAX having bounced off the 5000 level twice during September which is often a sign of a short-term bottom. The DAX, however, still remains below its 50-day average (blue line). A close above that resistance line is needed to signal that a short-term bottom is in place.
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Chart 1
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Chart 2
FOREIGN ETFS REFLECT CHANGES IN DOLLAR VALUE... Chart 3 suggests another reason why the German stock market is trying to stabilize. It shows German iShares (EWG) bouncing off chart support formed during the during the second quarter of 2010 just above 1700 (French iShares are doing the same). You may be wondering how that can be since the German DAX has already broken that support level, and why the EWG and DAX show slightly different chart pictures. The answer has to do with the U.S. Dollar. I've explained several times in previous messages that dollar direction determines relative strength of foreign stocks. Normally, a rising dollar causes foreign shares to fall faster than those in the U.S. [Since the U.S. Dollar bottomed around May 1, the S&P 500 has lost -8% while EAFE iShares (developed foreign markets) and Emerging Market iShares have lost -13% and -21% respectively]. During that same period of time, the German DAX fell -25% while German iShares (EWG) suffered a bigger drop of -31%. So there are two dynamics at work here. First, a rising dollar causes foreign stocks to fall faster than the U.S. Secondly, a rising dollar causes foreign stock ETFs to fall even faster than their cash indexes. Why is that and why is it important?
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Chart 3
FOREIGN ETFS ARE QUOTED IN DOLLARS ... The red line in Chart 4 is a "ratio" of German iShares (EWG) divided by the German DAX Index. The green line is the U.S. Dollar Index. You can see the two lines trending in opposite directions. When the dollar drops (January through April), the iShares outperform the DAX (rising ratio). When the Dollar bottoms (since May and especially during September), iShares underperform (falling ratio). Why is that? The reason foreign stock ETFs are more sensitive to dollar trends is because they're traded in New York and quoted in dollars (while foreign cash indexes are quoted in their local currencies like the Euro). An entity quoted in a rising currency (like the dollar) will always fall faster than one quoted in a weaker currency (like the Euro). That's why I prefer to use ETFs in my analysis of foreign stock markets. I believe that ETFs give a truer picture of foreign stock trends by more accurately reflecting currency trends. And, as Chart 3 shows, German iShares are now in a potential support area.
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Chart 4
NASDAQ STILL STALLED AT 2600... My September 15 message also showed the Nasdaq Composite Index stalled at overhead resistance near 2600. Chart 5 shows that still to be the case. A minor upside penetration early last week failed to hold and the COMPQ is back below that resistance level (marked by the June low) and its 50-day moving average. The Nasdaq would have to close decisively above its September high (2643) to reverse its current downtrend. Chart 6 shows the S&P 500 in an eight-week trading range between overhead resistance at 1230 and underlying support near 1100. It also remains below its moving average lines which means that the major trend is still down. That favors an eventual drop to new lows (technical odds favor continuation of an existing trend). The SPX would have to close above its mid-September peak at 1220 (and its 50-day average) to reverse that lower trend. Arthur Hill recently described the current trading range as a "wave four" consolidation within a "five-wave" decline. That fits with my view for another downleg which would most likely occur during the month of October. That carries good and bad news. The bad news is that lower prices are expected into October. The good news is that a five-wave decline is usually followed by a rally. In addition, Octobers have a history of experiencing lower prices which are often followed by market bottoms. In other words, things may have to get worse before they can get better.
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Chart 5
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Chart 6
VIX STILL IN UPTREND... The message from two Thursdays ago showed the CBOE Volatility (VIX) Index testing chart support along the 30 level (and its 50-day moving average). That earlier message warned that a VIX bounce off that support level would lead to lower stock prices. And it has. Chart 7 shows the VIX in a trading range between support near 30 and resistance in the 45-47 region. The 47 level has contained every major VIX advance over the last decade (except for 2008 when it surged to 90). I'd suggest keeping an eye on the VIX for hints to future market direction. A retest of summer highs would be bearish for stocks over the short-run. A move to new highs would be very bearish. The bouncing VIX has kept a bid under defensive stocks, especially utilities.
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Chart 7
UTILITIES THRIVE ON FALLING RATES AND RISING VIX... Utilities have emerged as the year's strongest sector. Chart 8 shows the Utilities Sector SPDR (XLU) trading near a new 52-week high while the S&P 500 (solid line) is closer to a new lows. The rising XLU:SPX relative strength ratio (below chart) also shows the superior performance of utilities this year. That's not surprising since utilities are a defensive stock group that usually attracts money during a market downturn (as do staples and healthcare). But there's another dynamic driving money into utilities -- falling bond yields. The falling green line shows the 10-Year T-Note Yield (TNX) falling all year. With bond yields having fallen below 2% for the first time in 60 years, the utilities' yield of 4.3% looks pretty attractive. Falling bond yields are also symptomatic of economic weakness which is bad for the rest of the stock market. In a climate of a weak stock market and falling bond yields, utilities offer a relatively safe haven. People still have to use electricity in good times and bad. And, as I suggested a couple of weeks ago, defensive stocks do better when the VIX is rising.
