SMALL-CAPS AND MID-CAPS LEAD MARKET LOWER -- NDX PERCENT ABOVE 50-DAY FORMS BEARISH DIVERGENCE -- SURGE IN TREASURY BONDS IS NEGATIVE FOR STOCKS -- WHAT ABOUT THE QE3 EFFECT? -- OIL PLUNGES AS NATURAL GAS SURGES
SMALL-CAPS AND MID-CAPS LEAD MARKET LOWER... Link for todays video. Even though the major index ETFs remain in uptrends overall, relative weakness in small-caps and mid-caps over the last eight days is a concern. Chart 1 shows the S&P MidCap 400 SPDR (MDY) surging in the first part of September and giving much of it back the last eight days. The advance from late July to mid September carried MDY from 166 to 186 (12%). MDY was clearly overbought and ripe for some sort of correction two weeks ago. How much of a correction is allowed at this point? A typical advance should evolve as two steps forward and one step backward. MDY took two big steps forward with the June-September surge. A step backward could involve a 50-61.80% retracement. Because there are two big moves during this period, I am drawing the Fibonacci Retracements Tool from the early June low and the late July low and looking for overlap. A 50% retracement of the June-Sept advance would also extend to 174 and a 61.80% retracement of the July-Sept advance would extend to 174. These two Fibonacci retracements represent a cluster. Broken resistance and the June trend line confirm potential support here. Allowing a little buffer, MDY should hold the 172-174 support zone in a normal pullback. A break below would suggest more than just a pullback and a reassessment of the overall uptrend would then be warranted.
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Chart 1
The indicator window shows the price relative (MDY:SPY ratio) turning down the last two weeks. MDY was outperforming the broader market from early August to mid September, but is now underperforming again. Relative weakness in mid-caps is a concern because these stocks represent the appetite for risk. Risk appetite (confidence) is strong when mid-caps outperform. Risk appetite (confidence) is weak when mid-caps underperform. Chart 2 shows the Russell 2000 ETF (IWM) with support around 80 and the price relative turning down.
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Chart 2
NDX PERCENT ABOVE 50-DAY FORMS BEARISH DIVERGENCE ... The percentage of stocks above the 50-day moving average is a breadth indicator that measures the degree of participation within an index. There are at least three ways to use this indicator. First, the indicator favors the bulls when above 50% and the bears when below 50%. Second, readings above 80% reflect overbought conditions, while readings below 20% indicate oversold conditions. Third, divergences and reversals can be use to anticipate trend changes in the underlying index. Chart 3 shows the Nasdaq 100 %Above 50-day SMA ($NDXA50R) becoming oversold in May and breaking resistance in June. Early July was a volatile period, but this breadth indicator trended higher for most of June, July and August. The trend started to change as the indicator formed a lower high in mid September and the trend reversed with a support break this week. Also notice that a bearish divergence formed from mid August to mid September. A bearish divergence forms when the indicator fails to confirm a higher peak in the index. This weeks breakdown shows deterioration within the Nasdaq 100 and could foreshadow a trend reversal in the index. Chart 4 shows the S&P 500 %Above 50-day SMA ($SPXA50R) turning down and poised to test support. This is an end-of-day (EOD) indicator that will be updated after the close, but this indicator will probably break support with todays weakness.
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Chart 3
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Chart 4
SURGE IN TREASURY BONDS IS NEGATIVE FOR STOCKS... Money moved into treasuries over the last two weeks and this is a big negative for the stock market. There are several possible reasons for this shift. Investors could be wary of third quarter earnings season because stocks were quite overbought in mid September. Attention could also be turning towards Europe and the never-ending sovereign debt saga. Or, uncertainty over the elections and the fiscal cliff could be pushing money to the sidelines for the rest of the year. And finally, money managers with gains may be booking these gains while the booking is good. Whatever the reason, stock market players should keep an eye on treasury bonds because these two are negatively correlated. Further gains in treasuries would be negative for stocks.
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Chart 5
Chart 5 shows weekly bars for the 20+ Year T-Bond ETF (TLT) over the last three years. The trend is clearly up with a possible five wave advance unfolding. I showed this wave count and the PPO bearish divergence on September 10th. Even though this wave count is still possible, I think the overall uptrend is still the dominant force here. Also note that the PPO remains in positive territory, which means momentum still favors the bulls.
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Chart 6
Chart 6 shows a potentially bullish pattern evolving in the 20+ Year T-Bond ETF over the last seven months. After a breakout and surge from March to July, the ETF pulled back with an ABC correction that retraced 61.80% of the prior advance. Also notice that broken resistance turned into support around 118. This weeks surge back above 124 is still within the confines of the falling wedge, but chartists should be on guard for a breakout that could trigger a medium-term bullish signal for TLT. Such a move would be medium-term bearish for stocks.
WHAT ABOUT THE QE3 EFFECT?... I first wrote about quantitative easing and its affect on the 10-year Treasury Yield ($TNX) on September 14th. Note that treasury yields rise when treasury bond prices fall and visa versa. Chart 7 shows the 10-year Treasury Yield rising at the beginning of QE1 and QE2. Yields also surged when operation twist was announced on September 21st, 2011. The Fed announced QE3 on September 13th, but the 10-year Treasury Yield was already off its low (1.4%) and challenging resistance. Instead of breaking out and moving higher, the yield failed at resistance and moved sharply lower the last two weeks. This reaction is at odds with what happened at the beginning of QE1 and QE2. Perhaps the bond market does not have as much faith in this round of quantitative easing.
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Chart 7
OIL PLUNGES AS NATURAL GAS SURGES... Now theres an unexpected headline. Oil is under pressure again today with Spot Light Crude ($WTIC) trading around 89.65 (-1.35%). Chart 8 shows Spot Light Crude hitting resistance near the 61.80% retracement and breaking down last week. Notice that $WTIC broke support and broken support turned into resistance. The uptrend since late June has reversed and a new downtrend is underway for oil. This is a negative for stocks because they are positively correlated with oil. There were short periods of negative correlation, such as now, but these did not last long as oil and stocks returned to their positive correlation rather quickly. This means something needs to give between stocks and oil. Chart 9 shows the US Oil Fund (USO) breaking support at 35 and holding this breakdown.
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Chart 8
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Chart 9
In a surprising twist, chart 10 shows Spot Natural Gas ($NATGAS) breaking triangle resistance and leading oil. In fact, natural gas has been outperforming oil since mid April. The trend is clearly up with support in the 2.6-2.7 area. Natural gas is up again today with a move to 3.19. Note that $NATGAS and $WTIC are end-of-day (EOD) charts that will be updated after the close. Chart 11 shows the US Natural Gas Fund (UNG) breaking triangle resistance with a move above 20 today. The August low marks support in the 18 area.
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Chart 10
