Friday, May 2, 2014

Technical Update on SPY, QQQ, DIA, IYT, MDY and IWM with Volatility Indexes, NH-NL%, PPO and RSI (4/28/2014)

Via Dvolatility Research (originally released on 4/28/2014)

Welcome to Dvolatility Research. It's time to have fun with some charts. This market and economic research blog is for risk managers, traders, investors, fund managers, market observers, economists, macro tourists, financial information and news addicts, and for educational purposes.

I want to chart out the major index ETFs and look at technical, breadth and sentiment trends and divergences in my first official DVR post. I think the market is in the process of pricing in the end of QE, but this time around the Fed is cutting its purchases slowly rather than abruptly, which could change the dynamic of the next move. The market corrected (or crashed) after QE1 and QE2 ended in March 2010 and June 2011 (combined with the negative debt ceiling catalyst), respectively. Here's a chart of the S&P 500 versus the U.S. Federal Reserve's total assets since 2009. It's clear what's been driving the market since the financial crisis and great recession ended.

^SPX Chart
^SPX data by YCharts

So there's a high probability that the market will correct (or crash) when the Fed officially ends QE3, and if the probability of tightening increases, it could put even more pressure on the market. Before I get into the charts, since Federal Reserve policy is so important right now to the stock market, Treasury yields and asset prices, I want to give a quick update on the FOMC's forward guidance on monetary policy. At Janet Yellen's press conference on March 19, 2014, Ann Saphir of Reuters asked important questions about the timing of QE and the federal funds rate.

From the FOMC's transcript on March 19, 2014 (emphasis mine):
ANN SAPHIR. Ann Saphir with Reuters. First, I just wanted a quick clarification. You said that something would happen by next fall, and we—on a clear path—on a path until next fall. I was unclear if you were speaking of rate hikes or if you were speaking—

CHAIR YELLEN. I simply meant to say that if we continued to reduce the pace of our asset purchases in the manner that we have, in measured steps, that the program would be winding down next fall.

ANN SAPHIR. In this coming fall, you mean, not the fall of next year, is that—just—

CHAIR YELLEN. Yes, this coming fall

ANN SAPHIR. To be clear—I just wanted to be clear about that. Then once you do wind down the bond buying program, could you tell us how long of a gap we might expect before the rate hikes do begin?

CHAIR YELLEN. So, the language that we use in the statement is “considerable” period. So, I—you know, this is the kind of term—it’s hard to define. But, you know, it probably means something on the order of around six months or that type of thing. But, you know, it depends. What the statement is saying is, it depends what conditions are like. We need to see where the labor market is, how close are we to our full employment goal—that will be a complicated assessment not just based on a single statistic—and how rapidly are we moving toward it? Are we really close and moving fast? Or are we getting closer but moving very slowly? And then, what the statement emphasizes, and this is the same language we used in December and January, we used the language especially if inflation is running below our 2 percent objective. Inflation matters here, too, and our general principle tries to capture that notion. If we have a substantial shortfall in inflation, if inflation is persistently running below our 2 percent objective, that is a very good reason to hold the funds rate at its present range for longer. complicated assessment not just based on a single statistic—and how rapidly are we moving toward it? Are we really close and moving fast? Or are we getting closer but moving very slowly? And then, what the statement emphasizes, and this is the same language we used in December and January, we used the language especially if inflation is running below our 2 percent objective. Inflation matters here, too, and our general principle tries to capture that notion. If we have a substantial shortfall in inflation, if inflation is persistently running below our 2 percent objective, that is a very good reason to hold the funds rate at its present range for longer.

In a speech given on April 16, 2014 at the Economic Club of New York, Janet Yellen tried to clear up what the FOMC's forward guidance was on the federal funds rate (emphasis mine).
Recent Changes to the Forward Guidance
At our most recent meeting in March, the FOMC reformulated its forward guidance for the federal funds rate. While one of the main motivations for this change was that the unemployment rate might soon cross the 6-1/2 percent threshold, the new formulation is also well suited to help the FOMC explain policy adjustments that may arise in response to changes in the outlook. I should note that the change in the forward guidance did not indicate a change in the Committee's policy intentions, but instead was made to clarify the Committee's thinking about policy as the economy continues to recover. The new guidance provides a general description of the framework that the FOMC will apply in making decisions about the timing of liftoff. Specifically, in determining how long to maintain the current target range of 0 to 25 basis points for the federal funds rate, "the Committee will assess progress, both realized and expected, toward its objectives of maximum employment and 2 percent inflation."24 In other words, the larger the shortfall of employment or inflation from their respective objectives, and the slower the projected progress toward those objectives, the longer the current target range for the federal funds rate is likely to be maintained. This approach underscores the continuing commitment of the FOMC to maintain the appropriate degree of accommodation to support the recovery. The new guidance also reaffirms the FOMC's view that decisions about liftoff should not be based on any one indicator, but that it will take into account a wide range of information on the labor market, inflation, and financial developments.

