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Yesterday's rally finds selling

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Equities are back in the red today as yesterday's late session rally becomes a distant memory. Stock have gotten little help from the bond market as the 5-year YIELD ($FVX.X) and 10-year ($TNX.X) yield are both in the red. The 30-year YIELD is marginally green, but looks like it to is going to dip in the red.

Without the effect of selling in the bond market, I think equity bulls and bears are not too eager to be buying stocks today. Hewlett Packard (NYSE:HWP) did everything it could possibly do to put some bad news in the market as the company said it sees continued slowing and lay off 6,000 workers as a result. Shares of Dow Industrials Component HWP hit a new 52-week low today and have traded as low as $23.45.

Yesterday I received several e-mails from subscribers regarding John Murphy's comments that a lower bond YIELD is good for stocks. I couldn't disagree more! I'm a fan of Mr. Murphy and he's one of the first technical analysts that got me interested in technical analysis, but I think he's dead wrong on this one. If bond YIELDS go lower folks, that means money is flowing into bonds. I'm not sure how that is going to help stocks. The 1970's and 1980's were completely different than today.

Here's some things I noticed yesterday. Maybe I am guilty of "tunnel vision," but the only thing that I saw yesterday that had stocks higher was a higher bond YIELD. Here are observations I made yesterday after the close of trading when we got to look at some charts more closely and diagnose just what took place.

Follow up is important

Let's wrap up some observations made from this morning and then again at 01:30 EST. Let's also try and bring into the fold what took place in the bond market today, because I don't want bullish traders to get a false sense of security with today's higher bond yields. The way the trading day unfolded was interesting and hopefully we all understand that the longer-term trend must start with the short term. Sometimes I think its is easy to talk about levels during market commentary and then never think of them again. Let's start with the bond market as that was our first alert for a potentially higher stock market. We'll then talk abut that darned Semiconductor Index (SOX.X) and how it got turned around and totally erased an earlier loss of 2.5% and ended up with a gain of 0.91%. Then we'll see if some levels from the SOX.X and bond yield levels become meaningful with the S&P 500 and things mentioned this morning at 09:00 EST. What we're doing is looking at the MARKET in three-dimensions. Not just because we're talking about three different indexes, but because we're looking at different parts that make up the whole. Just as the X-ray allowed doctors to look at the patience insides, the MRI provided the ability to look at the patient in 3-dimensions. All the parts make up the whole and the bond market is a part of THE MARKET we invest our hard earned money.

First of all, before the stock market opened, the first "upside" alert that hit my trade station was the upside action in the 10- year YIELD ($TNX.X) at 5.117%. This was mentioned in the second paragraph of the 09:00 Update. I've felt for sometime that for stocks to do well, we needed to see a higher YIELD. By today's end, the 10-year YIELD finished at 5.159% (higher than first alert at 5.117%). Often times, I get questions on why I look at charts on 60-minute time frames for bond YIELDS. These questions usually come from investors or longer-term swing traders. I agree that what happens in a 15-minute time frame is rather meaningless to the longer-term trader, but we do have a diverse group of subscribers. If we believe that the longer-term trend starts with the short-term, perhaps some of what we saw take place in the bond market makes sense as it relates to what I've been talking about. That would be the "not so popular" belief of HIGHER YIELDS makes for HIGHER STOCK PRICES. This logic is simply based on supply/demand. Sell the bond (higher yield results) and buy the stock or buy the bond (lower yield results) and sell the stock.

10-year Treasury YIELD Chart - 15-minute interval

It doesn't always unfold this nicely, but I show the 15-minute interval chart to help bring in perspective just how the bond YIELD action can influence the stock market bias. I've said before that equity bears are looking over their shoulders at the bond market. Right now I feel the biggest threat to a short position I hold would be for some institution to unload $1 million worth of 10-year notes that is only yielding 5.1%, take that cash and buy $1 million worth of the stock I'm short! Study the time line that I've marked on the chart. I've tried to highlight "key" inflexion points. The four "key points" are the alert at 08:20 EST, the jump in yield at 10:05, then the pullback in yield to 11:05, then a small breakout in yield at 01:50 (all times are EST and come at the end of the 15-minute interval). Remember that the bond market opens before the stock market and closes before the stock market.

