BIG DROP IN FOREIGN STOCKS PULLS US MARKET LOWER -- DOLLAR BOUNCES AS COMMODITIES DROP -- STOCK INDEXES SLIP BACK BELOW 50--DAY LINES -- FED POLICY MAY ACTUALLY BE HURTING STOCKS
FOREIGN STOCK ETFS GAP LOWER ... Foreign stocks are having a really bad day. Chart 1 shows EAFE iShares (EFA) gapping 4% lower. In so doing, the EFA has left a potential "island reversal" top behind. [An island reversal is formed when an up gap is followed shortly by a down gap (see circle)]. The fact that prices failed at the 200-day moving average is another bad sign,. Chart 2 shows essentially the same negative pattern in Emerging Markets iShares (EEM). With such big foreign losses, there's no way U.S. stocks can escape global selling.
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Chart 1
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Chart 2
BOUNCING DOLLAR PUNISHES COMMODITIES... With foreign markets under so much pressure, money is flowing out of foreign currencies into the safety of the U.S. Dollar. Chart 3 shows the PowerShares US Dollar Index Bullish Fund (UUP) continuing to bounce off chart support along its March high and 50-day average. The rising dollar is having a very negative on commodities. Cha 4 shows the DB Commodities Tracking Fund (DBC) falling to the lowest level since 2010. Economically-sensitive commodities like copper and oil are being hit especially hard. Gold and silver are also falling. Chart 5 shows the Gold Trust SPDR (GLD) falling below its early June low. Stocks tied to commodities are among the day's biggest lowers.
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Chart 3
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Chart 4
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Chart 5
S&P 500 SLIPS BACK BELOW 50-DAY LINE... Foreign stock selling is pulling U.S. lower as well. Unfortunately, it's coming at a bad time. Chart 6 shows that the S&P 500 has been testing an overhead resistance line drawn under its April lows near 1360. That's an important test because it determines if the recent rebound is just a bounce in a downtrend or a rally with legs. The S&P 500 has not only backed off from that resistance line, but is trading back below its 50-day average. . Chart 7 shows theNasdaq Composite Index also in danger of failing that test of resistance. Decisive closes below those 50-day lines would raise the possibility of a rally failure.
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Chart 6
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Chart 7
FED POLICY MAY BE HURTING STOCKS ... A week ago I wrote that higher bond yields might be needed to support a continuing stock market rally. So far, that hasn't happened. Chart 8 shows the 10-Year Treasury Note Yield still in a downtrend, and dropping again today. Bond yields are falling because investors are buying Treasuries as stocks drop. The Fed wants bond yields to fall further. That's why it announced an extension of its Operation Twist yesterday (when it sells short-term holdings to buy longer-term bonds). Here's a problem I have with that policy. Bonds and stocks compete for investor money. Falling bond yields encourage investors to keep funds in Treasuries instead of stocks. That's because bond prices rise when yields fall. At the same time, the Fed has stated that it is trying to encourage investors to move into riskier assets like stocks. It seems to me that pushing long-term rates even lower (or preventing them from rising) may actually be preventing a rotation out of bonds and into stocks. Investors won't switch until they see bond prices falling. That won't happen as long as the Fed keeps downward pressure on bond yields. In other words, lower bond yields may actually be hurting stocks. Chart 8 shows that falling bond yields since March have hurt stocks. I doubt if that's what the Fed had in mind.
