Let’s start with the treasury bond market tonight. Celebration of the end of the bear market in bonds, and its corollary cousin higher interest rates, was premature just as I had expected. The weekly chart above highlights a few of the bond market sell signals. Lower bond prices mean higher interest rates. There is much more, and the technical principles and rules are the same whether applying them to a 5-minute or weekly chart, and the stock or bond markets.
When you break a rising wedge, your first target down is equal to the base of the wedge, and in many cases, the beginning of the wedge itself is tested. In this case, that would be a test of the March/April lows. We would have to deal with a potential head and shoulders topping pattern if that were to occur.
I don’t want to believe that the pattern will materialize. The measured move would be 40 points down from the neckline, taking us to the 2018 lows. That would be a 25% drop from current levels. With current corporate and sovereign debt levels, this would be Armageddon in bonds, interest rates, and the economy at large.
Yet, maybe this is precisely how all this craziness ends. I don’t know about you, but I want to be off the grid with solar panels, a satellite dish, and a greenhouse by then. If I short the market, will the firm that has my account still be in business to pay me?
In short, the intermediate to long-term treasury bond market appears to have completed a corrective parabolic wedge rally into down trendline resistance on the weekly chart. The weekly bear bar closed on its low last week, which was below the previous week’s low. The bear bar was one among other sell signals. We also have a Navigator Algorithm sell signal.
Looking at a close-up of the TLT action on the daily chart, you see the breakaway gap Friday closing on its low, also breaking the 21-EMA or mean.
I have been anticipating this turn of events which is why we picked up the XLF and XLE positions a few weeks ago. What is bad for bonds is bad for technology and growth stocks. But it is good for the rotation trade back into financials and energy, at least for a short while. I was a bit early, but my patience has been rewarded.
When you step back and look at the Financial Sector ETF (XLF), a 10% allocation in the Navigator Swing Trading Strategy, you will see that the sector is breaking to new highs for the first time in 15 years, only recently rising above its January 2007 peak. Banks are flush with liquidity, recently passed their stress tests, and will now be allowed to restart stock buy-backs.
Moreover, as you will see above on the close-up view of the daily XLF chart, it was a happy Friday. Just take the TLT candle Friday and flip it and you have the XLF candle. The XLF has a breakaway gap UP from a shelf and consolidation with an initial target of the old high to the left. TLT will test the former low and XLF will test its former high. The XLF measured move target is even higher at double the consolidation range. The XLF likely will get to the top of the channel, with a few zigs and zags along the way.
Our other 10% position, the XLE, has a bit more work to do to catch up to the XLF.
If you haven’t noticed, gasoline prices just hit 7-year highs this weekend. Don’t you love inflation? The XLE is coming off the bottom of its channel in what appears to be a rising wedge pattern on the monthly chart. If the pattern materializes as expected, this rally would be the third push higher in that monthly chart pattern.
The XLE macro rising wedge would make some sense. The inflation narrative is likely to be back on the table. This will put pressure on the NASDAQ 100 as rates begin to move higher again. Financials and Energy will experience a window of rotation and benefit. However, they both need a Goldie Locks scenario to sustain rallies.
Rates can go up some, just not too much. Higher rates increase bank profits from loan spreads. Inflation fears will temporarily make commodities attractive again, helping oil and energy stocks. But at some level, higher interest rates will choke the economy and bring on a recession.
That may explain the wedge pattern on the monthly XLE chart. One more push to go with this next, potential rally. We have to monitor all of this carefully. The head and shoulders topping pattern on the TLT chart above, should it complete, would be ominous for all stocks.
Refer to last week’s outlook on the market (S&P 500 Index). Nothing has changed, except the positive news that we broke out above the balance area into Friday’s close at new all-time highs. Volume could have been better, but we are in the dog days of summer, and volume is typically light this time of year.
The breakout was unimpressive nonetheless. Apparently, it was not enough to force a gamma squeeze, which would really drive prices higher. We are still on guard for the look above and fail on Monday. Hopefully, the market is simply climbing the wall of worry.
Holding Friday’s SPY low around 442 by the close on Monday is the next mission. Our stop for our 60% SPY call swing position remains the 5-day EMA at 441 or so tonight. The equivalent low is 4416 on the S&P 500 Futures.
Even though I will be out this week, I will post any buy or sell signals and any other material issues should they arise. My biggest concern remains how well the S&P 500 can progress with tech and growth stocks under interest rate pressure, offset by energy, financials, materials, and other reflation trade candidates. As I have said before, it is a math problem. We may switch to a more focused index depending on how the week progresses.
There are still many “ifs” and “maybes” in this market. I have repeatedly voiced my concerns about what it is like to look out the window from the 99th floor. I feel like I am pinching my nose every time I jump in the water. But the market is anything but frothy at the moment, compared to the first quarter. There is a healthy dose of fear and skepticism, and that comforts me.
Fear only dropped fractionally last week, despite the market’s progress and breakout. This tells me that there is a ton of cash on the sidelines, also confirmed by various Fed reports and money manager surveys. For money managers, the only emotion that beats fear of loss is fear of missing gains or FOMO as we affectionately reference it. Underperform, and clients walk out the door.
Until the crowd gets giddy or even bullish again, I am willing to dip my toe in the water here and there.
Vigilance and flexibility are the keys.
A.F. Thornton