StockCharts Blogs - ChartWatchers

TRENDLINES AND 50% RETRACEMENTS REACHED

The following three charts show the three major U.S. stock indexes having reached formidable overhead resistance barriers. Charts 1 and 2 show the Dow Industrials and the S&P 500 having retraced 50% of their bear market declines. More importantly, both indexes are testing major down trendlines drawn over 2007/2008 peaks. Given the fact that the market has rallied 60% in the last eight months without a meaningful correction, that's some cause for concern. Chart 3 shows a slightly different picture for the Nasdaq market, but the message is essentially the same. The Nasdaq Composite has reached important overhead resistance along its early 2008 trough around 2200. That puts all three stocks up against meaningful resistance barriers. Combined with the fact that numerous short-term divergences are starting to appear among market groups, and the recent rotation toward large-cap stocks in the consumer staple and healthcare categories, it looks like investors are starting to lock in or protect some yearend profits. That could lead to choppier market conditions.

BARRICK AND NEWMONT MINING TURN UP

With gold hitting new record highs each day, gold stocks are starting to play catch-up. Two of the biggest are at or very close to hitting new 52-week highs. Chart 1 shows Barrick Gold closing at a new 52-week high today. The gray line is the ABX/SPX ratio which has been dropping since February and just starting to rally. Chart 2 shows Newmont Mining closing at a new 52-week high as well. Its relative strength ratio (gray line) is turning up as well. What the two RS lines tell us is both big gold stocks are pretty good values relative to the rest of the market and are starting to show upside leadership for the first time in eight months.

BREAKDOWN IN BOND YIELD MAY BE BAD FOR STOCKS

One of the catalysts behind Thursdays heavy stock selling was the breakdown in Treasury bond yields. The 10-Year T-note yield fell below its July low to the lowest level in more than four months. Bond yields are an indicator of confidence in the economy. When investors are optimistic, they buy stocks and sell Treasuries. That pushes bond yields higher. When they're more pessimistic, they sell stocks and buy Treasuries. That pushes yields lower. So the direction of Treasury bond yields has some bearing on the direction of stocks. That's been especially true over the last two years. The weekly bars in Chart 1 compare the trend of the 10 Year Treasury Note Yield (TNX) to the S&P 500 (green line). At least two things are apparent. One is that bond yields and stocks have usually trended in the same direction. The second is that bond yields have tended to change direction first. Bond yields started dropping during the summer of 2007 several months before stocks peaked. Bond yields started bouncing at the start of 2008 and anticipated a stock rebound that spring. After falling together during the second half of last year, bond yields turned up several months before stocks. Chart 2 shows bond yields turning up in January of this year two months before stocks' March bottom. Bond yields peaked in June, however, and have been weakening since then while stock prices have risen. That "negative intermarket divergence" grew more serious with yesterday's breakdown in yields.

BREAKDOWN IN BOND YIELD MAY BE BAD FOR STOCKS

One of the catalysts behind Thursdays heavy stock selling was the breakdown in Treasury bond yields. The 10-Year T-note yield fell below its July low to the lowest level in more than four months. Bond yields are an indicator of confidence in the economy. When investors are optimistic, they buy stocks and sell Treasuries. That pushes bond yields higher. When they're more pessimistic, they sell stocks and buy Treasuries. That pushes yields lower. So the direction of Treasury bond yields has some bearing on the direction of stocks. That's been especially true over the last two years. The weekly bars in Chart 1 compare the trend of the 10 Year Treasury Note Yield (TNX) to the S&P 500 (green line). At least two things are apparent. One is that bond yields and stocks have usually trended in the same direction. The second is that bond yields have tended to change direction first. Bond yields started dropping during the summer of 2007 several months before stocks peaked. Bond yields started bouncing at the start of 2008 and anticipated a stock rebound that spring. After falling together during the second half of last year, bond yields turned up several months before stocks. Chart 2 shows bond yields turning up in January of this year two months before stocks' March bottom. Bond yields peaked in June, however, and have been weakening since then while stock prices have risen. That "negative intermarket divergence" grew more serious with yesterday's breakdown in yields.

