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posted on 31 March 2017

Technical Nuggets: Has the Super Trump rally run into a wall of Kryptonite?

by Investing Daily, Investing Daily

Investing Daily Article of the Week

The post-election “Trump" rally has been weakening, which shouldn’t come as a surprise. The Federal Reserve is raising interest rates, the global economy is in a lurch, and the “Art of the Deal" looks more like “The Art of the FAIL."

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While we can argue as to what went wrong, and who won or who lost in last week’s Trumpcare debacle, the market is sending a clear message: The Super Trump rally has run into a wall of Kryptonite.

Nonetheless, Trump seems to have not nine, but nine million lives. Even with the current negative market picture, this could be just another dip that gets bought.

Bonds Disagree with the Fed

Since the Federal Reserve is on the interest rate raising warpath, the bond market’s behavior is a good place to start our analysis for the week. Bond yields are related to the state of the economy, the potential for the direction of interest rates, and the Fed’s current and future position on interest rates.

Figure 1: CBOE 10-Year U.S Treasury Yield Index (TNX)

However, the U.S. 10-year bond yield has actually fallen since the Fed raised interest rates a few days ago. That is a significant development, since bond yields usually move in tandem with the Fed, except when the bond market’s opinion is that the Fed is wrong. If we take this indicator at face value, the bond market does not believe in the Fed’s assessment of inflation and the strength of the economy. What it means is that bond traders are betting that the Fed won’t be able to continue along the rate hiking path that they’ve promised.

U.S. Dollar Disagrees with the Fed

Our second stop is the U.S. dollar. As with bonds, the dollar tends to follow the Fed, if traders agree with the central bank. Generally, higher interest rates lead to a rally in the U.S. Dollar Index (USD). But as we saw with bond yields, the U.S. Dollar Index has fallen of late, especially since the Fed raised interest rates. More interestingly, the dollar’s fall has accelerated despite some fairly loud Fed voices touting a faster pace of interest rate increases in the next few months.

Figure 2: The U.S. Dollar Index (USD)

In fact, a careful look at the USD chart shows that the dollar topped in early 2017 and has been steadily falling ever since. The more the Fed crows about higher rates, the faster the dollar seems to fall.

Three Hikes and a Stumble

The Standard & Poor’s 500 Index, unlike the dollar and the bond market, seems to be listening to the Fed. Higher interest rates are usually the kiss of death for a bull market. The old Wall Street adage, “Three hikes and a stumble," where the third interest increase by the Fed in a single cycle usually leads to decline in stocks, is being put to the test.

The Fed raised interest rates in December 2015, December 2016, and March 2017. That would be three hikes. Sure enough, the S&P chart suggests that stocks are starting to stumble.

Figure 3: The S&P 500 Index (SPX)

The biggest worry at this point is that money is starting to flow out of stocks. You can see this trend in the rolling over of the On Balance Volume Indicator (OBV). I also double stacked the money flow indicators this week, by using both the Chaikin Money Flow (CMF) and the Money Flow Index (MFI) indicators.

When these indicators agree, as they do this week, the money flow trend is confirmed. When you put OBV, CMF, and MFI together, it’s clear that stocks are in some sort of correction, as more money comes out than goes into stocks.

Breadth Is Not Comforting

The NYSE advance decline line is as good a measure of the market’s general direction as well as the health of the market’s liquidity. This week’s NYAD chart goes along with our other three charts, suggesting that unless something changes, the path of least resistance in the short term is down for stocks.

Figure 4: The NYSE Advance-Decline Index (NYAD)

The NYAD seems to be in the early stages of a short-term down trend, as money clearly comes out faster than it’s going in. NYAD is below its 20-day moving average (dotted line) which has been an excellent support level for quite some time and both the Bollinger Bands (blue solid lines) are starting to move down without any sign of shrinkage or tightening.

The bands tighten in periods of low volatility, often before a major move or a change in trend. The fact that they are starting to roll over and are moving to the down side is of concern. The RSI indicator is coming off of an oversold level but is starting to weaken. In addition, the ROC indicator, which measures momentum, just crossed above the zero line, as the line heads down. When taken together, this set of indicators suggests that downward momentum may be starting to pick up.

We May Have Entered a Correction

It’s early at this point, and conditions could still change. But the market is fickle and it was betting on President Trump being invincible. Now that Trump has suffered his first major setback, his invulnerability is in question. And with the Fed spreading more Kryptonite without the countervailing Trump boost, it’s possible that the market may increase its downward action in the short to intermediate term.

From a charting perspective, a strong bond market, a weak dollar, and a stumbling stock market suggest that some are betting that the Federal Reserve’s rate hikes will trigger a recession. It could happen, although it is not guaranteed. From a pure price standpoint, a solid break below the 2300-2330 range for SPX would confirm that a more serious slide in stock prices is the most likely scenario at the moment.

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