VACACIONES OCTUBRE 2016 ( CLICK ON LINK)
Last week I wrote that the Sept. 9 selloff, sparked by hawkish comments from the Fed, created an important technical breakdown.
Certain technical ratios that give us a read on the market’s mood and risk aversion weakened ahead of the Sept. 9 decline, but in the days that followed, they actually turned more bullish.
The one thing we know about the market is that it always throws curveballs. But we can use this information to set up the environment in which the Fed’s lack of action will manifest.
Let’s start with the Standard & Poor’s 500 index. After the Sept. 9 downturn, it traded down to touch the top of its former — and huge — two-year trading range (see Chart 1).
The question now is all about what happens at that test, which is the zone between 2130 and 2135. (The S&P 500 traded at 2146 Wednesday morning.) With the Fed’s decision to hold rates where they are, we should see if that very important support level holds once the volatility from the initial knee-jerk reaction fades.
Now let’s look at the ratios.
Just ahead of the Fed Wednesday, the small-capitalization Russell 2000 index was still outperforming the S&P 500 in 2016. And despite the significant bearish reversal seen in the Sept. 9 decline, it bounced off a long-term support level that goes back to 2014 (see Chart 2).
The next ratio is emerging markets versus the U.S. market. A chart of the iShares MSCI Emerging Markets exchange-traded fund EEM EEM in Your Value Your Change Short position (ticker: EEM) versus the SPDR S&P 500 ETF Trust Y in Your Value Your Change Short position (SPY) showed a fledgling breakdown a few weeks ago, but it has since reestablished its rising trend (see Chart 3). I wrote that the breakdown was bearish, and that is clearly no longer the case now.
The chart of the iShares iBoxx $ High Yield Corporate Bond ETF HYG in Your Value Your Change Short position (HYG) to the iShares iBoxx $ Investment Grade Corporate Bond ETFLQD in Your Value Your Change Short position (LQD) stalled last month (see Chart 4). I wrote that it was looking for direction, but in the days that followed it edged slightly higher.
As fixed-income instruments, these bond ETFs could really feel the effects of the Fed decision.
We will know that by the ratio either breaking out or abruptly sinking. Sideways movement will just be more of the same in terms of the market’s attitude toward risk.
Pulling it all together, the lows seen after the Sept. 9 decline in all markets — the S&P 500, the Russell 2000, emerging markets, and even junk bonds — are critical. If these supports do not hold, then the ratios of the riskier markets to the safer markets will likely break down as well, and that would lead to a rough ride into the election.