Are Bonds Preparing to Weaken?

The bond market has been the star performer for 2014 with the 20+ Year Treasury Bond ETF ($TLT) up nearly 6%. In January I discussed the bond chart I was watching and highlighted the positive divergence that had taken place in the Relative Strength Index. We saw bonds continue to head higher, outpacing the lackluster equity price action.

Today I want to discuss the same chart, but this time look at the negative divergence that is starting to play out. In July ’12 and April ’13 we saw the ratio between long-duration bonds ($TLT) and short-term duration bonds ($IEI) begin to see a divergence in momentum. The Relative Strength Index was heading lower as the ratio which showed $TLT outpacing $IEI make a higher high. This divergence ended up starting a period of weakness for Treasury bonds, as shown in the price action of $TLT in the third panel of the chart.

This same type of divergence between the ratio of $TLT and $IEI is taking place right now. We saw the RSI indicator break above 70 but unable to hit ‘overbought’ status again as the ratio met the previous high. What I’ll be watching now is whether the previous low in momentum gets taken out. If 50 can’t hold for the RSI as support then I would expect to see weakness enter into bonds, which as the third panel shows – hasn’t been good news for $TLT.

However, if we see the momentum indicator hold support and the ratio takes out the previous two highs at 0.89 then we may be able to see the bulls bond trade continue. I’ll let price lead the way.

TLT IEI

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

The Bond Chart I’m Watching Right Now

Bonds have begun to come back to life in 2014 as traders began to realize that the Federal Reserve pulling back on its bond buying program is not the end of the world and that sentiment towards bonds is at record lows. I began getting interested in the bond chart back in September when the Barclay’s Aggregate Bond Index ($AGG) was holding support and seeing bullish internals. I’ve also been discussing the range the 10-year Treasury yield has been in with resistance at 3% in my weekly Technical Market Outlook.

Today I want to take a different look at the bond market, specifically the ratio between the long-dated Treasury bond ETF ($TLT) and the shorter-term bond ETF ($IEI). Typically during strong price action in the bond market we see investors move further out on the yield curve as they chase duration – i.e. showing a stronger preference for 20-year Treasury bonds ($TLT) than 3- to 7-year Treasury bonds ($IEI).

For the last half of 2013 we saw the ratio between $TLT and $IEI begin to bottom. While at the same time the Relative Strength Index (RSI) started to put in higher lows as it created a positive divergence. What was also interesting during this period was if we look at On Balance Volume of the ratio (bottom panel of the chart), which shows us if volume has been favoring $TLT or $IEI. As you can see, a strong divergence in this buying pressure (On Balance Volume rising) had been going into longer duration bonds than shorter-term Treasury’s.

When momentum (RSI indicator) and volume (On Balance Volume) begin to act in concert with one another, we often see price begin to play ‘catch up’ as it confirms the internals.

Now we have the ratio between these two bond ETFs testing its 200-day moving average which has acted as decent support over the last two years. If we take a look once again at the Relative Strength Index we can see that the past two divergences (lower highs while price makes higher highs) after becoming ‘overbought’ have led to a trend change that favored $IEI over $TLT.

At the moment we just have the RSI indicator over 70 but no divergence as developed just yet. What I watch for is if the RSI is unable to follow price higher and stays under the 70 level as it diverges. A lower high above 70, while a divergence, still shows buyers pushing momentum overbought, which can be read as bullish. It’s possible we could see a repeat of 2012, where the RSI indicator breaks 70 and then breaks it again as buyers continue to favor the long-duration trade.

TLT IEISentiment towards bonds continues to sit at historic lows as it seems traders are refusing to acknowledged the (so far) short-term trend change that’s taken place in the bond market. Going forward I’ll continue to monitor the relationship between long-dated and short-dated duration ETFs and see if the bond market can continue higher or if we begin to see a divergence in momentum as the first clue to a shift back to $IEI from $TLT.
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Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

Weekly Technical Market Outlook

I hope you all had a good weekend. I got a lot of great feedback from my Weekly Technical Market Outlook post from last week, so I’m happy you guys are finding this type of post useful. While the bulk of the categories I’ll cover will not change from week-to-week, I believe a level of consistency is important; I will try to add categories that I feel are important to cover as they pop up. With that said lets get into it…

Equity Trend

The trend for the S&P 500 ($SPX) continues to be up. Last week we saw a slight dip but buyers stepped in at the 20-day moving average to close out the week with strong move on Friday. I’ll continue to be watching the 20-day MA for short-term support on any further weakness.

S&P 500 TrendEquity Breadth

Last week we did not see much improvement in breadth, which is to be expected with the weakness we saw in the equity market for the bulk of trading.

