Stocks Point to Strength; Bonds Offer a Warning – Barron's

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On May 17th, the stock market shed about 2% to log its worst drop since the election. Jitters over the FBI investigation of President Donald Trump gave bears an excuse to sell, although it was not a long-lived panic.

While the CBOE volatility index (VIX) scored one of its biggest percentage increases in history, the sell-off lasted exactly one day. And considering that it happened just one day after the Standard & Poor’s 500 reached an all-time high on an intraday basis, the fear clearly was overblown.

Indeed, I wrote about the VIX’s one-day jump here earlier in May, saying that “a one-day explosion of the VIX doesn’t help much in terms of predicting market direction.”

The S&P 500, Nasdaq and broad-based Wilshire 5000 all touched all-time highs last week. But more importantly, breadth indicators scored a few positive chart events to tell us the bull market is still alive and kicking.

The New York Stock Exchange advance-decline line, which keeps a running tab of NYSE stocks that go up each day minus those that go down, scored another record high and even broke out to the upside from a one-month trading range.

If we look at the volume changing hands on these advancing and declining stocks we get further encouragement. The NYSE advancing volume minus declining volume line broke out to the upside from a three-month slide (see Chart 1).

What this means is the stocks that go up are getting more volume than stocks that are going down and, of course, that leans bullish. Buyers are more aggressive than sellers – the hallmark of a bullish market.

There is more to like in the volume area as major market exchange-traded funds (ETFs) finally saw a positive change in their on-balance volume charts. This indicator keeps track of daily volume on up days minus volume on down days.

For example, on-balance volume on the SPDR S&P 500 ETF Trust SPY -0.08688097306689835% SPDR S&P 500 ETF Trust U.S.: NYSE Arca 241.5 -0.21 -0.08688097306689835% /Date(1496192400001-0500)/ Volume (Delayed 15m) : 31337724 AFTER HOURS 241.5 % Volume (Delayed 15m) : 3864173 P/E Ratio N/A Market Cap N/A Dividend Yield 1.711168530020704% Rev. per Employee N/A More quote details and news » (ticker: SPY) started to fall in early March and continued lower until the May 17 market slide. The next day it started to rise and has now broken through the trendline that guided it lower for the past two months (see Chart 2).

That suggests money is finally flowing back into the ETF, confirming the new highs in price.

We can see the same breakout in the on-balance volume of the SPDR Dow Jones Industrial Average ETF Trust DIA -0.15673981191222572% SPDR Dow Jones Industrial Average ETF Trust U.S.: NYSE Arca 210.21 -0.33 -0.15673981191222572% /Date(1496192400002-0500)/ Volume (Delayed 15m) : 1060883 AFTER HOURS 210.24 0.03 0.014271442842871414% Volume (Delayed 15m) : 5741 P/E Ratio N/A Market Cap N/A Dividend Yield 3.4706436420722135% Rev. per Employee N/A More quote details and news » (DIA). The iShares Russell 2000 ETF IWM -0.7852261160389705% iShares Russell 2000 ETF U.S.: NYSE Arca 136.46 -1.08 -0.7852261160389705% /Date(1496192400001-0500)/ Volume (Delayed 15m) : 23129964 AFTER HOURS 136.58 0.12 0.08793785724754506% Volume (Delayed 15m) : 2414147 P/E Ratio N/A Market Cap N/A Dividend Yield 1.1337358933020665% Rev. per Employee N/A More quote details and news » (IWM) does not show a trend break in in the indicator but it did reach its highest levels of the year. That’s even better.

New highs in several major indexes, rising breadth and positive money flows into index ETFs together paint a rather strong picture for stocks. However – and there always is a however – the bond market does offer a warning.

One year ago, I started watching the yield curve more closely as it sounded a warning for the economy. At that time, the curve started to flatten as the spread between the 10-year Treasury yield and the 2-year Treasury yield got tight. It was not quite as flat, and certainly not upside-down, as the yield curve we often see as a precursor to recession but it seemed to be on its way.

The spread bottomed in August and really started to climb after the election, when hopes for tax reform and an upswing in hiring were fresh. A steepening curve often begins when the economy is starting to warm up. Unfortunately, that trend reversed and the yield curve is now flatter than it was before the election (see Chart 3).

While the stock market has gotten its act back together, investors should keep an eye on the yield curve. The bond market seems worried about dysfunction in Washington putting the kibosh on such desired initiatives as tax reform. If they look to be in trouble, the stock market could be vulnerable.

Getting Technical Mailbag: Send your questions on technical analysis to us at online.editors@barrons.com. We’ll cover as many as we can, but please remember that we cannot give investment advice.

Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.

Comments? E-mail us at online.editors@barrons.com

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