In recent weeks deteriorating internals and diverging relative strength sent strong warning signals that recent highs were unlikely to sustain and presented a technical sell opportunity on indices. The trigger for rejection of recent highs came in the form of yields jumping to new multi year highs. As a result multiple short term trend lines have broken to the downside on multiple indices and short term technical damage has been inflicted while longer term trends remain intact.
Before I dive into some of the details some macro context first:
Global markets overdosed in January from the cumulative effects of record global QE and the anticipated liquidity effect from US tax cuts:
US markets crawled to new highs since the February correction propelled by buybacks and the tax cut related earnings and economic growth sugar rush, while Europe, emerging markets and China markets fell off to new lows, a historic global divergence.
Ironically the relative strong performance in US markets and economy has produced a jump in yields that has now turned problematic for markets:
Since the early 80s yields have been in a steady downtrend. During this time we’ve witnessed multiple stock market bubbles resulting in crashes and bear markets. The Fed responded by cutting interest rates as a form of stimulus and, once markets and the economy recovered, the Fed proceeded to raise interest rates again. Yet, following each recovery, the Fed had to cut rates again at an interval of lower highs repeating the cycle anew.
Notable here is that during each bubble markets pursued price channels of tightening trends that eventually broke to the downside. Both in 2000 and 2007 we can observe that market peaks occurred around the time the 10 year yield reached its upper long term trend line.
Last week’s yield spike has now produced a move above this trend line hence it is very notable as it represents a potential inflection point of historic significance. Jeffery Gundlach indicated this week that higher yields are to be expected for this very reason:
While rates are still historically low the world has never been in so much debt as now and rising yields will have a significant impact not only on the cost of carry, but also on future growth.
In fact one can argue that sustained low rates have enabled the unprecedented debt expansion in recent years:
And yet already here, at this still historic low point, the cost of carry is expanding significantly:
Bottomline: What’s happening with yields is critically important to watch as stock markets have clearly reacted to the jump in yields last week.
Let’s walk through some index charts.
Firstly note volatility has emerged again following a renewed multi-week slumber and reached short term overbought conditions as $SPX has broken a short term trend line, but has so far defended its 2018 support trend line:
$DJIA: Made a new high on a negative divergence and then fell below the January highs:
$WLSH broke its 2018 trend line, but recovered just above the January highs:
This price zone is a critical battle field for control.
The weekly chart highlights the potential significance as the trend is broken:
The longer term context suggest the potential formation of a larger top:
None of this is confirmed as price remains above the monthly 5 EMA, but the structure suggests strong similarity with the 2007 top and hence bears watching.
$NDX broke its trend line in September and has failed to recapture it multiple times before falling away from the trend line last week:
In process $NDX printed a potential double top which also remains unconfirmed. However it should be noted the $NDX has now broken a longer term trend line that acted as support multiple times in September:
Small caps got hit the hardest during the recent corrective move by dropping over 7% from the highs before finding support at the 200MA:
Note the RSI is now the most oversold since the February correction and suggestive that a bounce may be in the works.
The move in small caps highlights that the recent corrective move has been a lot more severe than the other indices indicate.
In recent weeks I’ve been pointing to weakening internals and diverging markets. While mega cap stocks have been largely able to mask weakness due to their size and massive buyback programs the overall market has been indicating weakness for quite some time.
For example the recovery rally since the February correction has been significantly weaker than the lead up to the January blow-off move as seen in the lack of expansion in new highs vs new lows::
And equal weight has been dropping off a cliff lately and is far below the January highs:
$SPX has defended its lower daily trend line and the 50MA on Friday as $VIX has been breaking above its recent wedge:
It should be noted that $SPX’s recent high came also on a negative divergence and printed a potential double top. Also of note: Both 2016 trend lines remain broken.
$SPX has also broken a short term trend line:
Here too we can note short term oversold readings as the 2 hour chart has reached its most oversold readings since June.
In fact it is $NYMO that highlights how significant the recent pullback has been reaching its most oversold reading since March:
What’s particularly notable here is that all recent market highs in September and October have come on negative $NYMO readings again accentuating how weak underlying markets have been.
And cumulative $NYAD also shows a very oversold RSI here commensurate with previous market bottoms:
What’s the message here? While key market cap stocks still react positively to the tax cut stimulus the larger market is already reacting negatively to the rise in yields.
Current oversold conditions could yield another rally, especially if yields retreat in the short term and there is a technical case to be made for such a retreat to emerge.
After all $TLT just hits long term trend line support following several bear flag breaks and its RSI is also near oversold:
Hence if the trend holds and yields retreat stock markets show enough oversold conditions to mount another rally.
However should trends break in the days/weeks ahead the lower risk price zone may come soon into play:
Aides from yields Q3 earnings will be key to watch in the days ahead, not so much for results achieved under the current tax cut/buyback regime, but rather the coming outlooks accounting for increasing cost pressures, wage pressures rising yields, tariff wars and the reality of the sugar rush from tax cuts no longer being a growth factor in 2019:
Conclusion: Markets are heading toward oversold on a number of indicators. A pullback in yields can produce a sizable rally in the days ahead. Investors and traders however need keep a close eye on yields as long term trends are at risk of breaking and could result in a dramatic shift in asset valuations going forward. Without a sustained retreat in yields short term market strength into 2910/2920 $SPX may prove to be an opportunity to sell into. January highs remain critical support, a break below these implies immediate technical risk into 2820-2850 $SPX. A sustained break below opens the path toward the weekly risk zone outlined earlier.
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Categories: Market Analysis