Don't Take Your Eyes Off The Bond Market
When viewed from a short-term perspective, it is now clear that the S&P 500 is in a downtrend. And unlike most of the recent declines, which were interspersed with violent up days and oftentimes displayed no memory from one day to the next, the current trend seems to have a purpose and is more one-dimensional.
While there are a multitude of issues for traders to worry about these days, the primary concern in the stock market at the present times would appear to be the backup in interest rates.
All About Bonds
From the end of January, the yield on the 10-year has increased from 1.675% to 2.417% - a rise of 44%. And since mid-April, the yield on the 10-year has advanced from the 1.85% area, which represents a surge of 30% in less than two months. As such, it is easy to argue that the spike in rates could very well be spooking the stock market here.
10 Year T-Note Yield - Daily
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The reasoning behind the backup in rates is three-fold. First there is the reality that at some point the Federal Reserve is going to begin "normalizing" the Fed Funds Rate. This means taking rates from 0% to somewhere in the vicinity of 3%. Yes, Ms. Yellen's merry band of central bankers has assured us that the move will be gradual and perhaps take years to complete. But at the same time, everybody knows that the bond market likes to stay one step ahead of the Fed.
The second issue at work here is the general assumption that the economic weakness seen in the U.S. during Q1 will turn out to be temporary and that the economy will strengthen going forward. Exhibit A in this argument is the labor market, which by most counts seems to be pretty strong right now. And if the job market is improving, it is hard to see how the economy could stay in the dumper for long.
Along those lines is the issue of "inflation expectations." Nothing spooks the bond market more than inflation perking up. And while there is still no real sign of inflation in the headline numbers, one can argue that the "expectation" for inflation is on the rise at this time.
Then there is "the trade." By now, every fast-money, macro trader on the planet knows what to do when central banks print money. However, with the U.S. out of the QE game, the reality is that the world's central banks won't continue to play the game forever. This means that, at some point, "the trade," which is to buy the bonds that the central banks are buying, will end. Therefore, there are sure to be some folks out there that want to sell while they can as opposed to when the music actually stops in this game of musical chairs.
But Is It Really Different This Time?
But at the same time, it is worth noting that the current spike in bonds doesn't appear to be anything out of the ordinary from a longer-term perspective.
10 Year T-Note Yield - Weekly
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As you can see in the chart above, the current move is in keeping with similar moves seen almost every year since the credit crisis ended. And technicians will argue that until the yield on the 10-year moves above 2.9%, there really isn't much to be concerned about. And until/unless the 10-year moves above 2.85%, the downtrend which has been intact for years now, remains in place.
So, is this it? Will this become "the move" in the bond market that traders have been predicting now for years? Is this the time to head to the sidelines with your bond funds? And will falling bond prices eventually take stocks down with them?
While we could argue the answers to the above questions until the cows come home, the bottom line is that stock market investors had best keep an eye on the world's bond markets at this stage of the game. Because in short, the action in the bonds would appear to be the primary driver at this time.
This Morning's Pre-Game Indicators
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
Hong Kong: -1.12%
Crude Oil Futures: +$1.46 to $61.60
Gold: +$12.40 at $1190.00
Dollar: higher against the yen, lower vs. euro and pound
10-Year Bond Yield: Currently trading at 2.476%
Stock Indices in U.S. (relative to fair value):
S&P 500: +7.30
Dow Jones Industrial Average: +56
NASDAQ Composite: +16.19
Thought For The Day:
"I have no special talents. I am only passionately curious." - Albert Einstein
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of Interest Rates
2. The State of Fed/ECB/PBoC Policy
3. The State of the U.S. Economy
4. The State of the U.S. Dollar
The State of the Trend
We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 3 months, and long-term as 3 months or more. Below are our current ratings of the three primary trends:
Short-Term Trend: Negative
(Chart below is S&P 500 daily over past 1 month)
Intermediate-Term Trend: Moderately Positive
(Chart below is S&P 500 daily over past 6 months)
Long-Term Trend: Positive
(Chart below is S&P 500 daily over past 2 years)
Key Technical Areas:
Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:
- Key Near-Term Support Zone(s) for S&P 500: 2070-2080
- Key Near-Term Resistance Zone(s): 2120-2135
The State of the Tape
Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...
- Trend and Breadth Confirmation Indicator (Short-Term): Negative
- Price Thrust Indicator: Negative
- Volume Thrust Indicator: Negative
- Breadth Thrust Indicator: Neutral
- Intermediate-Term Bull/Bear Volume Relationship: Moderately Positive
- Technical Health of 100+ Industry Groups: Moderately Positive
The Early Warning Indicators
Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.
- S&P 500 Overbought/Oversold Conditions:
- Short-Term: Oversold
- Intermediate-Term: Moderately Oversold
- Market Sentiment: Our primary sentiment model is Neutral .
The State of the Market Environment
One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward.