Chart 1


Charts 2
 

FALLING DOLLAR FAVORS FOREIGN STOCKS

Arthur Hill reviewed some standard intermarket relationships on Thursday. One of the best known is the inverse relationship between the U.S. Dollar and commodity prices. That's why a falling dollar has had a bullish impact on commodity prices since the spring. The falling dollar has also boosted global stocks as money moved out of that safe-haven currency into riskier assets like stocks. But not all stocks rise equally at such times. A falling dollar has a much more bullish impact on foreign stocks. Since the March top in the dollar, for example, the S&P 500 has risen 56%. Foreign stocks, however, gained 72%. The stronger foreign performance was due largely to the falling dollar. The red line in the chart below is a ratio of the Morgan Stanley World Index (Ex USA) and the S&P 500. The green line is the U.S. Dollar Index. The inverse relationship between the two lines is very clear. Foreign stocks did much better than the U.S. from 2002 to the end of 2007 while the dollar was falling. Foreign stocks did much worse than the U.S. during the second half of 2008 as the dollar rallied. The dollar peaked in March of this year and has been falling since then. The rising ratio shows foreign stocks outpacing the U.S. since the dollar top in March. A weaker dollar favors heavier exposure in foreign stocks. The direction of the dollar also determines when it's better to use foreign ETFs.

GOLD AND SILVER HAVE BIG WEEK

GOLD TESTING ALL-TIME HIGH... Last Friday I wrote about the bullish potential in gold and gold shares. That optimism was based on two bullish chart patterns which are shown below. The first is the bullish symmetrical triangle shown in Chart 1 for the Gold Trust ETF (GLD). This week's upside break of the upper resistance line (on heavy volume) is bullish and signals a test of its February high near 100 (which corresponds to $1,000 in bullion). Chart 2 shows why that's an important resistance level of its own. Chart 2 (based on the price of bullion) shows an inverse (or continuation) head and shoulders pattern with a neckline drawn over gold's 2008-2009 highs. A close through that level (which appears likely) would be even more bullish for gold and gold shares. In fact, gold shares have risen even more than bullion this past week. So did silver.

ON HIATUS THIS WEEK

John will return for our next issue....

ITB VERSUS XHB

On Monday, I wrote a bullish message on the homebuilding group and suggested using the SPDR S&P Homebuilding ETF (XHB) as one way to participate in the housing recovery. I pointed out, however, that the XHB has a relatively heavy weighting in a lot of housing-related stocks that aren't necessarily homebuilders (like Home Depot, Bed Bath & Beyond, Masco, etc.). A purer homebuilding play can be found in another ETF -- iShares Dow Jones U.S. Home Construction (ITB) -- which is shown in Chart 2. The two charts are basically similar, show the same bottoming characteristics since last November, and are both on the verge of breaking out to the highest levels in nine months. On percentage grounds, however, the ITB has an edge. Since the start of 2009, the ITB has gained 23% versus 19% for the XHB (the S&P 500 has gained 9%). Since the March bottom, the ITB has rallied 87% versus 74% for the XHB (and 44% for the S&P 500). The top holdings in the ITB are homebuilders like NVR, DR Horton, PHM, Toll Brothers, Lennar, and Centex. The XHB offers participation in a broader array of housing-related stocks. If you want a purer homebuilding play, however, ITB would be the better choice.

DOLLAR SELLS OFF AS EURO HOLDS SUPPORT

It looks like you can throw out most of what I wrote last Friday. I was expecting a deeper market correction after most market indexes broke short-term head and shoulder "necklines" (and daily EMA lines turned negative). I also wrote about the possible threat from a rally in the CBOE Volatility (VIX) Index. It turns out I was wrong on both counts.  Stocks rallied strongly and the VIX touched a new low.

Although some readers have asked if the current rally could be just another "right shoulder", I'm somewhat doubtful. A retest of the June high at 956 looks more likely. The fact that the technology-dominated Nasdaq market has already exceeded that high is also influencing a rising market. That doesn't rule out the possibility for a market correction later in the summer or the autumn. This week's upturn, however, has postponed that possibility for the time being.

