TREASURY BOND ETF HITS MOMENT-OF-TRUTH -- ARE 10-YEAR TREASURY YIELDS SIMPLY RETURNING TO NORMALCY? -- RELATIONSHIP BETWEEN YIELDS AND STOCKS SOURS -- S&P 500 EQUAL-WEIGHT ETF STALLS AT CHANNEL TREND LINE
TREASURY BOND ETF HITS MOMENT-OF-TRUTH ... Link for today's video. In an effort to distance myself one Fed meeting and reactionary analysis, today's commentary will come before the Fed meeting and focus on price action. Trying to second-guess a Fed moment and the market's immediate reaction is often a lesson in futility. The Treasury bond market is, of course, the most sensitive to changes in interest rate policy and the economic outlook. Treasuries fall and rates rise when expectations are for tighter monetary policy and/or the outlook for economic growth is positive. Conversely, Treasuries rise and rates fall when the market expects the Fed to loosen monetary policy and/or the economic outlook is negative. In this regard, Treasuries are the canary in the coalmine when it comes to Fed policy and the economic outlook.
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Chart 1
Chart 1 shows the 7-10 year T-Bond ETF (IEF) surging from early March to early May and then peaking on May 1st. The ETF then plunged with a move that gave it all back, and a little more. The May employment report started this decline and IEF found support around the time of the June employment report. Trading has been extremely volatile the last three weeks, but the swing is clearly down since early May. The May trend line and last week's high combine to mark resistance in the 105-105.75 area. The indicator window shows the Commodity Channel Index (CCI) in negative territory since early May. A break above zero would turn this momentum indicator bullish. Chart 2 shows weekly prices with IEF trading in a support zone and the Stochastic Oscillator turning up. Careful here because a break below 104 would signal a continuation lower and target a move to the 2012 lows in the 100 area.
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Chart 2
ARE 10-YEAR TREASURY YIELDS SIMPLY RETURNING TO NORMALCY?... Now let's turn to yields with a look at the 10-year Treasury Yield ($TNX). Chart 3 shows $TNX over the last three years. 10-year yields were above 3% in early 2011, but then plunged in July-August 2011 as turmoil hit the equity markets. During this timeframe, the European sovereign debt crisis was in full swing and European stocks plunged. Standard & Poor's downgraded the US credit rating and the S&P 500 fell over 15%. The Fed came to the rescue by announcing open-ended QE three in mid September. The 10-year yield firmed and stocks rebounded over the last six months. The S&P 500 is up substantially since September 2011, but the 10-year Yield remains well below its September 2011 highs. A return to "normalcy" would mean the 10-year yield should move back to the 3% area, which would imply a serious decline in Treasury bonds. If the economy and labor market are indeed improving, a return to normalcy is the least we can expect. On the chart, $TNX is clearly trending up since July 2012 with a zigzag higher. The yield is bumping up against channel resistance, but has yet to back down and reverse the eight week upswing.
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Chart 3
RELATIONSHIP BETWEEN YIELDS AND STOCKS SOURS... The relationship between stocks and yields gets interesting on the daily chart for the 10-year Treasury Yield ($TNX). Chart 4 shows $TNX breaking above its February-March highs with a sharp move since early May. Broken resistance turns support in the 20-21 area, which represents a 2 to 2.1% yield. Admittedly, it is tough to pick one level as "key" support. It is, however, probably safer to assume that yields are headed higher as long as 2% holds. What does this mean for stocks? Even though stocks and yields were positively correlated for most of the last three years, it seems we are seeing this relationship sour over the last few weeks. Notice how the Correlation Coefficient moved to its lowest levels since May 2011. If stocks and yields are becoming negatively correlated, an extended rise in the 10-year Yield could weigh on stocks over the short-term, even if yields are rising for the right reasons (economic outlook, inflationary pressures, job growth).
