WATCHING BOND YIELD AND PRICE FOR CLUES TO STOCK MARKET DIRECTION -- APPLYING BOLLINGER BANDS TO THE S&P 500 -- EMERGING MARKET CURRENCIES AND STOCKS ARE TESTING CRITICAL CHART SUPPORTS -- VIX INDEX IS TESTING RESISTANCE ALONG 2013 HIGHS
BOND YIELD TEST NEARS CHART SUPPORT ... The downturn on bond yields at the start of the year forewarned of a pullback in stocks. Both have fallen together as some money left stocks for the relative safety of Treasury bonds. Chart 1, however, shows the 10-Year Treasury Note Yield ($TNX) very close to potential chart support at its 200-day moving average (red line) and its October low. What bond yields do from here should help determine the fate of the stock market. That's because bond yields and stock prices are positively correlated. Chart 2 shows the 7-10 Year Treasury iShares (IEF) in the process of testing chart resistance along its October high. If the IEF is able to clear that chart barrier, that would likely mean more bond buying and stock selling. If it fails that test, and starts to weaken, that could help stabilize the stock market. In other words, the direction of bond prices and yields should help determine the direction of the stock market.
(click to view a live version of this chart)
Chart 1
(click to view a live version of this chart)
Chart 2
WATCHING BOLLINGER BANDS ... I recently used Bollinger bands to help determine potential support below the stock market, especially in the event of an intermediate downside correction. Chart 3 applies 20-week bands to a weekly S&P 500 chart. [Bollinger bands are plotted two standard deviations above and below a 20-period moving average]. The rule of thumb is that a move below the middle (dashed line) often signals a further drop to the lower band. With that having happened, there's potential for the SPX to fall back to its lower band near 1690. In order for that situation to be reversed, the SPX needs to close back above its 20-week line. Chart 4 applies 20-day bands to a daily SPX chart. That shorter-term chart shows the SPX having already reached its lower band (a short-term support level). In order to turn its short-term trend back up, however, the SPX would have climb back above its 20-day average (dashed line). It's a long ways from doing that.
(click to view a live version of this chart)
Chart 3
(click to view a live version of this chart)
Chart 4
EMERGING MARKETS ARE TESTING CRITICAL CHART SUPPORT... The best way to get a read on whether or not global stocks have more downside correcting to do may be to keep a close eye on emerging markets. That's where most of the trouble started. Currencies first. Chart 5 shows the WisdomTree Emerging Currency Fund (CEW) still testing major chart support along its 2011, 2012, and 2013 lows (around 1950). It dipped below it slightly last week, but is back above it again. That's a very important test. It's extremely important for the CEW to hold that support level. If it breaks, emerging markets should undergo more selling pressure. And so would developed markets.
(click to view a live version of this chart)
Chart 5
EMERGING MARKET ISHARES TEST IMPORTANT SUPPORT... Emerging market stocks are also testing important support levels. Chart 6 shows Emerging Market iShares (EEM) trying to stabilize at a previous low formed during August of last year (near 37.00). Given the size of its recent drop, there's little chance of it turning its trend back up again in the near future. What would help, however, would be for it to stop going down. If it holds in this area, global stocks could also stabilize. A break of that support would be a turn for the worse and would set up an even more important test of last June's intra-day low at 35.37. Chart 7 shows why that support level is so important. The weekly bars in Chart 7 show the EEM in a "triangular" formation between two converging trendlines over the last three years. The EEM is dangerously close to the lower line, which could provide much-needed support. A drop below last summer's intra-day low at 35.37 would also break that major support line which would signal lower prices. The blue line on top of Chart 7 shows EAFE iShares (foreign developed stocks) testing a support line going back to spring 2012. So far, that line has held. It probably won't if the EEM doesn't stay above last year's lows.
(click to view a live version of this chart)
Chart 6
(click to view a live version of this chart)
Chart 7
VIX TESTS 2013 HIGHS ... I heard a market commentator say on TV yesterday that the CBOE Volatility (VIX) Index hadn't worked well over the past few years. In fact, it has worked very well by doing exactly what it is supposed to do -- stay down while stocks are rallying. Chart 8 shows the inverse correlation between the VIX and the S&P 500 over the last three years. A spike in the VIX over 40 during 2011 coincided with a 20% correction in the SPX. The peak in the VIX in October 2011 coincided with a sharp upturn in stock prices which continued into this year. A pattern of "lower highs" in the VIX between 2011 and 2013 coincided with rising stock prices. The VIX failed two previous attempts during 2013 to close decisively over the 21 level. It's testing that resistance barrier once again. That's an important test for it and the stock market.