I also wrote that a dollar rally would most likely coincide with a stock pullback. The reverse happened. The dollar dropped as most foreign currencies rose (except for the yen). Chart 1 shows the Euro bouncing off chart support near 137.5 and its 50-day moving average. The Euro has the biggest influence on the dollar. The Euro has also had a positive correlation to stocks since March. The week's bounce kept its March uptrend intact which helped stocks as well. The Japanese yen (which rallied the previous week on safe haven buying) pulled back this week as stocks bounced. Chart 2 shows the XJY retesting its neckline near 106. A close back below that support line would be positive for stocks.

Chart 1

Chart 2

DEFENSIVE ROTATIONS DURING JUNE

A sign that investors have turned more negative over the last month is the rotation out of economically-sensitive groups (like consumer discretionary and energy stocks) and into defensive groups (like utilities, consumer staples, and healthcare). Chart 3 shows relative strength lines for those five groups (versus a flat S&P 500) since the start of June. The downturn in the Discretionary SPDR (XLY) performance in early June is consistent with views that retail spending is being held hostage by rising unemployment numbers (which were borne out yesterday). The downturn in energy (XLE) is consistent with weaker commodity prices owing to a strong U.S. Dollar. Three of June's best performers are defensive staples (XLP), healthcare (XLV), and utilities (XLU). All of those rotation shifts are consistent with a much-needed correction in a market that's risen too far too fast. While stocks and commodities fell together during June, money has moved back into Treasury bonds and the U.S. Dollar.

BPNYA TURNS DOWN FROM OVERBOUGHT TERRITORY

I recently showed the NYSE Bullish Percent Index (BPNYA) having reached overbought territory over 70. the BPNYA is the percent of NYSE stocks that are in point & figure uptrends. I suggested that a drop below the May trough at 68 could signal a short-term top. Chart 1 shows that downturn has taken place as the breath indicator has fallen to 65% and formed a small "double top" in the process. Chart 2 shows the point & figure version of the same indicator. A three-box reversal into the down column also took place this week. That's another sign that the current uptrend is losing some breadth momentum. [Arthur Hill showed a similar downturn in the number of NYSE stocks trading over their 50-day moving averages]. Those are at least two reasons to be a little more cautious at current levels.

200-DAY AVERAGE IS STILL DROPPING

Virtually all major market indexes (including the Dow) have now exceeded their 200-day moving averages. That's a positive sign for the stock market, and adds more weight to the view that a major bottom has been seen. As I wrote a couple of weeks ago, however, the "direction" of the moving average line itself is also important. Legitimate bull markets usually require that the 200-day average also turn higher. For that to happen, stock indexes have to first clear the 200-day line (which they've done). Then, stock indexes have to reach the price level formed 200 days ago. In other words, the latest closing price has to exceed a closing price 200-day days ago. The solid line on top of the chart below shows the 200-day "price channel" currently at 1303. It's doubtful that prices will reach that level in the near future. The S&P has yet to even clear the middle (dotted line) which currently sits at 985. [The dotted line sits midway between the upper and lower channels and often acts as resistance in a downtrend]. As good as the spring rally has been (with most indexes having also cleared their January highs), I believe that the market is still in need of some corrective action (or consolidation) before moving substantially higher. V bottoms are extremely rare. W bottoms are a lot more common. So are head and shoulder bottoms. It seems unlikely that the market will continue to rally in a straight line. More basing activity is most likely needed. And that's going to require more time.