Along with this general framework, the FOMC provided an assessment of what that framework implies for the likely path of policy under the baseline outlook. At present, the Committee anticipates that economic and financial conditions will likely warrant maintaining the current range "for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored."25

The Fed is currently purchasing $25 billion of agency mortgage-backed securities and $30 billion of longer-term Treasury securities every month (injection $55 billion into the banking system), which is essentially excess liquidity flowing indirectly into the hands of high frequency traders in the market, who then create even more liquidity and misprice risk.



Technical Update on SPY, QQQ, DIA, IYT, MDY and IWM with volatility indexes, the percentage price oscillator and new highs-new lows percent (and some RSIs)

If you want to see how the major indices are looking in nominal and real terms since 1995, see the charts I posted on Distressed Volatility on April 11, 2014.

1) SPY, the S&P 500 ETF (SPDRs): SPY hasn't broken through any major uptrend lines yet (mainly from the 2009 and 2011 lows), but keep watching them as the bull market sails through its fifth year. SPY is still using its 50 and 200 day moving averages as support levels.

As noted in the chart below, SPY is diverging with its new highs-new lows percent ($SPXHLP) and its percentage price oscillator (PPO) with a $VIX that is coiled up and setting up for a move. To me this means there's a high probability that we'll see a major correction soon. SPY will probably test its 200 day moving average and major uptrend line during the next correction, which will be judgment day for the cyclical bull market (asset prices) and the economy.

Source: StockCharts.com

SPY's weekly chart smooths out the data. In summary, SPY is trading in a risky wedge and diverging with its percentage price oscillator and new highs-new lows percent while the Fed continues to taper QE. The $VIX is also saying that traders and investors are still very complacent, so something has to give.

Source: StockCharts.com

2) QQQ, the Nasdaq 100 ETF: QQQ looks risky here. It is nearing a critical point in its rising wedge; it recently broke through its 50 day moving average and tested its 200 day and major uptrend line on strong volume; it's been diverging with its percentage price oscillator (PPO) for about a year now (recently went negative); and it's been diverging with NDX's new highs-new lows percent ($NDXHLP) (see it better on the weekly chart). In addition, the Nasdaq 100's volatility index $VXN looks like a coiled spring that's ready to pop.

Source: StockCharts.com

Here is QQQ's weekly chart. The bearish divergences are much clearer on this chart.

Source: StockCharts.com

I think all of this tech bubble talk is spooking the Nasdaq right now. What's interesting is QQQ's weekly RSI (Relative Strength Index) tested its 2000 high recently, which was hit right before the tech bubble burst. The Nasdaq 100's P/E ratio is much lower this time around, but it's still interesting to compare the technical activity. QQQ's recent high of 91.15 was still 19% below its all-time high of 112.53 in 2000, but it almost quadrupled from the March 2009 low.

Source: StockCharts.com

3) DIA, Dow Jones Industrial Average ETF: I see a similar type of situation going on in DIA. It is trading in a risky rising wedge and diverging with its percentage price oscillator and new highs-new lows percent ($DOWHLP) with too much complacency ($VXD).

Source: StockCharts.com

DIA's weekly chart looks more interesting than the daily.

Source: StockCharts.com

4) IYT, Dow Jones Transportation Average ETF ($TRAN doesn't have a volatility index): I see the same divergences and rising wedge on this chart. Watch IYT's relative strength index (RSI) because it's going to make a big decision soon.

Source: StockCharts.com

5) MDY, SPDR S&P Mid-Cap 400 ETF ($MID doesn't have a volatility index): Same divergences, different ETF. But the divergence between MDY and $MID's new highs-new lows % ($MIDHLP) is the most bearish daily divergence on this post. Not a good sign for risk assets.


Source: StockCharts.com

6) IWM, the Russell 2000 Small-Cap ETF ($RUT doesn't have a NH-NL% on StockCharts.com): It is trading in a risky wedge and recently broke through its 50dma on strong volume. Watch the red volume trend and $RVX's coiled spring.

Source: StockCharts.com

Previous Dvolatility Research post on DistressedVolatility.com:  The 2009-2014 Cyclical Bull Market Is Running on Fumes at Resistance in Real and Nominal Terms (4/11/2014)

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