Technical Nuggets: Wall Street’s Twilight Zone May be About to Change
It’s not Halloween yet, but Wall Street feels a lot like a mix of the Twilight Zone, Lucy in the Sky with Diamonds, and Strawberry Fields, as the big brokerage houses and their talking heads float in a central bank easy-money fueled boat on a mythical river where nothing is real and they fantasize about meeting a girl with kaleidoscope eyes.
I can’t remember a market that’s been stuck in a more frustrating and dangerous trading range since 1994 when the S&P 500 (SPX) started the year at 481 and closed at 470 at the end of January 1995 during a period of time when the Federal Reserve raised the Fed Funds rate, which is the overnight rate used by banks to balance their books, from 3% to 6%. The difference this time is that the weird trading range that started on July 14 is only six weeks old, and that 2016 is not 1994. So the possibility that this could go on longer is certainly there.
Yet, there are other significant distinctions to note between 1994 and 2016 which can all have a major influence on the way things play out. For one, the election is fostering a sense of insanity and the country is different demographically, technologically and philosophically in many tangible ways. Economically, there are some stark contrasts as well. For example, in 1994 U.S. GDP was growing at a robust 3% annual rate compared to the meager and questionable (due to seasonal adjustments) 1.1% annual rate recently reported. The Consumer Price Index grew at a 2.7% rate in 1994, vs. the current annualized (2015) rate of 0.7%. And there were around 66 million Americans out of work in 1994 compared to some 94 million out of work in July 2016. Altogether, the U.S. economy could withstand a doubling of interest rates back then.
Signs of Stress in Stock Market Appear
Call me crazy from the heat. After all, it’s been a hot summer in Texas. But when the usually wishy-washy Fed Chair Janet Yellen says, “I believe the case for an increase in the federal funds rate has strengthened in recent months,” and when the next speaker, Fed Vice Chair Stanley Fischer, at the same Jackson Hole meeting (8/26/16) almost announces that the rate hike may come as early as September, it may be time to pay attention. Some traders were paying attention as the S&P 500 reversed its intra-day gains following Fischer’s remarks. And as I will show during my chart review, things have quietly but noticeably changed on the charts over the last two weeks.
In my August 15 Technical Nuggets column, referring to the market’s complacency as highlighted by very low volatility, I noted: “Something has to give, and when investors decide that economic fundamentals do count, we could see a significant decline in stocks. That said, we may not be anywhere near that point yet.” Well, maybe we are getting closer to the point where what didn’t matter last week suddenly matters.
Sellers Gain Some Ground
First, I want to concentrate on the S&P 500 (SPX), which continues range-bound and whose low volatility I will discuss in the next section. Look at the two lower panels on the chart, Accumulation-Distribution (Accum/Dist) and On Balance Volume (OBV). Both have topped out and are heading lower. This suggests that sellers are starting to gain the upper hand. Note also that two weeks ago the grey volume bars (signifying buyers were in charge) were larger than the pink volume bars (indicating sellers are rising), which have risen over the past three trading days.
Meanwhile, SPX not only failed to extend its recent breakout to new highs, but has also failed to hold at its first support line, the 20-day moving average (dotted line), and is now just above the lower Bollinger Band (solid green line). At this point, the index could well rally again to the upper Bollinger Band, or start to slowly decline. More important for the longer term is what happens if the index falls to 2144 or so, where the 50-day moving average closed on August 25th.
Bollinger bands, (solid green lines above and below prices) are built on the premise that prices can’t deviate from the mean (moving average) forever and that when prices move too far in one direction, up or down, they will reverse direction. For this example I will use the 20 day moving average (green dotted line).
The salient point about the bands this week is that they are starting to widen a bit. When this happens, it’s a sign that volatility is about to increase, which means that traders are starting to review their current positions and that there may be some meaningful changes in asset allocation.
Beyond the Bands
Another useful way to look at the market is to review the number of stocks that are advancing versus those that are declining. And the New York Stock Exchange Advance Decline Line (NYAD, upper panel) is the best way to analyze this dynamic also known as market breadth. Under normal circumstances:
- The NYAD rises along with the indexes
- When the NYAD rolls over it’s often a sign that a meaningful correction may have started
- It is most useful to look at the NYAD at the same time as exploring several market indexes and comparing their overall trend to the NYAD
In this snapshot it’s clear that the NYAD is rolling over. At the same time, we see the S&P 500 (first lower panel) also showing some weakness. Even more pronounced is the weakness in the Dow Jones Industrial Average (INDU, middle lower panel) which has started to make a string of lower highs and lower lows, and seems to be in a short term down trend. The Nasdaq 100 Index (NDX, bottom lower panel) has also flattened out. These three indexes, when viewed in conjunction with the NYAD, are suggesting that the market is starting to weaken.
We may be nearing a period of increased volatility. There are several momentum, money flow, and price indicators that suggest that the market is starting to weaken. And the Federal Reserve has made it clear that it is interested in raising interest rates, and that perhaps it may do so in September, which is traditionally the most dangerous month of the trading year.
I may be wrong and this may all blow over. Similar indicator clusters over the last few months and years have been proven to be of little use through the past eight years of zero interest rates and central bank manipulated markets. It is also true that the high frequency algorithm traders are well-known to jack prices up and down for no good reason just to take a few pennies away from the rest of us. But, if this is the time when reason and traditional analysis replaces the Twilight Zone, Lucy in the sky with diamonds and Strawberry Fields machine market, the next few months could be tough for investors who are not cautious and fail to consider the protection of their portfolios.