MARKET FAILS TEST OF JANUARY HIGH

I started the week on Monday with the headline that "Upside price and time targets had been hit" and added that overbought readings suggested that the market was vulnerable to profit-taking. The NYSE Composite Index had just reached overhead resistance at its January high and its 200-day moving average as shown in Chart 1. A number of other indexes (like the Nasdaq Composite in Chart 2) and sector indexes were stalled at their 200-day moving averages as well. So were numerous foreign stock markets. Chart 3 shows the MSCI EAFE (Europe Australasia and Far East) Index stalled at its January high and 200-day line. It was no surprise then to see global stocks selling off this week. When a market has rallied too far and is ripe for profit-taking, some fundamental trigger usually starts things off. A weak retail report on Wednesday caused stocks to sell off on heavy volume and got the correction started. After a modest bounce on Thursday, stocks fell again on Friday. The result was a weekly loss for all of the major stock indexes. I also suggested that a pullback to the 50-day moving average was likely and could be part of "right shoulder" in a bottoming formation. Arthur Hill expanded on that idea during the week. In addition to some fundamental trigger, there are technical triggers as well. Chart 1 shows two examples. The 14-day RSI line (top of chart) broke its two month support line after reaching overbought territory at 70. The MACD histogram bars (below chart) turned negative (red circle). There were other technical triggers as well.

NASDAQ TESTS 200-DAY LINE

One of the problems with doing an analysis of the "stock market" is choosing which market index to represent it. Like most analysts, I rely on the S&P 500 which is generally viewed as the market benchmark. As we've pointed out several times, however, some parts of the market have been rallying much stronger than others. One of those groups is technology which is heavily represented in the Nasdaq market. Generally speaking, relative strength by technology and the Nasdaq are good signs for the rest of market. And the fact that the Nasdaq Composite has already exceeded its January high is a definite sign of leadership. However, the Nasdaq is undergoing another test of its uptrend. Chart 5 shows the Nasdaq Composite Index testing its 200-day moving average near 1750. It's a good idea to keep an eye on that test. It's also a good idea to watch the rising 20-day average (green line). The Nasdaq needs to stay above that rising support line to keep its uptrend intact.

MCCLELLAN OSCILLATOR IS STILL POSITIVE

The McClellan Oscillator is a short- to intermediate-term momentum breadth indicator. It's calculated each day by taking the difference between the 39-day and 19-day exponential moving averages of the number of net advances on the NYSE (see Chart School for a more in-depth explanation). The chart below shows the NYMO (black line) compared to the NYSE Composite Index (green line). The McClellan Oscillator fluctuates between an oversold level below -100 and overbought territory above 100. Short-term buy and sell signals are given when it crosses above or below its zero (flat) line. The chart shows, for example, the NYMO bouncing from oversold territory in late February before crossing over its zero line in early March (circle). Although it has backed off from overbought territory at 100, it remains above its zero line. It would have to fall below that line to signal an end to the rally. The McClellan Oscillator is only useful over the short to intermediate term. In my view, its greater value lies in its longer-range version which is called the Summation Index.

DAILY EMA COMBO TURNS POSITIVE

I've received a number of requests to review the current position of the 13-34 exponential moving averages (EMAs). As you probably know, I place a lot of importance on that combination because of its strong track record over the years. I apply the 13-34 EMA combination to daily, weekly, and monthly charts. Let's start with the "daily" lines which measure the market's "short-term" trend. Chart 1 shows the 13 and 34 day moving average combination. For a short-term buy signal to occur, the 13-day (blue line) has to cross over the 34-day (red line). That short-term buy signal took place earlier in the week. But there's more. The black line below chart 1 plots the "spread" between the two EMA lines. [You can create that line by inserting 13,34,1 into the MACD indicator]. You can see a positive divergence taking place during March when the black line held above its October low (black arrow). [We've shown similar positive divergences in several other technical indicators]. More importantly, the black line has exceeded its January high and risen above the zero line for the first time since last May. [A crossing above the zero line by the black line coincides with a positive EMA crossing]. That's a sign that the current rebound has legs.

GOLD STOCKS TOP 200-DAY AVERAGE

The Fed's midweek surprise announcement that it was buying Treasury bonds had a fairly predictable ripple effect through the various financial markets. Naturally, Treasury bond prices jumped and yields collapsed. The big drop in bond yields pushed the dollar sharply lower and commodities higher. As Arthur Hill described during the week, gold experienced an impressive upside reversal and may have reverted back to an inverse relationship to the dollar. One of the top stock groups on the week was precious metals. A month ago, I turned cautious on the short-term outlook for precious metals when the Market Vectors Gold Miners ETF (GDX) fell back below its 200-day moving average. Chart 1, however, shows the GDX closing well above that resistance line and on the verge of a new six-month high. That puts precious metal assets back in the fast lane. The main reason for the jump in gold and other commodities is the belief that a weaker dollar resulting from the Fed's printing of so much money will increase inflation pressures. One way to hedge against that possibility is to own some precious metal assets. Another way is to own some TIPS.