The bottom panel of the chart below shows the percentage of stocks above their 200-day moving average. This measure of market breadth has garnered quite a bit of attention over the last few months. While the negative divergence is important to point out, the percentage itself is still north of 60%.

I reference 60% because that’s the level it was unable to get back above at the 2007 high. We saw the percentage of stocks above their 200-day moving average drop for nearly eight months before a top was put in for the S&P 500 ($SPX) in ’07. While we are presently approaching the same duration of deterioration, the percentage itself still shows the bulk of stocks in theoretical up trends (above their long-term MA). A break of 60% would also end the trend of making higher lows for the percentage above 200MA, and that’s when I think it’ll be time to start getting concerned. So while this metric of market breadth is worrisome, it’s not yet to levels I feel trigger a red flag.

breadthEquity Momentum

Nothing major happened in equity momentum last week. We saw the Relative Strength Index hold above 50 during the slight bout of weakness and the MACD and Money Flow indicators both dropped but aren’t sending serious warning signs. We still must contend with the negative divergence between momentum and price, especially if we see another lower high made in the RSI if the S&P makes a run at a new high.

equity momentumS&P 500 60-Minute

In last Monday’s Technical Market Outlook I discussed the negative divergence I was seeing in two momentum indicators (RSI and MACD) on the 60-min chart and that they could lead to lower prices in the short-term. The level of support I was watching was unable to hold as price fell to the November 20th low. Going into the short drop we had a negative divergence in the RSI indicator (top panel) and as price went lower we began to see a positive divergence in the same indicator. This helped act as kindling and the match that lit the fire to send stocks high being the non-farm payroll report on Friday. If things continue to improve I’ll be watching the 1810 and November high as possible resistance levels.

S&P 500 60min Last Week’s Sector Performance

Below is a chart of the relative performance of the nine major S&P sectors for last week. The percentages shown represent the sector’s performance in relation to the S&P 500, not their actually return. As expected the defensive sectors lead last week, with utilities showing the strongest gain. It’s interesting to see health care be further back in the pack, away from its lower-beta counterparts.

weekly performanceYear-to-Date Sector Performance

No big changes in sector strength year-to-date. The three strongest sectors are still health care, cyclicals (consumer discretionary), and industrials.

YTD sector performanceBonds

The bond market had some interesting price action last week. The strong non-farm payroll data that showed unemployment had dropped to 7% in October sent the 10-year Treasury Yield ($TNX) up 21 basis points and above 2.9% intraday on Friday. However, we also saw a positive move for several bond ETFs. Junk Bonds ($JNK), 20+ Year Treasury’s ($TLT), and the Aggregate Bond Index ($AGG) all saw gains in the face of rising bond yields on Friday.

With that, I wanted to take a look at the chart for the 10-year Treasury Yield. We have an interesting level of resistance just a few basis points away. The blue line on the chart below creates a trend line off the 2010 and 2011 highs in yield. I’ve also marked the 2013 range with green dotted lines. To break out of this range we either need to see the 10-year yield get above (and hold) 3% or get down to 2.4%, which would be under the July and October ’13 lows.

10yr TreasurySentiment

There are two sentiment-related charts I want to show this week. Both come from SentimenTrader, which is an excellent subscription service for sentiment data.

SentimenTrader has a set of indicators that are classified as intermediate-term (1-3 months). The chart below shows the overall composite score of those indicators, which includes for example  COT data, AAII Survey, and option activity. This gives a good overall view of equity sentiment. As the chart shows, sentiment is still at elevated levels but only for the second time this year.

intermediate sentimentNext is a bond sentiment chart, which uses data from the Rydex family of mutual funds. The chart below shows the percentage of assets held in bond bullish funds. As you can see, assets have been flooding out of the bullish bond fund and hitting levels not seen since at least 2010. We’ve seen many predominate economists and analysts turn bearish on bonds, and the data from Rydex indicates the individual investor has the same thinking. You’ll notice that previous low levels over the last year have not led to substantial bounces in bonds, which means we should not expect troves of cash to steer back into the bond market based on this set of data. However, this level of bearishness is important to keep in mind, especially as bond yields get close to testing resistance as I mentioned in the Bond section.

bond sentimentMajor Events This Week

This week doesn’t look to be a very data-intensive week. Here’s what is scheduled to be announced that traders may want to keep an eye on:

Monday: None
Tuesday: JOLTS (job openings) report
Wednesday: Treasury budget
Thursday: Jobless claims, Retail sales, and Business inventories
Friday: Produce Price Index

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Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.