CRB INDEX TESTS MAJOR SUPPORT -- BOND SURGE SHOWS EXHAUSTION -- JUMP IN HIGH YIELD BONDS IS ENCOURAGING -- S&P 500 BOUNCES FROM OVERSOLD CONDITION -- BUT MORE TESTING MAY BE NEEDED -- SMALL CAP RALLY FADES ON FRIDAY
CRB INDEX IS TESTING MAJOR SUPPORT... I'm starting today's message with a look at commodity prices because they've been the focus of a lot of attention of late. That's because falling commodity prices are deflationary in nature, which is something central bankers are trying to stop. The weekly bars in Chart 1 show the CRB Index of nineteen commodities threatening a support line drawn under its 2012/2013 lows. Crude oil weakness has been a big drag on the commodity index (black bars). Despite a midweek bounce in crude, signs of a major bottom are still lacking. One of the main catalysts behind the commodity drop has been a rising dollar. The Dollar Index has suffered a minor setback over the last two weeks (green bars). But its uptrend is still very much intact. That's not an encouraging sign for commodity markets and the battle against global deflation.
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Chart 1
TREASURIES SHOW EXHAUSTION TOP -- HIGH YIELD BONDS BOUNCE... A big selloff in stocks at midweek caused a huge flight to the safety of Treasury bonds. The circled bar in Chart 2 shows the Barclays 20+ Year T-Bond iShares (TLT) spiking sharply higher in Wedesday's early hectic trading, before closing just off its daily low. Bond trading was the heaviest in ten years. Wednesday's late selloff (combined with heavy trading and an overbought RSI reading) has the appearance of the end of a rally, rather than the start of one. That may hold some good news for stocks which closed well off Wednesday lows and ended the week on an upnote. Action in high yield bonds was also encouraging. Previous messages warned that selling of high yield bonds warned of a possible stock market correction. That's because junk bonds and stocks are positively correlated. The daily bars in Chart 3 show the iBoxx High Yield Corporate Bond iShares (HYG) staging a strong recovery late in the week in heavy trading. That may carry good news for stocks as well.
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Chart 2
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Chart 3
S&P 500 IN OVERSOLD BOUNCE... A number of factors contributed to the late week bounce in stocks this week. Chart 4 shows the S&P 500 having reached the next level of support along its April low. Wednesday's price plunge also retraced 62% of the February-September rally. And, the 14-day RSI line bounced off oversold territory at 30. The fact that the S&P 500 closed so far off its Wednesday low (in very heavy trading) also has the look of a potential "climax" bottom. That's the good news. The bad news is that the two day bounce on Thursday and Friday came on declining volume. In addition, the SPX remains below its August low and 200-day moving average (just above 1900). It would have to close above those two chart barriers to turn this week's oversold bounce into something more lasting. Daily MACD lines (below chart) would also have to show a lot more improvement from their current negative position. Even if Wednesday's low marked a bottom, a retest of that low may be necessary as part of any potential basing process.
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Chart 4
SMALL CAPS BOUNCE FADES ON FRIDAY... Small caps, which have been leading the market lower, led the market out of Wednesday's tailspin with a 1% higher close. Unfortunately, small cap leadership faded on Friday. The daily bars in Chart 5 shows Russell 2000 iShares (IWM) closing lower on Friday after approaching their August intra-day low at 109.56. That's an important test because broken support levels become overhead resistance barriers.
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Chart 5
% NYSE STOCKS ABOVE 50-DAY MOVING AVERAGE IS OVERSOLD... I recently showed that the percent of NYSE stocks trading above their 50-day and 200-day moving averages was falling, which warned of a downside correction in major stock indexes. The percent of NYSE stocks above their 50-day average has fallen to the lowest level since 2012 and 2011 where it bottomed. The three circles in Chart 6 compare the current level to two past October bottoms in 2011 and 2012. The fact that the blue line has reached those bottoms suggests an oversold condition. But the blue line needs to start bouncing to signal that it has bottomed. The red line in Chart 7 shows the percent NYSE stocks trading above their 200-day averages. It recently fell to a three-year low of 30 before rebounding slightly. I'd like to see that line start climbing as well.
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Chart 6
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Chart 7
NYSE BULLISH PERCENT INDEX STILL IN DOWNTREND... The BPNYA shown in Chart 8 measures the percent of NYSE stocks that are in point & figure uptrends. It's a good way to help determine the market's current trend. The indicator gave a sell signal in August when it fell below a previous O column at 62%. It has since fallen to 40% which is the lowest reading in three years. [P&F charts show alternating columns of rising X prices and falling O prices. A sell signal is given when a falling O column falls below a previous O column. Buy signals require a rising X column to exceed a previous X column. The red numbers mark the start of a new month. Red letters A, B, and C mark the start of October, November, and December]. During October 2011, the indicator fell to 18% before bottoming. It subsequently gave a buy signal later that month at 44%. The BPNYA is still in a downtrend. The first thing it needs to do to reverse that downtrend is to rise to 46% which would push it into a rising X column. [Prices must rise by at least three boxes (or 6%) to put in into a rising X column]. After that, some backing and filling is usually required to lead to a actual p&f buy signal. That bottoming process hasn't started yet. But we'll be watching for signs of improvement.
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Chart 8
OCTOBER BOTTOMS ARE NORMAL IN MIDTERM ELECTION YEARS... Most major market shocks to the downside have started during October. At the same time, that's also the month when most major bottoms have taken place. Earlier this year, I warned that midterm election years usually experience a downside correction which usually end with an October bottom. I thought that correction would start earlier (in the spring). It did in smaller stocks, but not in large caps. The historical record, however, shows that markets usually put in important lows during the fourth quarter of mid-term years (especially during October). I don't know if we've seen the lows of this correction, or if more downside testing is needed. But the record of fourth quarter bottoms during midterm election years (like 2014) argues against getting too pessimistic. November also marks the start of the best three seasonal months of the year that ends in January. It also marks the start of the best six-month seasonal span that lasts until April. And U.S. stocks are still in a secular bull market. The monthly bars in Chart 9 shows that the S&P 500 would have to lose 20% of its value to drop to its 2000 and 2007 peaks. Even if it did that, they would most likely represent a major support level. Most of the recent problems in U.S. stocks appear to be coming from foreign markets. We will need to see some improvement (from Europe in particular) to help us regain our footing over here.
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Chart 9
EAFE ISHARES REACH OVERSOLD LEVEL ... The weekly bars in Chart 10 show EAFE iShares (EFA) backing off from overhead resistance along its 2007 peak (see circles). [EAFE includes developed stock markets in Europe, Australasia, and the Far East]. It has corrected -14% since July, before rebounding on Friday. Although it's intermediate trend is still down, Chart 10 shows EFA very close to a potential support line drawn over its 2011 highs. It also remains in a major uptrend starting in 2009. In addition, the 14-week RSI line (top of chart) has slipped into oversold territory below 30 for the first time since 2008. Those two factors may help stem the decline in foreign shares. That would certainly be good for them, and for us. For the U.S. market to turn back up again, foreign shares have to start showing some signs of stabilization.