Now! Of the four "key" inflexion points, the one that is probably MOST KEY is the 5.146% YIELD at 01:50 EST. Remember that "rolling retracement" update today at 01:30 EST? We rolled down retracement in the Semiconductor Index (SOX.X) to try and define some levels of market maker support. We needed to do this because the SOX was breaking down and we didn't have anyway to assess risk in the sector/index. The first level we were monitoring then (and will continue to want to monitor) is the 528 area.

Semiconductor Index Chart - 15-minute intervals

The Semiconductor Index (SOX.X) was the topic of conversation today as this index looked to be breaking recent lows and leading sector losers. It also seemed to be putting pressure on the NASDAQ Composite. As we look at various broader market indexes, it's probably unfair to think that the SOX by itself was pulling the SPX back to breakeven levels after a higher open and early advance. I'd also argue that the recovery in the SOX from the lows of 530.86 was just a turning point that the market had decided upon.

I'd argue it was the YIELD action in the bond market and perhaps the 10-year YIELD ($TNX.X) at approximately 01:50 EST that had stocks finding bidders (perhaps bears looking over their shoulder) and that had stocks recovering. When you study the chart of the 10-year YIELD, notice how that little break higher at 01:50 EST probably set off some short-covering by bears when they felt, "uh oh, it looks like the bond market is going to see further selling and I can lock in some gains in semiconductor stocks near a retracement support level" and perhaps market makers started lightening up on their offers in four-lettered semiconductor stocks (and other NASDAQ stocks).

I'll admit, it's rather "simplistic" to think this way, but that's the way market makers think. All a market maker cares about is support and resistance levels by witch they will manage their inventory risk. Market participants that are bearish have all the recent bad news in earnings and economic slowing in their favor. Their only threat is money coming into the stock market from participants that think stocks offer a more favorable risk/reward compared to the YIELDS (reward) and safety of the treasury. When the 10-year YIELD kicked higher, I think that's when many market makers lightened up on their offers, took in some stock near support (as it relates to the SOX) and started adjusting inventory should a prolonged bout of selling continue in the bond market (higher YIELD). A market maker is no fool. If he/she thinks there will be buyers for stocks based on the selling of bond, they'd want to have some inventory of stock to sell their customers without having to short it to them and take on that risk (a market maker can either sell long to provide liquidity to a buyer, or sell short to provide liquidity to a buyer).

DIVERGENCE! I think last night I said something like, "I've profited more from divergence that I have from similarity." Today we saw DIVERGENCE for a little while as it relates to the scenario of higher bond YIELD creates a higher stock market. After all, the 10-year bond YIELD never went red today, but the SOX sure as heck did and so did the NASDAQ and the QQQ. That is DIVERGENCE for my scenario and all of a sudden I got the feeling that the break to new intra-day highs for the 10-year YIELD all of a sudden had market participants buying some stocks or at least had some market participants not selling as much stock (in the belief that money may be freeing up from bonds and that money may go into stocks.) By sessions end, the bulk of the day's divergence was erased and stock ended higher.

OK, this is a very short-term perspective, but hopefully you can now begin to understand how even the short-term can eventually turn into the long-term. If the market is so focused on what the heck bond YIELDS are doing on a 15-minute basis, then perhaps we can continue to use the power of this indicator to better asses how the market is going to react.

I look at the bond market differently than stocks. In a way they are the same, but they are also very different investment instruments. The understanding of the difference between a stock and bond is like night and day. The stock has no guarantee of return, while the bond is a guarantee of stated coupon YIELD and return of face value of the bond.

If you can look at some other stocks and try to see what happened to their price action around 01:50 EST. Was there a support level nearby? Did the stock seemingly find buyers out of nowhere like most other stocks seemed to find. Did the stock just continue lower and didn't seem to care what the broader stock or bond market was doing?

Aha! If you find a stock that continued lower and didn't seem to care about the higher bond YIELD and the turn higher in stocks at 01:50 EST, then that's DIVERGENCE and that might be tomorrows opportunity. If the market was willing to sell a stock even though the bulk of the market direction had turned higher, that might mean the MARKET has more stock to sell.

Tomorrow an equity bull wants to see more selling in bonds I think. Today was just one day. That is very short-term, but we all know that the longer-term is built one day at a time!

Jeff Bailey
Senior Market Technician

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