Weakness Could Morph Into Stock Correction

By: Chris Ciovacco | Wed, Sep 26, 2012
Print Email

Rising Spanish Yields Troublesome

The recent strength in defensive assets, coupled with an uncertain bailout timetable in Spain, tell us to continue to manage risk closely. The "risk-off" trade may be returning to the Spanish bond market, which is not what the bulls want to see. According to CNBC:

Worries about Spain increased as the Bank of Spain said the economy fell "at a significant rate" in the third quarter and after protesters clashed with police in Madrid on Tuesday before the government's 2013 budget, due on Thursday.

"The more jittery the market gets about when Spain will seek aid the higher yields will go ... The key will be whether Spain asks for a bailout before their yields surge," said Paul Robson, currency analyst at RBS.

On the chart of the Spanish ten-year below notice the higher high in yields made above the red arrow. While it may turn out to be nothing, a higher high is needed for a change in trend. If yields pop back above 6.00%, it would be a red flag for risk assets, such as stocks, commodities, and precious metals.

Spanish Government Generic Bonds - 10 Yr Note

Defensive Assets Say "Be Careful"

The recent strength in defensive assets has been telling. Twitter acts as a de facto trading diary, allowing us to monitor changes in the market over time. The tweets below from the last four trading sessions refer to strength in defensive assets, such as bonds (TLT), consumer staples (XLP), and healthcare (XLV). These red flags were part of our rationale for taking profits off the table last week in silver (SLV), mining stocks (GDX), Spain (EWP), Italy (EWI), and the EURO STOXX 50 (FEZ). The second tweet below "we are skeptical until this changes" still applies; as long as defensive assets are the best performers, we will err on the side of caution. If defensive ETFs start to lag again, it will send a bullish signal.

Defensive Assets Were Strong On Monday & Tuesday

In a recent video, we outlined numerous bearish concerns on the chart of stocks relative to bonds, or risk-on relative to risk-off. The chart of the S&P 500 (SPY) relative to intermediate-term Treasuries (IEF) below continues to say "be careful" with risk. The last three times Williams %R, a measure of momentum, broke below -20, it marked the onset of a period of weakness for stocks (see A, B, and C). We have a similar bearish break this week (see orange arrows). The chart below is as of Wednesday at 10:45 AM. Since it is a weekly chart, it could still "take back" the bearish signals before the close on Friday. Thus, it is concerning but some patience/open-mindedness is in order for the next three trading days.

$SPX:IEF (S&P 500/iShs T-Bnd 7-10y) INDX/NYSE

Not A Time For Bullish Complacency

Over the weekend, we outlined our concerns relative to a possible topping process in stocks. After Monday's session, we described reasons to worry about Spain's bailout timetable and showed numerous risk markets that looked tired.

If the S&P 500 closes below 1,435 today, the door may be opened for a key test of support between 1,406 and 1,396 (see support near A below). The Relative Strength Index (RSI) may provide some help for a bounce in stocks (see B). Point C shows waning upside momentum in stocks, which is typically followed by more weakness. From a bullish perspective, MACD on the weekly chart below still has not deteriorated in a significant manner (see D). It is only Wednesday - we need to see how the chart below looks at the close on Friday. The current read is one of ongoing concern for risk.

$SPX (S&P 500 Large Cap Index) INDX

S&P 500 Push Toward 1,490 Still Possible

If Spain asks for a formal bailout, risk assets could experience a sharp rebound. We remain flexible and open-minded, but with a high cash position until the markets give us signals to buy again. If the charts improve and the news from Europe allows, we are happy to jump back on the reflation train. Our shopping list includes QE2 winners such as silver, oil stocks (XOP), and mining companies (XME). A push toward 1,490 on the S&P 500 could be in the cards if Spanish yields calm down. The need for flexibility is evident in the lack of clarity relative to Spain. Posted on the Wall Street Journal's site September 26 at 8:00 AM:

Spain's prime minister, Mariano Rajoy, is still not committing himself to request a bailout. Asked in a Wall Street Journal interview whether his government would apply for a financial bailout from one of the European Union's two financial-rescue vehicles, Mr. Rajoy said: "At the moment, I cannot tell you," adding that the government would need to see if the conditions attached to the bailout are "reasonable."

It is important to understand a topping process could involve a new high in stocks. If risk assets move higher with tepid conviction from buyers, then it is time to be very concerned. Conversely, if the next push higher is accompanied by a "start buying bonds" command for the ECB, strong volume, and confirmation from technical indicators, the QE2 winners may be the place to be



Chris Ciovacco

Author: Chris Ciovacco

Chris Ciovacco
Ciovacco Capital Management

Chris Ciovacco

Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors and tax advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money management firm based in Atlanta, Georgia. CCM helps individual investors and businesses, large & small; achieve improved investment results via research and globally diversified investment portfolios. Since we are a fee-based firm, our only objective is to help you protect and grow your assets. Our long-term, theme-oriented, buy-and-hold approach allows for portfolio rebalancing from time to time to adjust to new opportunities or changing market conditions.

Copyright © 2006-2016 Chris Ciovacco

All Images, XHTML Renderings, and Source Code Copyright © Safehaven.com