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The Stock Market Might Be Hearing the Fed’s Footsteps

If the stock market were a wide receiver running toward the goal line, it would be hearing the proverbial footsteps of the Federal Reserve.

The financial markets are in a tough spot. The Federal Reserve seems to mean business with its intention to raise interest rates, albeit in an indirect fashion. As I noted in my last TN, the Trump rally recently got a dose of Kryptonite but it was uncertain that the decline at the time was indeed the rally’s death blow — until now, with odds rising of a meaningful decline.

One thing’s for sure: On the afternoon of April 4, investors were pushed up against the wall as the Fed announced, via its meetings minutes, that it intends to sell off the toxic mortgages on its balance sheet, a development that is likely to roil the bond markets.

Bond investors don’t like uncertainty. And to make life more interesting, this Friday’s employment report could well be the deciding event in whether this dip gets bought, as have all the others since November, or whether we get the highly predicted correction that has yet to materialize.

The S&P 500 Wobbles Will it Fall?

The Standard & Poor’s 500 Index of Large Cap Stocks (SPX) has been struggling of late with prices making lower lows and lower highs over the past two weeks (see chart below). So far, this is a short-term pullback but the index is struggling to remain above its 20-day moving average (green dotted line), and the Bollinger Bands (solid green lines above and below prices) are sloping down confirming the short-term downtrend.

The On Balance Volume Indicator (OBV) is heading lower, a sign that sellers outnumber buyers. The ROC indicator, which measures momentum, also is negative, a sign of weakness confirming the declining OBV. Meanwhile, the MACD and the MACD histogram indicators, another set of momentum indicators used to confirm ROC, are not giving much encouragement either. This technical configuration suggests that the stock market is vulnerable to heading lower in the short term.

Figure 1 – The S&P 500 Index

The Market’s Pulse Turns Irregular

The NYSE Advance-Decline line (NYAD), which measures the market’s breadth — its heartbeat, if you will — has been a nearly perfect indicator of the market’s trend over the last twelve months, clearly pointing out crucial turning points and marking the overall trend precisely.

Yet this pristine indicator is suddenly suggesting that the market is suffering from an irregular pulse and that prices could start to fall meaningfully. I’ve applied the 20-day moving average, Bollinger Bands, the ROC indicator and the RSI indicator to the chart. RSI is a good way to gauge whether a market is overbought or oversold. When markets reach either state, they often reverse direction.

In this case, RSI is turning lower without reaching an overbought reading, a sign that the bulls are losing their nerve before the uptrend is fully mature. This is akin to an army turning and running. The ROC indicator is also starting to roll over, another sign that the rally is stalling.

Finally, the A-D line itself is being turned back at the upper Bollinger Band. As the chart shows over the last 12 months, when this happens, the odds seem to favor a move back toward the lower band.  Any way you look at this, barring a quick price reversal, the odds are favoring lower prices.

Figure 2 – The NYSE Advance-Decline line with the OBV, ROC, and RSI Indicators

One Stock May Weather the Storm

At times like these investors often panic. However, I’ve found that looking for stocks that buck the general trend of the market can provide a nice place to wait out the storm and often make some nice counter-trend profits. Such a stock is Eli Lilly & Co. (NYSE: LLY), an old school big pharmaceutical company with a stable drug portfolio, solid earnings stream, cautious management and attractive looking chart.

Figure 2 – Eli Lilly & Co.

While the rest of the market is looking wobbly, Lilly is actually under accumulation. As you can see from the chart, it has formed an excellent cup and handle, a technical formation that often precedes big rallies.

For one thing, the stock didn’t crumble along with the market on April 4. By holding its ground, the stock shows that it’s in strong hands; a sign of relative strength, which is bullish. This is confirmed by the steady rise in the OBV indicator and by the Money Flow Index (MFI), which actually ticked up on the day suggesting that people were buying as the market dipped.

The ROC has been drifting lower of late. But in this case, this is not bearish given that the stock has been consolidating. Instead, ROC remains bullish, or at least not bearish, until it falls below zero.

Note also the Bollinger Bands are very compressed; this is a sign that a big move is coming. If OBV and MFI remain in an uptrend, the big move is more likely to the upside.

Given the generally bullish tone of the price chart and the above-average IDEAL rating of the stock, a breakout above 86 could take the stock into the low 100s.

 


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