Market Views 9 October 2014

The trend is your friend, until it ends…

The entrance of fall has seemingly brought with it a shift in the financial landscape. Mario Draghi looks ready to bring QE to Europe. Bill Gross has left PIMCO. The low volatility of summer has been replaced by a more volatile early fall, and the resulting price declines have sparked a bit of a concern. This concern is healthy, given the lengthy run up in asset prices over the last 5.5 years, and especially the last 2 years. No one rings a bell at the top, which is why it is important to be on the lookout for the early, technical signs.

S&P 500 Futures

The following is a chart of the S&P 500 futures since summer of 2011. (as with all charts, click for a larger view)

esweekly

This timeframe encompasses the lows from 2011, just after the US government debt downgrade fiasco, until now. As you can see, it’s been a one way street. 3 years and over 80% appreciation later, and the trend is seriously being threatened for the first time, as seen in the action in the upper right of the chart. The following is a closer look at that more recent action:

eswithlines3

What we have here is a daily chart going back over roughly the last 12 months of trading, with some horizontal price levels which I believe are important. Prices have been fliriting with breaking the red terndline over the last few days, and yesterday in particular was interesting. The release of the FOMC minutes from the last meeting in late September sparked a violent afternoon rally. As impressive as that was, it has yet to break the lower moving momentum which has been in place since the September 22 high at 2014. The following chart provides a closer look over the last few weeks of action:

es4h

Yesterday’s rally is a relief rally until proven otherwise. That proof would be a break of the 1970-1980 area to the upside. Until then, the sellers are in charge of this market, with how much lower they can drive things a mystery. Referring to the prior chart, the yellow horizontal lines are ‘lines in the sand’ where opportunities will present themselves. Assuming the 1970 area holds on the upside and the market is driven lower, 1900 is the first such level, and a move there would almost certainly be supported. On a very short term basis, the market would be plenty oversold, having come down from 2014. Panic would probably ensue for a few hours, especially if it happens in one day or two. But it would be a good place to bottom pick for a move back towards 1980 again.

It would however, also represent a clear break of the red trend line. It remains to be seen whether this break would be the beginning of a full on bear market, as in fall 2007 or merely a big correction, as in 2010 and in 2011. In either case, a relief rally following a break of the red trendline isn’t out of order. Below 1900 is a bit more interesting, but we’ll cross that bridge if we come to it.

Russell 2000, Social Media, Homebuilders

While the S&P 500 has only begun looking sketchy over the last month or two, other equity markets and certain sectors have been struggling for much longer. The Russell 2000 chart looks much worse than the S&P 500, which paints a darker picture from an economy point of view, given that the Russell 2000 is full of smaller cap, more domestic companies which are US facing, versus the multinationals that populate the S&P500:

rut5yr

The Russell 2000 has definitively broken it’s 3 year trendline and is definitively making a series of lower highs and lower lows. The following is a closer view.

rutcloser

On a strictly technical basis, the double top at 1219 serves as sort of a head, with the two touches of the yellow line at 1180 either side of the double top serving as shoulders. If this pattern plays out, it’s resting place would be between the 940-960 area which I’ve also drawn.

The fundamental story for the price rises in stocks since 2011 has been the bouncing back of the housing market, as well as the advances made by technology companies, particularly social media related companies. These two sectors have basically led the market up. The following two charts are two ETFs, the S&P Homebuilders ETF (XHB), and a Social Media ETF (SOCL). Home builders

social media

Both charts show the action over the last two years, and both have seemingly run its course.

The divergence between the Russell, Homebuilders, social media and the S&P is interesting to note, with the former three being down 5.7%, 10.6% and 9.06% for the year respectively, while the latter is still up 6.5% for the year. In what could be one of those historical markers people discuss for years to come, the largest IPO of all time, Alibaba, came to market on, what is at this point, the high print of the market. This sort of divergence and individual sector weakness does not mean the larger indices will go lower tomorrow, it merely means that the pieces are starting to align themselves. Unless the market finds a new leader, or the Fed stops tapering, and reverses course, the S&P 500 will ultimately go lower.

US Dollar Strength

The other major story line in recent weeks has been the strength of the US dollar. To maintain some perspective on the recent moves, here is the view of the dollar index over the last 20 years:

dxindex

The dollar is strong relative to the lows in early 2008, which had been flirted with in 2011. Having failed to make new lows, the dollar has been steadily increasing since and looks primed to reach the 92.5 level highlighted on the chart. Given this is still miles away from the highs at 120 and above from the early part of the century, it isn’t quite accurate to label the dollar as ‘strong,’ particularly when this strength is predicated on the weakness of other currencies it is compared to.

The rise in the dollar has been explained as a reaction to the tapering of QE by the Federal Reserve, a process that is scheduled to end within the month. This will mark the third time the Federal Reserve has ended QE programs, the prior two coming in 2010 and 2011. The following chart is of the S&P 500, over a time frame encompassing the ends of both QE programs.

fedes

The two white circles are the days when the QE programs officially ended. What followed both times was a slight price increase and then a sharp declines of roughly 20% each time. Fundamentally this makes sense, as in order for prices to keep rising continually, more monetary injections are also needed. Ending QE ends the impetus for price rises. The same thing is slated to happen now, which perhaps more than anything else explains the bumpy nature of prices over the last few weeks.

All that said, the S&P 500 is less than 3% from all time highs, with yesterday’s action being the best day of the entire year. While signs are emerging that the bull market is struggling, the facts are the facts. The most one can say as a longer term holder of stocks (which I’m not, I trade short term only), is that now is not the time to initiate new positions, but to monitor your portfolio and taking note of stocks which are under performing. Reassess at 1900, and doubly reassess when the Fed ends QE.

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