As noted Friday, markets surged on Thursday’s FED announcement of unending QE for mortgages. With this in mind, what should we expect?
Short answer – The same thing we expected Wednesday, but perhaps worse. Here’s a quote from the FED statement.
[T]he Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.
For how long?
[T]he Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.
With the markets already enjoying some strong movements, the resulting pop should not be something to get excited about. In fact, rather than a direction changer, it most likely will cause a bit of overbuying, which always results in a strong correction (the strength of the correction corresponds with the degree of overbuying).
To illustrate this point we’ll look at the charts we promised Friday. Something to keep in mind is that the different time frames on the chart help us to better understand what to expect in the near, mid and long-term.
Our first chart is the daily. It simply reflects the end of day levels of the S&P 500. Day traders will watch different intraday charts, including one hour down to 1 second charts. For our purposes, the daily will suffice. Notice that on days when the RSI climbs up near 60 or so, we get a correction. And when it drops near the 30 region we get a correction to the upside. The MACD reflects these periods of overbuying and overselling as well.
In March the S&P was severely overbought, from a daily perspective, resulting in a strong correction that lasted all the way into June. Toward the middle of May it was becoming apparent that the market was entering oversold territory. This reached the most oversold condition, due to volume and other indicators, about mid-month. However, the correction was relatively shallow and gave way to further consolidation into the beginning of June. At that time the signal line, indicated by the light-blue bars, turned positive along with other indicators rolling upward.
As can clearly be seen, we are entering a range of severe overbuying again, such as was seen in the Spring. While it is not inevitable that the market will turn down in the next few days, this offers us a strong warning that such could happen in the short-term.
To get a broader perspective, we’ll look at the weeklies. In this study we’ve marked a few of the turning points to give readers an idea of what we’re looking for. First, note that when we look at the weekly chart we look at a broader time frame; in this case three years. Next, note the first green band. Again we find ourselves in overbought territory, with a correction imminent. However, as you can see, such conditions were continually fended off with varying degrees of success throughout the prior year.
As the bottom came in late June, 2010, the RSI dipped to about 40, along with a strong drop in the MACD. This was followed by a rally that, other than a couple of pullbacks, lasted about 8 months. From there it met a small correction that really just consolidated prices, before regaining previous highs. However, the RSI continued to warn of topping, with the MACD actually diverting away from the market. This culminated in the crash we endured about a year ago, which gave way to a very strong rally that we’re enjoying to this day.
But look again at the conditions today. The daily is overbought already. The RSI in this weekly is showing overbought territory, but the MACD is still headed up. It’s possible that we can continue going up, with some give and take, over the coming weeks. However, according to the RSI there is a strong indication that we’ll have a rather severe consolidation in the near future, especially if the MACD begins rolling over.
These are tools to help us consider the most likely direction the market will take in the near future. There are other technical indicators that help us understand timing and levels better, but the formulae for them are more complicated. For now, we just want to understand what the market’s doing and attempt to discern the most likely direction.
The daily looks very bearish. The weekly is looking bearish, but less so. Tomorrow we’ll take a look at the monthly and quarterly to see what they’re telling us. Then, later in the week, we’ll look at gold and silver.
For your prosperity,
J. Keith Johnson
The Gold Informant