The Lowdown on Bonds

 | Jul 25, 2013 | 7:36 AM EDT
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Not only did we have a down day, we actually have had two in a row. The market is actually able to ebb and flow.

What is even more interesting is that we reached our maximum short-term overbought reading on July 10. On July 11, the market gapped up with Nasdaq closing at 3575 that day. Nasdaq closed this week at 3579 both Tuesday and Wednesday. That is how an overbought market is supposed to work. It either goes sideways or down. My point is that the difference between the rally off the late June lows and the one that began in November is that this one has more ebbs and flows than that one did. It is not a one-way street.

The S&P has fared somewhat better, but on July 11 it closed at 1675 and today it is at 1685. So, it has managed to climb 10 points in nearly 10 days. Yet if you ask most folks, even market folks, I'd bet they don't realize how sideways we have been for two weeks.

Statistically speaking, breadth had a bad day on Wednesday, with the decline in breadth much worse than the decline in the indexes. It was the worst breadth day since the lows of June. But the McClellan Summation Index for the NYSE had a cushion big enough to absorb it. If we get another day or two of that kind of selling, it won't be able to absorb it. But for now it was absorbed.

Nasdaq's McClellan Summation Index, which we reviewed yesterday, did not roll over, but it did not resume its upward climb. It is still hovering at the lower high.

I continue to expect that short-term pullbacks will be followed by more upside attempts.

But it is the bonds that everyone seems to want to know about. Let's review for a minute. A week ago I noted the 5-Year yield had dropped back to June levels and the 10-Year yield had fallen to a support level. At the time I said I thought it should rally (yield up, bonds down) and that a rally toward 2.60% would set up a head-and-shoulders top potential.

Two days ago I showed the same chart and noted it still hadn't budged, despite my cheering it on. I suggested perhaps that we'd begin to hear Taper Talk as we head into the FOMC meeting next week and perhaps that would be a catalyst. Well, it took long enough, but the Taper Talk arrived and the bonds fell. Here we find ourselves at 2.58%, so we're close now. If yields can hang out here for a few more days without seriously screaming much higher (this 2.60% area) then I do think it sets up the head-and-shoulders pattern to see rates fall again next week, perhaps in conjunction with the FOMC meeting.

Take a look at the chart of the iShares iBoxx and High Corporate Yield ETF (HYG) and notice that it has come way off its June lows. It too had a rough day on Wednesday, but look at the support at $92.50. If that holds, then I'd look  for a rally in HYG, which should also mean a rally in the 10-Year Note (a decline in yields).

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