DOW THEORY STILL IN DOWNTREND

At the start of the 20th century, Charles Dow invented the Dow Theory. It was a simple idea. He created two stock indexes -- one for industrial stocks and one for the transports (which were exclusively rails). His reasoning was that both indexes should rise together in a healthy economy. While industrial companies made the goods, the rails transported those goods to market. One couldn't function without the other. Although he was applying that idea to the economy, his Dow Theory became a basic part of traditional technical analysis. When both indexes are rising together, a bull market exists. When they fall together, a bear market is present. Charts 1 and 2 compare the Dow Industrials and Dow Transports over the last three years. Both are in major downtrends which is bad for stocks and the economy. Although the transports turned down first in the second half of 2007, they retested their old highs in the spring of 2008 before finally peaking. The transports fell sharply during the second half of 2008 and are now trading at the lowest level since 2003 (the industrials have already broken that low). Since most attention is given to industrial stocks, I'd like to examine some driving forces behind the transportation plunge.

A LOT OF MARKETS ARE AT CRITICAL CHART JUNCTURES...

GOLD TOUCHES $1000 FOR FIRST TIME IN A YEAR... A number of financial markets are testing important chart points. Let's start with gold. Bullion touched $1,000 today for the first time since last March. Chart 1 shows the streetTracks Gold Trust (GLD) very close to touching its March 2008 high at 100. On a short-term basis, however, the price of gold looks overbought. Some profit-taking from this level wouldn't be surprising. If that's true, some counter-trend moves may be seen in some other markets. The dollar may have also started one.

DOLLARS DIPS AS EURO BOUNCES ... The U.S. Dollar has been rising along with gold since December. Chart 2, however, shows the Power Shares DB US Dollar Index Fund (UUP) dropping today from chart resistance near its November high. Chart 3 shows the Euro bouncing off chart support along its November low. That suggests that some "short-term" market dynamics might be changing. A weaker dollar might contribute to some profit-taking in gold and buying in some oversold commodities. A bouncing Euro might suggest that the recent selloff in stocks is overdone as well. I've shown before that stocks have been trading in tandem with the Euro since midyear and opposite the dollar.

MACD LINES SHOW SOME PROMISE

A reader complained this week that we failed to point out the "negative divergence" in the daily MACD lines during January prior to the latest downturn. The reason I didn't point it out was because none existed. In fact, it may be the other way around. At the moment, the daily MACD lines look more positive than negative. Chart 1 overlays the MACD lines (and MACD histogram) over daily bars for the S&P 500. The chart shows that the MACD lines bottomed during October and gave a positive divergence during November (rising trendline) before rallying into the start of January. No negative divergence was given at the early January top. Although the S&P fell to the lowest level in two months during January, the MACD lines remained well above their earlier lows. The lines have now turned positive again (see circle). To me, that looks like positive divergence and hints at more market strength. The market is rallying today with the biggest gains coming from financial stocks (and banks in particular). The S&P is up more than 2% and is nearing a test of last week's intra-day high at 877. A close through that initial chart barrier would strengthen the market's "short-term" trend and keep the three-month trading range intact. There's even more good news.