- Weekly Market Environment Model Reading: Neutral
Wishing you green screens and all the best for a great day,
David D. Moenning
Founder and Chief Investment Strategist
Heritage Capital Research
Trend and Breadth Confirmation Indicator (Short-Term) Explained: History shows the most reliable market moves tend to occur when the breadth indices are in gear with the major market averages. When the breadth measures diverge, investors should take note that a trend reversal may be at hand. This indicator incorporates an All-Cap Dollar Weighted Equity Series and A/D Line. From 1998, when the A/D line is above its 5-day smoothing and the All-Cap Equal Weighted Equity Series is above its 25-day smoothing, the equity index has gained at a rate of +32.5% per year. When one of the indicators is above its smoothing, the equity index has gained at a rate of +13.3% per year. And when both are below, the equity index has lost +23.6% per year.
Price Thrust Indicator Explained: This indicator measures the 3-day rate of change of the Value Line Composite relative to the standard deviation of the 30-day average. When the Value Line's 3-day rate of change have moved above 0.5 standard deviation of the 30-day average ROC, a "thrust" occurs and since 2000, the Value Line Composite has gained ground at a rate of +20.6% per year. When the indicator is below 0.5 standard deviation of the 30-day, the Value Line has lost ground at a rate of -10.0% per year. And when neutral, the Value Line has gained at a rate of +5.9% per year.
Volume Thrust Indicator Explained: This indicator uses NASDAQ volume data to indicate bullish and bearish conditions for the NASDAQ Composite Index. The indicator plots the ratio of the 10-day total of NASDAQ daily advancing volume (i.e., the total volume traded in stocks which rose in price each day) to the 10-day total of daily declining volume (volume traded in stocks which fell each day). This ratio indicates when advancing stocks are attracting the majority of the volume (readings above 1.0) and when declining stocks are seeing the heaviest trading (readings below 1.0). This indicator thus supports the case that a rising market supported by heavier volume in the advancing issues tends to be the most bullish condition, while a declining market with downside volume dominating confirms bearish conditions. When in a positive mode, the NASDAQ Composite has gained at a rate of +38.3% per year, When neutral, the NASDAQ has gained at a rate of +13.3% per year. And when negative, the NASDAQ has lost at a rate of -8.5% per year.
Breadth Thrust Indicator Explained: This indicator uses the number of NASDAQ-listed stocks advancing and declining to indicate bullish or bearish breadth conditions for the NASDAQ Composite. The indicator plots the ratio of the 10-day total of the number of stocks rising on the NASDAQ each day to the 10-day total of the number of stocks declining each day. Using 10-day totals smooths the random daily fluctuations and gives indications on an intermediate-term basis. As expected, the NASDAQ Composite performs much better when the 10-day A/D ratio is high (strong breadth) and worse when the indicator is in its lower mode (weak breadth). The most bullish conditions for the NASDAQ when the 10-day A/D indicator is not only high, but has recently posted an extreme high reading and thus indicated a thrust of upside momentum. Bearish conditions are confirmed when the indicator is low and has recently signaled a downside breadth thrust. In positive mode, the NASDAQ has gained at a rate of +22.1% per year since 1981. In a neutral mode, the NASDAQ has gained at a rate of +14.5% per year. And when in a negative mode, the NASDAQ has lost at a rate of -6.4% per year.
Bull/Bear Volume Relationship Explained: This indicator plots both "supply" and "demand" volume lines. When the Demand Volume line is above the Supply Volume line, the indicator is bullish. From 1981, the stock market has gained at an average annual rate of +11.7% per year when in a bullish mode. When the Demand Volume line is below the Supply Volume line, the indicator is bearish. When the indicator has been bearish, the market has lost ground at a rate of -6.1% per year.
Technical Health of 100 Industry Groups Explained: Designed to provide a reading on the technical health of the overall market, this indicator takes the technical temperature of more than 100 industry sectors each week. Looking back to early 1980, when the model is rated as "positive," the S&P has averaged returns in excess of 23% per year. When the model carries a "neutral" reading, the S&P has returned over 11% per year. But when the model is rated "negative," stocks fall by more than -13% a year on average.
Weekly State of the Market Model Reading Explained:Different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Market Model. This model is designed to tell us when risk factors are high, low, or uncertain. In short, this longer-term oriented, weekly model tells us whether the odds favor the bulls, bears, or neither team.
The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program.
Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.
The analysis provided is based on both technical and fundamental research and is provided “as is” without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.
David D. Moenning, an advisor representative of CONCERT Wealth Management Inc. (CONCERT), is founder of Heritage Capital Advisors LLC, a legal business entity doing business as Heritage Capital Research (Heritage). Advisory services are offered through CONCERT Wealth Management, Inc., a registered investment advisor. For a complete description of investment risks, fees and services review the CONCERT firm brochure (ADV Part 2) which is available from your Investment Representative or by contacting Heritage or CONCERT.
Mr. Moenning is also the owner of Heritage Capital Management (HCM) a state-registered investment adviser. HCM also serves as a sub-advisor to other investment advisory firms. Neither HCM, Heritage, or CONCERT is registered as a broker-dealer.
Employees and affiliates of Heritage and HCM may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Editors will indicate whether they or Heritage/HCM has a position in stocks or other securities mentioned in any publication. The disclosures will be accurate as of the time of publication and may change thereafter without notice.
Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.