Friday Carried Over to Monday

To say that the markets have been acting in a highly unusual fashion since the first inklings of the Federal Reserve’s QE2 actions crept out would be the understatement of the year.  In that time, we’ve seen investor sentiment shift from nothing short of euphoric to downright skeptical.  Whether it be equities, debt, commodities, or emerging markets, it is clear that there is virtually no asset class out there that investors are willing to buy at this point.  Hit particularly hard has been the Treasury market, which saw yet another round of savage selling today.  The 30-year bond, in particular, saw its yield climb an eye-popping 12.43 basis points to 4.4153% today (after hours); a full 90 basis points higher than the 3.51% yield that was seen in late August.  Clearly, investors have decided that the risk of owning U.S. government-backed debt at this point in time is simply not worth the risk, whether they be related to inflation, default, or some other negative indicator. 

The more surprising element of this back up in yields, though, is the fact that the selloff in Treasuries has not been accompanied by a more robust bid in the equity markets.  In a ‘normal’ environment, it would be expected weakness in either the Treasury or equity markets would see a corresponding bid in the other market.  Needless to say, that’s not the case right now and it’s a divergence that I view as VERY significant.  Of course, the subsequent question from this assertion is what exactly is the significance of this divergence?  Does this mean that there’s a rally coming in the equity market or the Treasury market?  In truth, there is a fundamental case to be made for both arguments, so knowing which one will ultimately win out is merely a coin flip.  That leaves us, of course, with technical analysis. 

So what exactly do the charts say?  First, let’s take a look at the daily chart of the 30-year Treasury yield.

As you might expect, 30-year yields have zoomed higher, especially over the past two weeks.  As a result, yields are primed for a near-term correction of some degree.  As you can see, the RSI is clearly getting into overbought territory, which suggests a pullback is needed.  However, the MACD suggests that the intermediate term trend will likely remain higher, thus keeping any pullback fairly shallow.  With the 200-day exponential moving average sitting about 30 basis points below current levels and near the breakout level of 4.10%, I wouldn’t be surprised to see any selloff find some support around this level.  But the larger take away from this chart should be that that yields are likely to head higher for a while longer.  To an extent this makes sense since they fell rather precipitously this summer and, therefore, are in need of a decent-sized retracement. 

Looking at the 10-year we see an eerily similar story as well.  Like its longer-term cousin, 10-year yields are primed to continue their move higher for some time after a near term respite.

So, clearly, these charts (indications are very similar on the weekly charts as well) suggest Treasury yields are headed higher.  However, this spike isn’t likely to occur for a while as the market needs to consolidate after a huge rally of late.

In the case of equity prices (as judged by the S&P 500), the indications are nearly reversed.  Below is a daily chart of the S&P 500.  One of the key differences between equity and Treasury yields, at this point, is the fact that the intermediate term trend is likely to be downwardly biased as suggested by MACD.  Furthermore, as you can see on the chart, the S&P 500 has broken below its upward sloping trend line that has been in place since late August.  This yet another sign the rally is growing long in the tooth and confirms the MACD indications.  To be fair, the RSI has been declining over the past several sessions as selling momentum picked up.  However, the indicator is not yet in an oversold condition, which means that selling can continue in a relatively unimpeded manner.  This does suggest, however, that a near-term bounce could be in the offing.  If this does materialize, though, it’s likely to prove short lived.

So looking at these indications, the data is highly suggestive, in my opinion, of a market that will see weak equity prices and declining Treasury yields in the days leading up to the Thanksgiving holiday.  In the case of equity, the selling pressure could extend for a longer period as MACD indications tend to play out over a longer period than those of the RSI.  And looking at the unimpressive price action in the stock market today, it appears that the tide of bullish sentiment that reigned over the past two months is continuing to ebb.  Since investors tend to overshoot pricing on both the upside as well as the down, I wouldn’t be surprised to see the S&P 500 move down to the 1,150 level is relative short order.  However, breaking below the 1,125 threshold will prove much more difficult should prices get to that point.

Looking to tomorrow, and the rest of the week for that matter, I get the sense that the corporate and economic data points we get will take a back seat to investor sentiment and European debt concerns.  It seems that the market is simply on edge at this point and almost looking for a reason to drop.  While these concerns may prove unfounded, it seems clear to me that this isn’t the sort of environment that is conducive to initiating long positions.  For now, I’ll keep my small shorts and large cash positions.

Until tomorrow…..