OTHER BOND CATEGORIES ARE BOUNCING

I recently wrote about how investment grade corporate bonds were starting to gain some ground on Treasury bonds. Today, I'm adding two other bond categories to that list. The flat line in Chart 1 is the 20+Year Treasury Bond iShares (TLT) which has been the strongest part of the yield curve over the past few months. That's been partly due to a flight to safety and deflationary concerns. The three other lines in Chart 1 are relative strength ratios versus the TLT. All three bond ETFs have been gaining ground on Treasury Bonds since mid-December. The strongest has been the LQD (blue line) which I wrote about in the earlier article. The next strongest is National Muni Bond Fund (PZA) which is the green line. The next in line is the High Yield Corporate Bond Fund (HYG). Charts 2 through 4 show what those bond ETFs look like. The LQD in Chart 2 is trading well above its 200-day line. The Muni Bond ETF (Chart 3) is testing that resistance line and its early November peak. Chart 4 shows the High Yield Corporate Bond ETF trading at a three-month high and nearing its 200-day line. For those who think that the recent surge in Treasury bond prices is overdone (I certainly do), these other bond ETFs offer some alternatives.

INTERMARKET TRENDS TURN MORE POSITIVE

Chart 1 shows how the interaction between the four main asset classes unfolded during 2008 and how they're entering 2009. The two weakest assets were commodities and stocks. The two strongest were Treasury bonds and the dollar. During the first half of the year, commodities were the strongest asset class while the others lost ground. At midyear, however, a sharp rally in the dollar (green line) caused a massive collapse in commodities (black line) which continued until November. Treasury bonds (red line) rallied sharply on plunging commodities. During most of the second half, bonds and the dollar rallied while stocks (blue line) and commodities fell together. [During a recession, bond prices usually rise while stocks and commodities fall]. Starting in November, however, those trends started to reverse. The stock market started to recover as the dollar weakened. As we enter the new year, stocks and commodities are bouncing while the dollar and bonds are pulling back. While those trend reversals are still relatively small, they do suggest that investors are entering the new year in a more optimistic mood.

% NYSE STOCKS ABOVE 200 AVERAGE

A reliable measure of the market's strength or weakness can be found in the % of NYSE stocks trading above their 200-day averages. That's because 200-day averages are used to measure a market's long-term trend. [A 50-day line measures short- and intermediate- market trends]. Chart 1 shows the indicator since the start of 2006. The sharp drop during the second half of 2007 was one of the bearish signs that warned of a coming bear market. During bull market corrections, the indicator will often pullback into the 40-50% region. The April 2006 bull market correction bounced from 40%. Drops below 40% signal the start of a bear market which occurred during the second half of 2007. Bear market bounces can rise into the 50-60% region. The April/May bounce rose to 53% before turning back down again. The August bounce failed at 40%. A reading above 60% is normally needed to signal a new bull market. Chart 2 shows the trend during 2008 which is still very low 4%. That means that 96% of NYSE stocks are trading below their 200-day lines. While that historically low reading reflects a deeply oversold market, it doesn't show any sign of turning higher. Remember that the stock market is a market of stocks. The market can't be expected to rise much when the overwhelming majority of its stocks are still in major downtrends.

S&P JUMPS 6% AFTER TOUCHING NEW LOW

After dropping briefly to the lowest level since March 2003, the S&P 500 achieved an upside reversal day (as did all of the other major indexes) that resulted in a 6% gain. It also did that on the highest volume in weeks. The fact that the S&P touched a new low before rallying is especially impressive (Chart 1). The Nasdaq did the same (Chart 2). The Dow Industrials bounced off psychological support near 8000. The rally was aided by short-term positive divergences in both the daily RSI and MACD lines. Although all market groups participated, the biggest gains were seen in consumer discretionary, financials,REITS, and small caps. Commodity stocks also rallied strongly. Gold and energy stocks gained 12%. The commodity bounce was aided by stronger stocks and a weaker dollar. Many commodity markets were closed during the late stock rally and will probably see more buying tomorrow. Bond prices sold off as stocks rallied.

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LIBOR DROP ENCOURAGES MARKETS

One of the recent positive trends is the continuing drop in the three-month London Interbank Overnight Lending Rate (LIBOR). That rate determines what banks charge each other for loans. During the credit freeze that started in mid-September, the LIBOR jumped from 2.8% to 4.8% as stocks fell sharply. Since mid-October, however, the LIBOR has been dropping. It fell another 16 basis points today to 3.03 (see arrow) which is the lowest level in six weeks. That's helping to stabilize global stock markets.

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