The Market's Key Question: Is a Crisis on the Horizon?
One constant in investing is, the game is always changing.
One minute the focus is on Europe. The next it's on an earthquake in Japan, then the Fed, unrest in the Middle East, the economy, QE, earnings, commodity prices, inflation/deflation, the state of the economy, emerging markets -- and the list goes on and on. But frankly, the constant shift in the market's focus is what keeps the game interesting day after day, week after week, month after month.
As we've stated a time or two hundred, the primary purpose of this sometimes meandering market missive is to first identify, and then stay in tune, with the primary drivers of the market. If you can understand why Ms. Market is doing what she is doing, then you aren't likely to be fooled to any large degree when a big move occurs.
Still All About the Emerging Markets
Currently, the focus is squarely on the outflow of capital from and the movement of currencies in the emerging markets. Nobody seems to care about earnings or the economy. Suddenly, everyone in the game has to understand forex, in order to make sense of the action in stocks. Suddenly, traders are tying their algos to currencies you probably can't spell and most certainly can't easily watch during the day. And suddenly, volatility is back in a big way.
The Key Question is...
At this stage of the game, the key question is whether or not the current issue in the emerging markets will turn into a crisis or not. If so, then rest assured that, after an inevitable bounce higher in the stock market that would likely be tied to a sigh of relief, the crisis will reassert itself and prices will move lower - likely in a straight line.
Over the past week, we've spent an inordinate amount of time doing inter-market analysis and looking at charts. The goal has been to try and answer the key question: Is this a crisis or not?
While beating a dead horse, so to speak is never a good thing, the idea of listening to the message from the charts is probably our best/only way to figure out if the current decline in the stock market is the beginning of something nasty or merely a garden-variety pullback. Given the uncertainty in the markets, it is probably time to let price be your guide.
So while we've been hitting this topic hard lately, let's start the week with another review of the charts to see if anything has changed.
S&P 500 Daily
The message from the stock market is quite clear. In short, the sideways action seen over the past week "says" that traders aren't sure if a crisis is at hand.
The debate has certainly been lively. as intraday moves of one percent or more in the S&P have been become commonplace. This is largely due to the variety of algos doing their thing each day. There are algos tied to movements in currencies. There are "ignition algos" attempting to get a party started (in either direction). And then there are the trend-following algos that jump onboard any and all intraday trends and wind up exaggerating the extent of daily moves.
But the bottom line appears to be the stock market is currently positioned for any input that helps answer the key question at hand. News that supports the idea that the currencies of Turkey, Argentina, Czech Republic, South Africa, etc. are in trouble will likely cause price to decline. Yet any mention of "bazookas" from the various central bankers involved will bring buying.
Thus the key is to watch for a meaningful break below 1765-ish, or above 1820.
Next up is the bond market.
Yield of 10-Year U.S. T-Note
To be sure, this is not the direction that traders expected bond yields to be moving after the Fed tapered QE a second time. As has been discussed, the big funds have been caught on the wrong side of this move and as such, short-covering could be part of the game here.
However, true chartists don't care about the "why" -- no, it's only the "what" that matters. As such, the message from the downward trend in bond yields would appear to be a "flight to safety" is occurring. However, the extent and veracity of the move does not suggest there is much panic in the trade at the moment. This remains something to watch, each and every day.
For other signs of fear/panic, let's take a look at the yellow metal.
SPDR Gold ETF (NYSE: GLD)
To gold bugs, the answer to every question is the same: Buy more gold. However we're not talking about fundamentals such as inflation here. The reason to look at the chart of gold is that the yellow metal tends to attract a great deal of buying whenever a crisis occurs.
A quick glance at the chart shows gold has been rising in 2014. But the bottom line appears to be that there is no real sign of panic at this stage. So let's move on to the dollar.
PowerShares U.S. Dollar ETF (NYSE: UUP)
The greenback's chart would seem to be agreeing with the stock market. In short, the price action suggests there could be enough of a problem to encourage a flight to the safety, but it's not terribly obvious at this time.
In other words, like the chart of the S&P 500, the dollar appears to be at an important juncture. If we were to see a meaningful break above $21.90 on the UUP and some momentum behind the move, one could argue that we do indeed have a crisis on our hands. Thus this remains an important chart to watch.
VIX Daily - S&P Volatility Index
Like gold, the VIX (S&P Volatility Index) is many things to many people. And while the message from this chart can oftentimes be skewed by traders playing games with their option strategies, the overall point that volatility is rising appears to be pretty clear.
However, the question isn't whether or not volatility and/or fear is rising. Rather it is whether or not we have a crisis on our hands. And to get a clue on this question, we need to look at the longer-term picture of the VIX.
Below is a weekly chart of the VIX going back into early 2010.
VIX Weekly - S&P Volatility Index
The first observation here is there has been a monumental decline in the overall level of the VIX (NYSE: VXX)over the past few years. However, the bigger takeaway is the absolute level of the VIX is nowhere near the level seen during the European debt/U.S. debt downgrade crises seen in 2011.
Heck, the level isn't even back to the level seen in May of last year, when Ben Bernanke first started talking taper.
Therefore, the message from the VIX would seem to be that there is concern, but no panic at this stage.
The overall message from our latest review of the charts is that a full-blown crisis is not (yet?) at hand. However, the charts of the S&P, the dollar, gold, and the VIX are all at important junctures. Thus a meaningful break of any key levels should warrant attention and perhaps even some action.
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