FED CONTINUES TAPERING PROGRAM -- NO RELIEF FROM EMERGING MARKET SELLOFF -- US STOCK INDEXES TEST INITIAL SUPPORT -- WEEKLY BOLLINGER BANDS HELP FIND POTENTIAL DOWNSIDE TARGETS -- PREVIOUS PULLBACKS TO LOWER BAND HAVE PROVIDED SUPPORT
FED REDUCES MONTHLY BOND PURCHASES BY ANOTHER $10 BILLION ... The Fed announced this afternoon that it will continue bond tapering program by reducing its February bond purchases from $75 billion to $65 billion. Some observers thought that Fed might back off on its tapering after the recent plunge in emerging markets. It didn't blink. The fact that the Fed is continuing with its plan to wind down its bond purchases could lead to more stock market volatility as the year unfolds. The immediate reaction to the Fed's announcement was more selling of stocks and the buying of bonds. Although the buying of bonds may seem strange after losing more Fed support, keep in mind that bond prices are rising (and yields falling) in a flight to quality as global stocks remain under pressure. Chart 1 shows the 10-Year Treasury Note Yield ($TNX) falling today to the lowest level in two months. At the same time, bond prices are rising. Chart 2 shows the 20+Year Treasury Bond Fund (TLT) trading above its 200-day moving average and challenging its October high. As I suggested over the weekend, a decisive close above that resistance barrier could signal higher bond prices and a deeper stock market correction.
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Chart 1
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Chart 2
DOW AND S&P 500 TEST INITIAL SUPPORT LEVELS -- NASDAQ WEAKENS ... The recent combination of falling stock prices, and rising volume, suggests that the U.S. stock market may be in for a deeper correction. Chart 3 shows the Power Shares QQQ Trust falling below its 50-day line for the first in nearly four months. The burst in trading activity over the last week, as prices have fallen, is a warning of more urgent selling. In addition, its 14 day RSI line (above chart) has fallen below 50 for the first time since October, and the daily MACD lines (below chart) have turned negative. Other major stock averages look even weaker. Chart 4 shows S&P 500 SPDRs (SPY) in the process of testing initial chart support at its December low. The heavy volume during the recent selloff reduces the odds that support will hold. Chart 5 show the Dow Diamonds (DIA) testing initial support along its December lows and September highs. That's an important test.
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Chart 3
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Chart 4
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Chart 5
USING BOLLINGER BANDS FOR DOWNSIDE SUPPORT... Bollinger bands are useful for finding potential support levels during a market correction. [Bollinger bands are plotted two standard deviations above and below a 20-period moving average]. While most traders use 20-day bands for short-term trading, I find "weekly" bands more useful for intermediate trend analysis. Weekly bands apply a 20-week moving average to a weekly bar chart. I like to convert the weekly numbers to a daily chart by using a 100-day moving average (20x5). That allows me to use weekly bands on a daily chart. Chart 6 shows the Dow Industrials testing its 100-day (20-week) average (and its December low). That's normal during a short-term pullback (5%). A decisive close below 15700, however, would raise the odds for a further drop to the lower band (which also happens to be near its October low). That would entail a Dow correction of 10%. Chart 7 shows the S&P 500 also testing its 100-day average (and its December low). A decisive close below both levels would suggest a possible drop to its lower band near 1660. That would be a drop of 10%. That's not unusual in an ongoing bull market.
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Chart 6
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Chart 7
HISTORY OF SUPPORT AT LOWER WEEKLY BAND... Chart 8 applies a 20-week Bollinger bands to a weekly bar chart of the S&P 500. The arrows show the SPX falling back to its lower 20-week band four times since the 2009 bottom -- once during 2010, once during 2011, and twice during 2012. The last time the S&P 500 touched its lower Bollinger band was in November 2012. The longest period between those previous lows was 15 months (between 2009 and 2011). It just so happens that this February will be fifteen months from the last bottom, which suggests that a drop to the lower band (and 10% correction) may be due. If it gets there, let's hope it holds again.