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Chart 4
S&P 500 EQUAL-WEIGHT ETF STALLS AT CHANNEL TREND LINE ... Chart 5 shows weekly bars for the S&P 500 Equal-Weight ETF (RSP) over the last two years. I added 20 weeks to this chart to see how the channel extends into September-October. I like to use this ETF because it includes all stocks in the S&P 500, but weights them equally to reflect performance of the "average" stock, not just the large-caps. RSP surged to the upper trend line and then stalled the last five weeks. A normal correction within this channel could involve a 38-50% retracement of the prior advance and move to the lower trend line. This would target a move to the 57-58 area in September. Chart 6 shows RSP breaking flag resistance with a surge the last four days. RSI also bounced off its support zone (40-50) for the fourth time in six months. The bulls clearly have an edge right now and the recent breakout established support in the 61 area. A break below 61 on the price chart and 40 in RSI would turn this chart bearish.
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Chart 5
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Chart 6
IWM LEADS AS THE FIRST TO CHALLENGE THE MAY HIGH... The Russell 2000 ETF (IWM) is showing relative strength again as the ETF broke flag resistance and surged towards its May high. Let's look at the price chart first and then the different ways to measure relative strength. Chart 7 shows IWM breaking triangle resistance with a surge to 100. After becoming overbought in mid May, the ETF worked its way lower with a falling flag, which is a bullish continuation pattern. With a surge the last four days, IWM broke flag resistance to end the short-term downtrend and signal a resumption of the medium-term uptrend. The breakout zone marks first support, which I will set at 98. The June lows were used to mark key support at 96. Notice that IWM formed a piercing pattern with the 6-June low and a bullish engulfing with the 13-June low. These two candlestick reversals show buying pressure that now marks support.
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Chart 7
There are several ways to measure relative strength. Chartists can use the price relative, which is the ratio that compares performance to a benchmark (IWM:SPY). Chartists can look at the StockCharts Technical Rank (SCTR), which compares IWM to a basket of ETFs. Chartists can also compare the level of the Fast Stochastic Oscillator, also known as Fast STO. Fast STO shows the current price level relative to the high-low range over a given period of time. The higher the Fast STO is, the closer a security is to the high of the range. The chart above shows IWM peaking on May 22nd, which was 20 days ago. A 20-day Fast STO would measure the level of the close relative to the high-low range over the last 20 days, which includes the 22-May high. Notice that the Fast STO is currently above 80. Here are the Fast STO readings for other major index ETFs: DIA (65.13), SPY (58.50), QQQ (58.48), MDY (45.73). IWM is the only one above 70 and is clearly the closest to its 22-May high, which means it is the closest of the major index ETFs to its 22-May high. Chart 8 shows the S&P MidCap 400 SPDR (MDY) with a flag breakout and key support marked at 210. Notice that MDY is not as strong as IWM because the price relative is trending down, the SCTR is lower and Fast STO is below 60.
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Chart 8
CATERPILLAR IS AT THE MERCY OF MINING... We here claims of correlation all of time and StockCharts.com gives chartists the ability to test these claims using the Correlation Coefficient. Don't believe a claim just because you heard it from a qualified pundit. Test it for yourself. An analyst on Bloomberg recently discussed Caterpillar and its strong correlation to the global mining business. I decided to test this thesis by comparing Caterpillar (CAT) to the Metals & Mining SPDR (XME). Chart 9 shows CAT with the Correlation Coefficient in the three indicator windows. The first window shows the Correlation Coefficient (CAT,XME) holding in positive territory for three years. There was one dip to the zero line in the summer of 2012, but this did not last long as the indicator moved back up in August-September. This indicator proves that Caterpillar does indeed have a strong positive correlation with the mining industry. The second window shows the Correlation Coefficient (CAT,$SSEC) to measure correlation to China. Correlation is largely positive, but there were two dips into negative territory and this correlation is not as strong. The third window shows the Correlation Coefficient (CAT,$SPX) holding positive until spring 2012 and then dipping into negative territory three times over the last 15 months. These Correlation Coefficients prove that chartists should watch XME for clues on CAT.
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Chart 9
