QQQ AND SPY TEST THEIR GAPS -- SMALL AND MICRO CAP ETFS FILL THEIR GAPS -- SECTOR PERFORMANCE REFLECTS DEFENSIVE MARKET -- DOLLAR AND TREASURIES ARE IN RISK OFF MODE -- 20+ YR T-BOND ETF CHALLENGES AUGUST HIGH
QQQ AND SPY TEST THEIR GAPS ... Link for today's video. The S&P 500 SPDR (SPY) and Nasdaq 100 ETF (QQQ) forged intraday reversals last Thursday and followed up with gaps on Friday, but the bulls are getting cold feet already because both fell back into their gap zones this week. Short-term, this is not a good sign. The quick fall back suggests that we may be in for more volatility. This is pretty understandable considering that this is October, earnings season kicks off with Alcoa on October 8th, the mid-term elections are four weeks away and the markets are acting rather risk averse. Chart 1 shows QQQ within a falling flag or small price channel over the last few weeks. The ETF reversed intraday on Thursday, gapped up on Friday and challenged the trend line on Monday. This initial challenge failed as the ETF closed weak and moved back into the falling flag today. A close above 99 would break flag resistance and this level marks the next hurdle for the bulls.
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Chart 1
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Chart 2
Chart 2 shows SPY gapping up and closing near the upper trend line of a falling flag on Friday. The ETF opened above this trend line on Monday, but fell back and closed right at the trend line. Today's move below 195.5 puts SPY back in the falling flag and the breakout is on hold. Chartists can use Monday's high to mark the next hurdle for the bulls. The indicator window shows the Commodity Channel Index (CCI) stuck in negative territory. A break into positive territory is needed to turn this short-term momentum oscillator bullish again.
SMALL AND MICRO CAP ETFS FILL THEIR GAPS... Once again, the trouble extends as we move down in market cap. Chart 3 shows the S&P SmallCap iShares (IJR) moving lower on Monday and closing below Thursday's close (white candlestick). This means IJR filled the gap and negated Friday's follow through. It did not take long for small-caps to move back to their underperforming ways. Chartists can now mark short-term resistance at 105.10 and a break above this level is needed to revive small-caps. The indicator window shows the IJR:SPY ratio sinking to a new low for the year this week. Chart 4 shows Russell MicroCap iShares (IWC) with similar characteristics.
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Chart 3
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Chart 4
Relative weakness in small-caps is another sign that the market is shunning risk right now. As noted in Monday's Market Message, the Russell 2000 has underperformed the S&P 500 65% of the time in October over the last twenty years. Put another way, the Russell 2000 outperformed just 35% of the time. Small-caps are probably underperforming because the stock market has been in risk-off mode since the end of August.
SECTOR PERFORMANCE REFLECTS DEFENSIVE MARKET ... We can also see defensive action when looking at sector performance over the last 26 trading days (29-Aug to 6-Oct). Chart 5 shows the nine sector SPDRs. Notice that the healthcare and consumer staples sectors are the strongest. These two sectors are defensive in nature because they represent products and services that we need regardless of economic conditions. In contrast to defensive sectors, we are seeing relative weakness in the consumer discretionary and industrials sectors. Consumer discretionary is the most economically sensitive sector. The industrials sector represents the capital spending side of the economy. Chart 6 shows these the equal-weight versions of these nine sectors. Seven of the nine are down and there is clearly a defensive tilt. The healthcare and consumer staples sectors are the only gainers.
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Chart 5
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Chart 6
DOLLAR AND TREASURIES ARE IN RISK OFF MODE... It has been a while since we heard the terms risk-on and risk-off. These terms were quite popular in 2010 and in 2011, especially during the European sovereign debt crisis in the summer of 2011. Risk-off favors safe-haven trades such as the Dollar and Treasuries. Risk-on favors riskier assets such as stocks and commodities. Chart 7 shows that three of these four asset classes have been in risk-off mode since the end of August. Stocks and oil are down, and the Dollar is up. Treasuries are down and this does not fit with risk-off. However, the picture turns completely risk-off when we shorten the timeframe to two, three or four weeks. Chart 8 shows that stocks and commodities are down, while Treasuries and the Dollar are up. Overall, this confirms that the markets are in risk-off mode right now and this is part of the reason for relative weakness in small-cap stocks, which are less diversified than large-caps and have higher betas. Even though I think there is a good chance that stocks finish the year strong, we could first see some volatility in October.
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Chart 7
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Chart 8
20+ YR T-BOND ETF CHALLENGES AUGUST HIGH... Chart 9 shows the 20+ YR T-Bond ETF (TLT) bouncing off support in mid September and moving towards its early September high. There is nothing but uptrend on this chart. Chartists can use the early August and mid September lows to mark support at 112. The indicator window shows the 30-YR Treasury Yield ($TYX) peaking near 3.4% (34 on chart) and moving lower the last few weeks. Long-term yields are in a long-term downtrend as long as they remain below 3.4%. A strong Dollar could be helping Treasuries because it acts as a headwind for the economy by making exports more expensive. I do not think a strong Dollar will derail the economy, but this economic headwind will likely have a dovish influence on the Fed. Also note that weakness in commodity prices is also bullish for Treasuries because it seriously dampens inflationary expectations. Chart 10 shows the 7-10 YR T-Bond ETF (IEF) and the 10-YR Treasury Yield ($TNX) for reference.
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Chart 9
