But the most important charts of the week come from the treasury market, beginning with the weekly IEFs:
After hitting the 98 level at the beginning of the year, prices have been on a slow but steady climb. Notice the lack of any meaningful correction. Instead, prices simply continued to grind higher with a slight but noticeable increase in volume since the first of the year with increasing momentum.
And the TLTs which represent the long end of the curve, are telling the exact same story. But both the IEFs and TLTs are nearing resistance levels established earlier this year. And the 10 year is at 2.22 with the 30 year at 2.98 -- pretty high levels. This may indicate the treasury rally is nearing its high.
While he's not a trader per se, Krugman hits the nail on the head in explaining the importance of the above chart:
Most obviously, interest rates on long-term U.S. government debt — the rates that the usual suspects keep telling us will shoot up any day now unless we slash spending — have fallen sharply. This tells us that markets aren’t worried about default, but that they are worried about persistent economic weakness, which will keep the Fed from raising the short-term interest rates it controls.
In fact, with the exception of the junk bond market which has sold off recently, the other bond markets are in the middle of a decent rally:
The best-performing bond ETF for the last year has been the TLTs which have risen 17%, with the municipal market a distant second coming in a bit below 10%. The intermediate corporate market has gained ~7.5% with the 7-10 year treasury up 6%.
Let's take a step back and look at some of the factors that may lead to a bond market rally:
1.) When there is no or little fear of inflation.
2.) When economic growth will be insufficient to provide an environment in which companies can increase revenues.
3.) When the annual yield payments will be at least on par with and hopefully higher than the combination of dividends and capital gains associated with comparable equities
3.) When the risk premium offered by equities is insufficient compensation
Clearly number 1 is in play, as global inflation is minimal: the EU is near deflation, with no major economy is experiencing even an inflationary spike (Inflation is an issue in Russia, Brazil and India, but their respective central banks have acted aggressively in raising rates). With inflation low, even a 2%-3% is a fair return in a slow growth environment, which leads directly to point number 2. International markets have realigned to a "risk off" trade, caused by a realization that the EU may be in or near a deadly combination of recession and/or deflationary spiral. This has been exasperated by negative news from Japan and Russia, leading investors to rethink their global growth calculus. While the S&P is yielding a little over 2%, it is also fairly expensive by other multiple valuations. Combine the high valuation levels with a potential global slowdown on the table -- and a corresponding slowdown in earnings -- and a safe asset with a comparable yield looks a bit more attractive. And the risk off trade has already been alluded to. Over the last month or so it's just gotten riskier. Major international organizations have lowered their growth forecasts, military conflict is increasing and we have a bona fide global health problem. Those three factors combined would scare any trader at least a bit.
All that being said, let's now turn to the equity markets, beginning with the weekly SPY chart:
Technically, the underlying environment is clearly bearish with a declining MACD and RSI, increased volume on the sell off, rising volatility and prices breaking the 200 day EMA. But the 200 day EMA often acts as a center of gravity; when prices break below that level, they usually respond by rallying back to that point (which they did on Friday). In the current market, that's usually because of trading programs. But, irrespective of the reason behind Friday's bounce, bounce it did.
And breaking the 200 day EMA is not the bearish indicator you might think:
The situation may not be that dire, however. While market-timing systems based on the 200-day moving average had impressive records in the earlier part of the last century, they have become markedly less successful in recent decades — to the point that some are openly speculating that they no longer work.
In fact, since 1990 the stock market has actually performed better than average following “sell” signals from the 200-day moving average.
|Next four weeks||Next 13 weeks||Next 26 weeks||Next 12 months|
|Following ‘sell’ signals from 200-day moving average||2.5%||5.4%||6.1%||9.7%|
|All other days||0.9%||2.7%||5.6%||11.7%|
The full article is definitely worth a read.
Other charts are also pointing to the possibility that we may see at least a stabilization around these levels.
Above is a 30 minute chart of the IWMs -- the average that led the market lower, making it a decent potential leading indicator. Since trading on the 9th, prices have been moving a bit more sideways, consolidating between the ~104 and 109 level. Prices aren't forming a definitive pattern, making this a fairly week technical observation.
But we're also seeing it in the IWCs -- a micro-cap ETF. Both it and the IMWs (above) also broke through their respective 200 minute EMAs as well, a potentially bullish sign.
Adding onto the theme of a potential rebound next week, consider this chart:
Above is a three year graph of both the NASDAQ and NYSE stocks below the 200 day EMA (ignore the right hand side). Both are at very low levels, indicating the market, at least from this metric is very oversold. These types of conditions usually lead to traders nibbling on what they consider to be undervalued shares, as shown in the following chart:
Above is a chart with the SPYs on top and the percentage of stocks below the 200 day EMA on the bottom. For the last three years, this level of oversold (at least on the stocks below their 200 day average indicator) has usually led to a market rebound. And the current level on the 200 day EMA -- which we see at the end of 2011 (far left of the chart), led to the strong spring rally in 2012.
And finally, let's place this sell-off against the general US economic backdrop as expressed in the Fed's Beige Book which was released on Wednesday:
Reports from the twelve Federal Reserve Districts generally described modest to moderate economic growth at a pace similar to that noted in the previous Beige Book. Moderate growth was reported by the Cleveland, Chicago, St. Louis, Minneapolis, Dallas, and San Francisco Districts, while modest growth was reported by the New York, Philadelphia, Richmond, Atlanta, and Kansas City Districts. In the Boston District, reports from business contacts painted a mixed picture of economic conditions. In addition, several Districts noted that contacts were generally optimistic about future activity.
The market is a leading indicator. But there is nothing in the fundamental US economic picture indicating we're near a recession. As I noted earlier this week, the leading and coincident indicators are in good shape, and consumer spending is at decent and sustainable levels. That means traders aren't selling because a recession is around the corner. Ultimately they're readjusting portfolios. That arguably puts a higher potential bottom on the chart.
A rebound certainly isn't guaranteed. There is clearly a big change in the risk calculus caused by the EU, Japan and increased military conflict. And those external events can have a domestic impact in an increasingly inter-connected world leading to lower corporate earnings and, by extension, equity prices. It's also possible that there is simply too much downward momentum baked into the current market environment to stop now. And, honestly, considering the overvalued nature of most shares, that wouldn't be a bad thing. But the US markets are getting caught up in a sell-off that is arguably more globally based, while the US economy isn't showing any recessionary signs. And there are also very important indicators pointing to oversold conditions. Overall, the possibility for a rebound has at least increased.