Wednesday, October 24, 2012

Trouble on the horizon for stocks?

We've had two pretty ugly down days in the market in the last five trading days.  After an initial rally this morning, probably due to Facebook's better than expected earnings report, stocks faded into the close.

Most pundits on the street are attributing nothing more to this price action than a normal garden variety correction after a healthy run up.  Some are even celebrating the fact that stocks are reacting to traditional fundamentals (earnings reports) instead of the global macro issues which have haunted our market for the past three years.

To any of this I would not disagree but a correction is a correction and the question is: how deep will it be?

When I look at the inter market relationships which assist me in my analysis of the market's macro trend I'm getting mixed signals.

 Here's a comparison chart of the Dollar's performance to the other major global currencies (Euro, Yen, British Pound, Aussie Dollar, Canadian Dollar, Swiss Franc and Swedish Krona):

In our "risk on/risk off" world, a stronger Dollar weighs heavily on stocks and commodities.  As can be seen above, the Dollar is strengthening against the other major currencies.

But the Treasury market, which is also inversely correlated to stocks and commodities, is telling us a different story.  Here's the iShares Barclays 20+ Yr. Treasury Bond ETF:

TLT has been trying to rally above the yellow down trend line but has failed four times so far to do so.  Now it is getting sandwiched between the down trend line and its 200 day moving average. 

We're getting mixed signals which sometimes happens on a short term basis.  This divergence between these two "risk off" instruments will rectify itself soon.  Either Treasuries will confirm Dollar action or the Dollar will reverse its upside momentum.

I'm betting Treasuries confirm Dollar strength ...