Getting Technical
Stock Market Warnings From Bonds and the Dollar
The Trump trend is still to the upside, but there are a few potential dangers lurking out there.
By Michael Kahn
The news changes hourly and can trigger emotional responses that end up being very wrong.
The markets themselves offer more objective evidence, and right now I see a few items that investors should monitor.
The first is interest rates. In December I took a look at long-dated Treasury yields and concluded they had topped out for the time being. The iShares 20+ Year Treasury Bond TLT exchange-traded fund (ticker: TLT), which tracks long bond prices and moves inversely to interest rates, landed in a very major support zone (see Chart 1).
Chart 1
The inability for any market to move significantly higher after reaching a major support area is a bearish warning. Should the bond ETF break down, it would push long-term interest rates higher, and I suspect that would be a negative event for the stock market. This, despite market expectations for only two quarter-point federal-fund rate hikes this year.
The opposite end of the quality scale in the bond market also has a potential breakdown in play. Whereas Treasury bonds are considered to be default risk-free, high-yielding “junk” bonds do carry significant risk.
Major ETFs tracking junk bonds, such as iShares iBoxx $ High Yield Corporate Bond HYG), have already seen arguable breakdowns from the postelection rally (see Chart 2).
Chart 2
All told, this is not a positive for stocks as it tells us that investors may be fleeing riskier assets.
Junk bonds can be the canary in the coal mine for the stock market.
The next market to watch is the U.S. dollar. The greenback has been in decline since the start of the year and took a hit this week on comments from one of the president’s advisors that the euro was undervalued. The U.S. dollar index, which measures the dollar against a basket of currencies and is about half-weighted in the euro, set its lowest level since December.
Technically, the dollar is now testing the long-term upside breakout it made last November (see Chart 3).
But there is very little room for error by dollar bulls here. Unless the market can stabilize here and bounce at least a little, we will have to conclude that the breakout failed. Failed bullish breakouts are another bearish sign.
Chart 3
Again, I still believe stocks will be higher at some point this year, but the disruptive nature of current politics can easily spook investors and provide the excuse some need for a stock-market correction to begin.
Technical evidence, such as market breadth, is still good, but the warnings coming from bonds and the dollar should not be ignored.
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