OVERBOUGHT DIA AND QQQ ARE VULNERABLE TO CORRECTION -- TREASURY BOND ETFS BECOME SERIOUSLY OVERSOLD -- DOLLAR FIRMS WITHIN FALLING WEDGE PATTERN -- MEASURING THE 10YR-2YR SPREAD -- STEEPENING YIELD CURVE REFLECTS GROWING CONFIDENCE
OVERBOUGHT DIA AND QQQ ARE VULNERABLE TO CORRECTION... Link for todays video. The major index ETFs are in medium-term uptrends, but have become short-term overbought and vulnerable to a correction or consolidation. There are two ways to work off overbought conditions: trade sideways or pullback. Sometimes we see a combination with a falling flag or wedge. Chart 1 shows the Dow Industrials SPDR (DIA) breaking above its March-April highs last Thursday and then stalling on Friday. Stocks were under some pressure early Monday as events in Europe returned to the forefront. The European Central Bank (ECB) is making plans, the Bundesbank is criticizing these plans and the leaders of France, Germany and Greece are scheduled to meet (separately) later this week. Turning back to the DIA chart, I see two support zones taking shape. First, broken resistance and the early August consolidation mark a support zone in the 131-132 area. Holding this zone means DIA would simply consolidate with sideways trading. Second, there is a support zone in the 128-129 area. Broken resistance from the early July highs, the early August low and the June trend line mark support here. A pullback to this area could involve a falling flag or wedge. Chart 2 shows the Nasdaq 100 ETF (QQQ) with two support levels to watch.
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Chart 1
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Chart 2
TREASURY BOND ETFS BECOME SERIOUSLY OVERSOLD ... An oversold bounce in treasury bonds would also facilitate a pullback in the stock market. There is oversold and then there is OVERSOLD. With sharp declines the last four weeks, the 20+ Year T-Bond ETF (TLT) and 7-10 year T-Bond ETF (IEF) have become way OVERSOLD. This sharp decline fueled an advance in the stock market and a surge in the yield curve. An oversold bounce in treasuries could lead to a correction in the stock market. Chart 3 shows the 20+ Year T-Bond ETF with the Commodity Channel Index (CCI) and RSI. I like to use -200 for oversold in CCI and 30 for RSI. Notice that CCI dipped below -200 for the second time in 12 months and RSI dipped below 30. These two dips produced the most oversold conditions since mid March. TLT bottomed in mid March and ended up breaking its 2011 highs with a sharp rally. Also notice that TLT is in a potential support zone from broken resistance and the current advance retraced 50% of the prior decline. This is a good spot for an oversold bounce that could carry back to the 126-128 area. With stocks and treasuries negatively correlated, such a move would suggest a correction in the stock market.
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Chart 3
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Chart 4
DOLLAR FIRMS WITHIN FALLING WEDGE... With Europe coming to the forefront again, the US Dollar Fund (UUP) and the Euro Currency Trust (FXE) will also move back into the spotlight. Chart 5 shows the US Dollar Fund trading flat the last two months. UUP broke resistance around 22.5 and then consolidated with a trading range. The period from late June to late July was quite volatile as a series of grand announcements and disappointments whipped UUP around (blue arrows). Trading turned relatively subdued in August as a falling wedge took shape and RSI moved into the 40-50 zone. This is a moment-of-truth for the greenback (and the Euro). With the bigger trend up, the odds favor wedge reversal on the price chart and upturn in RSI. A break above 22.8 would be Dollar bullish, and bearish for gold and the Euro. Chart 6 shows the Euro Currency Trust with a rising wedge and relatively tight trading range the last eight days. Watch these boundaries for the next directional clue. An upside breakout in the Euro would be positive for stocks. A sharp breakdown in the Euro could hit stocks because the S&P 500 and Euro are negatively correlated for the most part.
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Chart 5
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Chart 6
MEASURING THE 10YR-2YR SPREAD... Treasury bonds fell sharply over the last few weeks and treasury yields surged. Keep in mind that bonds and yields move in opposite directions. In addition to a surge in the 10-year Treasury Yield, the yield curve also surged and steepened significantly this month. The yield curve is simply a long-term yield minus a short-term yield. There are two yield curve symbols available at StockCharts.com. First, the Yield Curve 10YR-2YR ($YC2YR) equals the 10-Year Treasury Yield ($UST10Y) less the 2-Year Treasury Yield ($UST2Y). Second, the Yield Curve 10YR-3MO ($YC3MO) equals the 10-Year Yield less the 3-Month Treasury Yield ($UST3M). Chart 7 shows the Yield Curve 10YR-2YR in the indicator window and the relevant yields in the main window. Notice how the yield curve fell from mid March to early June. The decline reflected a sharp decline in the 10-year Treasury Yield, which fell from 2.4% to 1.4%. This decline pushed it closer to the 2-year Treasury Yield and narrowed the spread. The 10-year Treasury Yield fell sharply because the economic outlook dimmed during this period. Also note that the decline in the 10-year Treasury Yield sparked a sharp decline in stocks in April-May. Chart 8 shows the Yield Curve 10YR-3MO for reference.
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Chart 7
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Chart 8
STEEPENING YIELD CURVE REFLECTS GROWING CONFIDENCE... How does the yield curve affect the stock market? First, note that a rising yield curve means the gap between the 10-year Treasury Yield and 2-year Treasury Yield is widening. This means the yield curve is steepening, which is generally bullish for the stock market and the economy. Second, note that a rise in the 10-year Treasury Yield caused most of this steepening. A rise in long-term treasury yields indicates growing confidence in the economy. Treasuries are the ultimate safe-haven and the ultimate economic indicator. Investors move out of treasuries and into riskier assets when the economic outlook improves. Chart 9 shows the Yield Curve 10YR-2YR ($YC2YR) and the S&P 500 (red line). At first glance, it may seem like these two are negatively correlated. However, the Correlation Coefficient ($YC2YR, $SPX) has been mostly positive the last 12 months. This means stocks and the yield curve tend to move in the same direction.
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Chart 9
