There are a number of important, broad market developments underway, and we’re going to use today’s letter to draw your attention to them.
- The first is found in the bond market, where the divergence between the price of the riskiest instruments is running entirely at odds with that of the safest.
- The second involves the relationship between the U.S. Dollar and the commodities complex, an inter-market comparison that has a number of important ramifications for market watchers.
- And finally, we take a look at the transport sector, an index that has important stand-alone value for those attempting to understand market direction.
Taken together, we hope our analysis of the above three items will provide you with a confident understanding of exactly where we stand today and where we’re headed over the intermediate term.
All right. We start with the fixed income sector, where high yield (junk) bonds have been flying, and the long bond – among the safest of all interest bearing instruments – has been stuck in a tight sideways range.
Have a look first at high yield, as represented by the iShares iBoxx High Yield Corporate Bond ETF (NYSE:HYG) –
Straight line profits.
Here, it’s clear that folks are on a risk buying bonanza. Much of this has to do with the recovery in oil prices. As volatile as they may be today, they’re nowhere near where they were in 2015, when plummeting crude forced many poorly capitalized outfits in the oil patch to either miss their junk bond payments or come frighteningly close to doing so.
Since then, of course, oil has stabilized and high yield has taken off.
The chart above shows price trending above all her moving averages, and all the MAs themselves in the process of unfurling higher. It could be a couple of months before that process is complete, but it’s certainly an indicator that risk appetite is growing and therefore bodes well for equities.
On the Other Hand…
In contrast to that, the iShares 20+ Year Treasury Bond ETF (NYSE:TLT) is showing signs of fatigue.
Here’s the last half year for the long bond –
As we note on the chart, a six week pennant has emerged (in red) that looks ripe for a breakout at any moment. Which way the break will occur is not easy to determine because 1) the pennant is a continuation pattern, and 2) we’re not certain if the current action is still part of the former uptrend, or whether a new downtrend began after the early July peak. We’d be happy to get your opinion on that one.
In the meantime, both RSI and MACD (in blue) are hugging their respective waterlines in what looks like an EKG flatline, pushing us to speculate that we’ll shortly see some selling momentum.
So is the long bond dead?
Maybe. Or perhaps she’s just in a deep freeze, waiting for the porpoise to sing.
Time will tell.
We note, of course, that the Fed is due to issue interest rate direction shortly, and slightly higher rates would certainly contribute to a selloff on the long bond.
But before we offer our final ruling on the bond market, let’s move quickly to the dollar and commodities.
Here’s a view of the dollar for the last six months. Take heed especially of the action of the moving averages.
We’ve circled in red the imminent folding over of the 274 day moving average (orange) below the long term 411 day MA (in yellow), a development that will be complete by the end of the week. At that point all the moving averages will have rolled over and will be completely unfurled, giving us a full-on bearish profile for the buck – according to the moving averages.
A fall in the dollar will be a boon to corporate America, as foreign purchasers of U.S. goods cash in on the ‘discount’ they acquire via the weakened currency. That could be good for stocks, too, as earnings and guidance numbers begin to rise over the next few quarters.
The dollar story is confirmed in large part by action on the commodities front, where, as the chart below will show, a constructive technical picture is forming.
This is the PowerShares Deutsche Bank Commodity Index Tracking Fund (NYSE:DBC) for the last half year. As you can see, a series of higher highs and higher lows (that actually goes back to January) shows that we’re in the midst of a bull move (in red). The ascension of the 137 day moving average (deep red) above the 274 DMA (orange) is also promising.
Unfortunately, bulls will have to wait until DBC breaks to new highs in the $15.75 range (in blue) before we get an unequivocal bull signal. At that point, price will be above all her moving averages as well as the last retracement high, marking a blue sky commodity future ahead.
But will it happen?
Good question. A lot depends on the fate of the aforementioned dollar. Should we see a decline in the dollar index, the commodities will certainly rise, as they’re still priced in U.S. Dollars. Should that fail to materialize, it could still happen, but the likelihood is diminished.
Speculation, Greed and Robots
We’re going to turn now to the transportation sector, where a break higher also appears in the cards. Have a look –
We’ve got a long term, downsloping trendline (in red) and price action that’s been bumping up against it for the last two months. In our view, it’s inevitable that a break higher is imminent, particularly since the chort term moving average and the 137 day MA are now ‘scooping’ price.
It’s likely that the rise above trendline resistance will also bring the trannies above their long term moving average (in yellow), and that would pretty much lock in place the turn higher for the intermediate trend.
Sum it up, Huey!
The transports are a key leading indicator of stocks, as orders to book new deliveries have to be made well in advance of actual industrial production. We view it as a very positive development that the trannies are now poised for a break higher, and we also feel confident enough to anticipate that occurrence in our trade for the week.
That said, we’re also buoyed by the action in the bond markets, where risk is apparently the order of the day. Rising junk bond and declining long bond prices are indicative of money flowing from ‘safe haven’ status to high-speed watersport daredevilry.
And the dollar/commodity relationship is also constructive for the corporate profit outlook.
It’s a transport trade, using the iShares Transportation Average ETF (NYSE:IYT).- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
With kind regards,
Hugh L. O’Haynew