October 29, 2014 (11:00 am)
We’re at an important inflection point in the markets. With the FOMC meeting later this afternoon, we are likely at the end of QE. The reaction over the past several years at the end of each successive QE operation has been negative. The reaction that follows the meeting today will set the stage for the next several months.
RUSSELL 2000 (IWM). Two important things on the IWM chart longer-term. The first is that it formed a very well-established trend line over the past six years. During the recent pullback, shares slid below that trend line for the very first time and are currently in the midst of re-testing it (now as resistance). If shares pullback from here, it will likely set the stage for a significant correction. It might act as that all-important “lower high”. However, if shares rally from here, the uptrend may remain in tact.
Another factor contributing to the bearish case is the multi-month resistance that has formed over the course of the entire year. The last two cases (shown in blue above), had similar double top patterns forming at multi-month resistance. What followed was a significant downturn. Interesting timing here… with the last of QE injections now in the rear view mirror.
Here is a closer look at the IWM long-term trend resistance. Also notice the negative divergence on both MACD and RSI.
S&P 500 (SPY/SPX). Shifting over to the SPX, we’re entering a convergence of resistances at current levels. We have a long-term trend line (black) that is currently acting as resistance at 1985. If shares are not able to re-take the 1985 level quickly, it will look like a failed re-test of the trend line. The second is the 2014 trend line (blue) that is acting as resistance at the exact same level. Lastly, there is additional resistance at 1985 formed during the July highs.
NYSE McClellan Oscillator (NYMO). The NYMO has reached the very significant 80 level. Looking at the chart below, this level has historically boded poorly for the near-term direction of the markets. Things have simply gotten too bullish after the early October correction. In almost every case, shares of SPY dropped between $5 and $20+ within two or four weeks.
Treasury Bonds (TLT). Shares of TLT, after rallying $16 in four weeks, have pulled back to a level of support at $119 (previous resistance). It has retraced 50% of its recent rally, and is consolidating right at that support. If the market does pull back, TLT is likely to climb significantly higher.
Additionally, TLT has moved along this long-term uptrend over the past decade. Each time it breaks through one blue resistance level, it continues higher. Would be surprised to see this fall below the current support at $110, and instead expect it more likely to continue climbing higher over the next several months.
ENERGY SECTOR (XLE). Here’s an important one. The XLE declined significantly in October, seeing one of its steepest corrections in years. Anytime it has hit a low teens RSI (i.e. a very strong pullback), the following has taken place: (1) a 38.2% Fibonacci retracement, which we have already seen, followed by (2) a re-test of the lows. If we do see the latter, we can expect the market to follow.
CATERPILLAR (CAT). Shares of CAT are one of the most closely aligned to the broader market and global economy. After forming a classic head and shoulders pattern, shares hit the H&S target around the $89 level. It has since re-traced half of the correction and is testing the 50- and 200-DMA. A pullback from here will be seen as a failed test of the moving averages.
TOKYO AVERAGE (NIKK). The NIKKEI has again tested its very long-term downtrend line. There was a brief false breakout followed by a pullback. This is an important one to continue watching in the global markets. The MACD is very bearish, and is beginning to look a lot like the 2008 price action. Lots of negative divergence here in both MACD and RSI, with those continuing lower while price made higher highs. Not what you want to see…
NATURAL GAS (UNL). Natural Gas prices have fallen to the very bottom of its intermediate-term channel. This will be an important one to watch, along with the commodities XLE fund.
CONCLUSION. We’re relatively bearish going into this FOMC meeting. However, that can change quickly depending on how the markets respond in the coming days. Currently net short the market at these levels, but have stops in place to limit downside if the market reacts well to the meeting this afternoon.