CHINA AND JAPAN LEAD GLOBAL RETREAT -- OVERBOUGHT S&P 500 SUFFERS DOWNSIDE REVERSAL DAY -- MAJOR TREND, HOWEVER, REMAINS HIGHER -- RISING BOND YIELD ALSO WORRIES STOCKS
ASIAN STOCKS LEAD GLOBAL SELLOFF... The stock market downturn that started in the U.S. yesterday afternoon spread to Asia today. The Japanese stock market, which has led the world higher during 2013, fell 7% today. The weekly bars in Chart 1 show Japan iShares (EWJ) having the worst weekly performance since its rally began during the fourth quarter. A spike in Japanese bond yields (in the face of aggressive bond buying by the JGB) has raised short-term concerns about how well that plan is working. The Japanese yen (which moves in the opposite direction of stocks) is bouncing today. A drop in Chinese manufacturing activity has also rattled global stocks. The weekly bars in Chart 2 show China iShares (FXI) down 3% for the week so far. Weak Chinese demand also hurts economically-sensitive commodities like copper and oil, which are dropping today as well. Gold, which has been closely correlated with the falling yen, is bouncing today.
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Chart 1
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Chart 2
OVERBOUGHT S&P 500 HAS WORST DAY IN MAY ... U.S. stocks suffered a downside reversal day yesterday in heavy trading. A downside reversal takes place when a market hits a new intra-day high earlier in the day, but reverses to the downside by day's end. The bigger the price bar, and the heavier the trading, the more serious it becomes. The red circles in Chart 3 shows that yesterday's action in the S&P 500 fills all three requirements for a downside reversal day. Not only was it the widest trading range in at least a month, but downside volume was especially heavy. The catalyst for yesterday's late plunge may have been Fed hints that it may start cutting back on quantitative easing over the next few months. A market pullback shouldn't be too surprising, given how long the rally has gone without a decent correction. The first level of potential chart support is the 20-day moving average (green line). Prices would have to close below that support line to signal a more significant setback, possibly toward its 50-day (blue) line. The 14-day RSI line (above chart) recently climbed above 70, which signals a short-term overbought condition.
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Chart 3
WEEKLY RSI LINE IS ALSO OVERBOUGHT ... The 14-week RSI line is also in overbought territory. The weekly bars in Chart 4 show the RSI line to be the most overbought since the first quarter of 2011. All that suggests is that the market rally has reached a level where a pullback, or period of consolidation, would not be surprising. [Although not shown here, the monthly RSI line is also overbought]. None of this suggests that the bull run is over. It may, however, be encouraging short-term traders to take some profits. The good news is that a pullback, or consolidation, may offer a lower entry point for long-term investors.
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Chart 4
U.S. BOND YIELDS ARE RISING ... Part of the concern in the financial markets is the recent backup in bond yields. Chart 5 shows the 10-Year T-Note Yield moving above 2.00% this week for the first time since March. That's contrary to what the Fed wants to see. A move to a new 2013 high would be even more cause for concern. I suspect that part of the bond yield backup is a normal rotation taking place out of Treasuries and into stocks. The Fed may be able to slow that process down, but can't completely prevent it from happening. Another reason for the backup in yields is concern that the Fed may start reducing its bond-buying program. That would lessen demand for bonds and push bond yields higher. [That expectation explains recent strength in the U.S. Dollar, which has kept commodity prices under pressure]. While any tapering off in Fed buying may cause short-term problems for stocks, I believe it will ultimately help stocks. When rates really start rising, bond prices will fall. That would cause a much bigger rotation out of bonds and into stocks.
