INVESTMENT EDGE
The US stock markets continue to consolidate and digest its huge 2017 year run-up and subsequent double digit correction. The lone exception being small cap stocks as they have moved on to all-time highs. Will the rest of the market follow suit? The benefit of the doubt has to be given to the prior underlying trend but I don't think the answer will be resolved any time soon. Until then, check out this month's Charts on the Move video at the link below ...
Looking at the daily chart of 20-year US treasury bonds TLT below, you can see after forming a double top, they have fallen more than 8% and closed right on the 116 support zone. With the large head and shoulders topping pattern in the background and price below a falling 200 day moving average, long term bonds look like a horrible place to be invested right now. This is especially true if price cannot stay above the pattern’s (green horizontal) neckline as it portends to another 8% or more decline.
As we have learned, looking at a longer term time frame helps identify the direction of the trend and helps to keep us focused on the bigger picture. The 5-year weekly chart below looks familiar, doesn’t it? The huge head and shoulders topping pattern stands out like a sore thumb. It should be obvious but if not, notice how the daily chart above is just a close up of the right shoulder in the weekly chart below. Yup, another example of a pattern within a pattern (see Monday’s post “Nesting”).
It goes without saying that if bonds break their current levels being pushed down by rising rates, we can likely put a fork in the 35+ year bond bull market. If this should occur, it could have an ominous impact for all investment markets. I have been warning about this potential for years, its impact to investor’s portfolios (most investors don’t know what a bond bear market is or how to deal with it) and just as importantly the huge potential negative impact to pension funds here in the US and across the globe. It’s time to be concerned, very concerned if this scenario unfolds and reaches its downside pattern target. The bullish alternative scenario would be If support holds right here and the pattern fails. Only time will tell but because of the impact bond holdings have on overall portfolio returns, its easy to see why we are at a crossroad.
Almost every prior stock market crash was caused, or at least exacerbated, by market illiquidity.
As you can see in the chart below, the FED’s recent activity of unwinding their balance sheet by selling a small fraction of their QE accumulated holdings coincided with the most recent 12% stock market consolidation (not the sole reason for the correction mind you). It is important stock investors understand the correlation between the FED removing liquidity and lower stock prices. When you combine this balance sheet activity with a simultaneous push higher in interest rates we are entering into uncharted territory knowing just how the market will react.
Regardless, the current consolidation in the SP500 has a clearly defined upper and lower boundary, 2670 & 2530 respectively, making it a much easier task to manage whatever happens. Above I add exposure, below I decrease.
The sideways chop continues but for how long? No one knows for sure but i think it will be months before we escape. What about you?
My latest Charts on the Move video which talks about this and a lot more can be viewed here ...
It should be no surprise to investors that stocks have been struggling since the short term parabolic rise completed back in late January. The subsequent 12% correction followed by extremely choppy, sideways action is not at all unexpected and is unfortunately far from being complete. Besides this being “normal” action after a double digit decline and an “easy-peasy” 2017 market, investors should look no further for additional explanation than what is happening in the bond market.
As you can see in the above chart of the 10-year treasury yield, it finally tagged the psychologically important 3% handle yesterday (although it actually closed a whisker below), a full 50 months since its last visit. Round numbers, whether they happen in stock indexes, bond yields or other investments are important as they act as magnets for potential future moves. The fact we hit that level yesterday is not a surprise as the setup unfolded in late January (I blogged about this possibility here). Breaking out of it box and moving higher could be a real impediment for the advancement of stocks. Stock investors need to keep a close eye on the bond market right here because as rates rise, eventually yields become attractive enough that stock owners throw in the towel shunning the wild volatility involved with owning stocks and instead opting for a more steady, fixed return that bonds have historically provided. As more and more investors switch out of stocks and into bonds, stock prices tend to fall as sellers eventually outnumber buyers.
