Traders and investors alike learned a painful lesson last week. In the span of five trading sessions, the market reminded us all that prices both rise and fall. Not rise or fall.
For the past two years, since the Fed announced its intention to proceed with a third round of quantitative easing, the S&P 500 has risen in a virtual straight line. The trajectory wasn't extreme, but the lack of ebb and flow was concerning. The natural tone and movement that an open auction would be expected to display had all but disappeared. We all know the market's tone changed dramatically during QE 1 and QE 2, but the lack of volatility, and the persistent bid underneath the market, became notably more extreme during QE 3.
Context will always be king. So with the official end date of QE 3 just around the corner (at this month's end), I thought we'd begin the trading week with a review of how the S&P 500 cash index and the 10-year treasury yield traded since the beginning of this grand experiment we all know as quantitative easing.
The most obvious development on the chart above is how quickly 10-year yields and equities collapsed after the end of QE 1. The most notable decline occurred in 10-year yields, where rates declined roughly 42% from early-April 2010 to early-October 2010.
A similar scenario unfolded at the end of QE 2, except that in this case, 10-year yields began declining several months prior to the official end date of the Fed's asset purchasing program. That said, rates still managed to decline roughly 47% in less than three months following the official completion of QE2. And again, while equities did suffer, they didn't collapse anywhere near the degree that rates did.
Moving along to QE 3, the most noteworthy development in my view is the full-year deterioration in 10-year yields, all while the S&P 500 has, up until very recently, continued to grind ever higher.
If you flip back to the chart of QE 1, you'll see yields and stocks declined largely in tandem once the Fed's asset-buying program ended. Sure, yields traded sideways for months prior to the end of QE 1 while stocks continued to climb, but the actual declines began around the same time. Fast forward to QE 2, and we see yields began declining well ahead of the Fed's program, and well ahead of stocks. Nonetheless, the decline intensified in rates, and began in stocks, following the official completion of the Fed's asset purchases.
This brings us to the present, when the Fed is expected to officially end its third round of asset purchases (QE 3) at the end of October. If we refer to QE 1 and QE 2 as our road map, we would expect rates to drop further, and the decline in equities that began last week to intensify over the coming months. Is past trading a guarantee for future movement? Of course not. But we don't need it to be.
What's important for us, as investors and traders, is to remain open-minded, humble and fully aware that we will never have all the answers. I continue to believe a simple, largely technical approach to the market is best. Let's focus on the fact that the market's four major index ETFs are all trading beneath their 50-day simple moving averages. And the Relative Strength Index (RSI) readings on each index ETF is beneath the 50-center line, and in decline. Don't over-complicate this. The bottom line is that the market is telling us via these simple technical studies that it is not healthy.
In Tuesday's Trader Daily we'll dig a bit deeper into the implications of a 200-day SMA breach. For now, just know that if a sustained trade beneath the 50-day SMA is negative for intermediate timeframe participants, a break of the 200-day SMA is simply another step in the wrong direction. But this time, that step in the wrong direction affects participants on an even higher timeframe.
Late-Friday morning, as energy shares were plummeting to new year-to-date lows, I initiated a position in the First Trust ISE-Revere Natural Gas ETF (FCG). Hopefully you caught my brief explanation in columnist conversation. But if you didn't, not to worry, my trade logic is pretty straight forward.
In a nutshell, I bought FCG against the multi-year support zone highlighted in red on the weekly chart above. Ordinarily, I wouldn't be in a hurry to buy an instrument in free-fall. However, with the clear-cut support between $14.10 and $14.60, and the fact that the ETF's top three components are QEP Resources (QEP), Newfield Exploration (NFX) and Apache Corp (APA), all names you'll recall are on my energy watch list, I opted to stare down the bears and buy some shares.
As far as a stop loss is concerned, I believe something between $13.75 and $14 would work fine. Whether one opts to wait for a weekly close, or prefers to cut losses after a single day's close is purely a function of risk tolerance. Suffice it to say if you're going to give something a full weekly bar, you'd be wise to consider your trade size (dollars at risk) carefully.
- Please check columnist conversation prior to Monday's open for an updated E-Mini S&P 500 Futures (Es) volume profile and trade plan.
Any trading or volume profile related questions can be posted in the comments section below, emailed to me at firstname.lastname@example.org or posted to my twitter feed @ByrneRWS.