The downtrending resistance level that has been forcing the 10-year Treasury Yield (TNX) lower and lower since December 2018 is still in full effect as the indicator has taken another bearish turn. Traders are scrambling to buy U.S. Treasuries to shore up their portfolios against a potential bearish pullback in the stock market. Most traders consider Treasuries to be a safe-haven asset that will protect their capital during economic downturns.
As demand for Treasuries increases, so too does the price – which pushes the yield on the Treasuries lower, since price and yield have an inverse relationship. This is what we are seeing today. Treasury yields like the TNX are falling because traders are pushing Treasury prices higher as the desire to protect their capital starts to outweigh the desire for a hefty return on their capital.
The TNX had been consolidating just above 2.5% for the past few weeks, but it fell to close at 2.45% today – its lowest close since March 29. While lower longer-term Treasury yields may be good for borrowers looking to buy or refinance a home, they are not good for major financial institutions or as a confirmation of trader confidence.
If the TNX continues to fall, it is likely a confirmation that traders are moving money out of stocks and into Treasuries, which is something no stock market bull on Wall Street wants to see.
The S&P 500 sent shock waves of concern up and down Wall Street today as the index fell to its lowest level since April 2, forming a bearish separating line candlestick pattern.
A separating line candlestick pattern forms when the open price of the previous day's bullish candlestick matches the open price of the current day's bearish candlestick pattern. The pattern is a bearish one because it shows that traders were nervous enough not only to wipe out the previous day's gains before the opening bell but also to continue pushing the index lower throughout the trading day.
In addition to forming the bearish candlestick pattern, the S&P 500 also broke down through the uptrending support level the index has been climbing above for months.
Interestingly, the bulls on Wall Street were able to rally before the closing bell, pushing the index up off its lows and providing some hope for a recovery. Any hope will be contingent on whether the Trump administration carries through on its threat to boost tariffs on $200 billion of Chinese goods from 10% to 25% on Friday.
If the administration delays, stocks will likely have a chance to recover. If the administration carries through on its threat, watch for more selling and a test of 2,800 on the S&P 500.
Risk Indicators – VIX vs. VIX3M
When traders want to get a sense for how nervous other stock market participants are, they often look at volatility indexes like the CBOE Volatility Index (VIX). The VIX is a measurement of the anticipated volatility being priced into S&P 500 options for the next 30 days.
When traders believe that the S&P 500 is likely to make a small move during the coming 30 days, the value of the VIX will be low. Conversely, when traders believe that the S&P 500 is going to make a large move during the coming 30 days, the value of the VIX will be high.
However, 30 days isn't always a long enough time frame to get a sense for the concerns longer-term traders may have. When a longer-term outlook is needed, traders often turn to the CBOE S&P 500 3-Month Volatility Index (VIX3M). The VIX3M is a measurement of the anticipated volatility being priced into S&P 500 options for the next three months, or 90 days.
Under normal market circumstances, the value of the VIX3M will be higher than the value of the VIX because the S&P 500 is more likely to make a large move if you give it three months – rather than just one month – to make the move.
Surprisingly, traders will push the value of the VIX up higher than the value of the VIX3M from time to time when they are especially concerned that the S&P 500 is going to make a dramatic move in the short term. You can identify these moments by creating a relative-strength chart between the VIX and the VIX3M.
Under normal market conditions, when you divide the value of the VIX by the value of the VIX3M, you typically get a value <1 because the value of the VIX is usually less than the value of the VIX3M. However, under nervous market conditions, when you divide the value of the VIX by the value of the VIX3M, you typically get a value >1 because the value of the VIX will have jumped higher than the value of the VIX3M.
This is precisely what happened today. The last time the VIX/VIX3M relative-strength chart had climbed to close above 1 was on Jan. 22. Since that time, it had been moving steadily lower in a downtrending channel. Today, the VIX/VIX3M relative-strength chart climbed to close above 1, its highest level since Dec. 28, 2018.
This dramatic jump above 1 tells us that traders are extremely nervous that the S&P 500 could continue to correct lower this month if the United States and China can't sort out their trade differences.
Bottom Line – Fool Me Once
Traders are justifiably skittish this week as the S&P 500 hovers just below its recent all-time highs while the Chinese and U.S. delegations try to hammer out a trade deal under the threat of increased tariffs.
The last time the index was this high, it turned south and entered its first bear market in a decade. Nobody wants to get caught holding the bag if the index does the same thing again. Fool me once, shame on you. Fool me twice, shame on me.
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