Why You Need to Be Watching the Bond Market

Bond yields could hold the key to a Nasdaq pullback

Senior Vice President of Research
Aug 9, 2021 at 8:46 AM
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“…round 1,000-point intervals on the DJI have acted as meaningful support and resistance in the short term. But a pattern has emerged around the 34,000-35,000 area that is similar to the behavior that the DJI displayed around two other psychological round number levels - 30,000 and 31,000 - from November 2020 into March 2021…a breakout above 35,000 would complete the bullish inverse ‘head and shoulder’ pattern, with a targeted move to 36,710 within three months

          -Monday Morning Outlook, August 2, 2021

Last week, I detailed a pattern that I am noticing on the Dow Jones Industrial Average (DJI— 35,208.51) with respect to its months-long battle at 35,000 and the potential bullish implications. With the DJI yet to make a convincing and sustained move neither above nor below this level, my attention this week turns to the Nasdaq-100 Index (NDX—15,109.36), which is battling at millennium area of its own;15,000.

Since July 2020, the NDX has crossed the 11,000, 12,000, 13,000 and 14,000 psychological round numbers. Since mid-July, and coincident with the DJI battling 35,000, the NDX has been trying to make a convincing move above 15,000. 

While the NDX’s 13,000 level was taken out with relative ease this past January, it was still coming into play as late as May, when it acted as support. But note that 11,000, 12,000 and 14,000 proved more difficult to overcome. The 14,000 is the most intriguing of all, which is also roughly double the closing low of early 2020 at 7,000. It was at 14,000 that a two-week,7% decline began, before another millennium level, 13,000, acted as the trough.

As we are going into about a month with 15,000 acting as a lid, one risk is a repeat of the action that occurred around 14,000, in which a pullback to the prior millennium area occurred before an eventual breakout. If such price action is imminent, lying just below 14,000 is the NDX’s 120-day moving average, which acted as support in early March and mid-May. 

NDX 120-day

I bring this up now not only because the DJI is battling 35,000 simultaneously, but because two prior pullbacks in the NDX occurred within the context of bond market weakness. 

Even though the NDX pushed back above 15,000 last week to its late-July high, the bond market displayed weakness, attributed to remarks by two key Fed governors. Fed Governor Christopher Waller outlined what he saw as a factor that could contribute to a tapering of bond purchases that begins in September, when he said two payroll numbers above 800,000 could be a trigger. Friday’s payroll number was above that threshold. Moreover, Fed Vice Chair Richard Clarida remarked lift-off with respect to an interest rate hike in late 2022, sooner than the 2023 the Fed’s dot-plot indicated at an earlier meeting. 

Per the chart below, the iShares 20 Plus Year Treasury Bond ETF (TLT — 147.78) broke below its 20-day moving average, which held multiple pullbacks since early June. If the TLT breaks below $147.31, which is 10% above its March closing low, or back below its 200-day moving average, risks may increase for another NDX pullback, attributed to rising interest rates.

TLT Chart

This scenario is worth keeping an eye on, especially with the buy (to open) put/call volume ratio on NDX components coming off an extreme low recently. As the low in this ratio occurred in early July, it may take the NDX to move below the early-July low at 14,600 before optimists begin feeling the pain that results in a more serious unwinding of big-cap tech optimism. If you want to hedge a short-term pullback in NDX related stocks, you could purchase QQQ puts, as the 30-day implied volatility (IV) reading is within a half percentage points of its 52-week low, per data from TradeAlert.

NDX 10dy pc ratio

“Delta Impact Increasingly Threatens Some Parts of U.S. Economy”

          -Bloomberg, August 5, 2021

“BofA’s Carey Hall Says Stock Sentiment Nearing ‘Sell Signal’”

         -Bloomberg headline, August 6, 2021

Regardless of how “tech-land” plays out via NDX in the short term, this has been a rotational market, which means investors simply rotate into other groups if one group suddenly becomes out of favor.

Therefore, I still expect that the SPX could continue to trade within its bullish channel that I have displayed weekly, even if tech undergoes a pullback or period of underperformance if bonds continue to decline.

Economically sensitive stocks, for example, have held their own, despite growing worries about the economy, whether the concerns are Covid-19 Delta variant related or a policy mistake by the Fed. Sentiment worries abound too, implying those market participants using sentiment as a tool to time the market are either hedged or on the sidelines, which may imply lower risk than appears on the surface in regard to the broader market. 

We find value in sentiment indicators too, but strongly believe they should be used in conjunction with price action. As such, the current sentiment backdrop should be elevated in its importance if there is a technical breakdown in equity benchmarks. Such a deterioration in the technical backdrop could mark the beginning stages of an unwind of the optimism that so many have been in tune with for months. Yes, optimism is likely to persist at short-term and longer-term tops, but such optimism may persist longer than anticipated, which has been the case in this environment.

If the Dow breaks out and sustains a move above 35,000 resistance, I would expect that at the very least the S&P 500 Index (SPX) will trade within the bullish channel that has been in place since mid-November…In order for short-term traders to get rattled and the shorts to be bolder after months of covering activity, I think it will take at least a week’s worth of continuous trading below its channel …  4,475 is double last year’s closing low at 2,237.40.”

         - Monday Morning Outlook, August 2, 2021

The above excerpt brings me to the S&P 500 Index (SPX — 4,436.52) chart readers of this commentary have seen weekly and is well worth paying attention to.

I continue to see 4,475 as a potential hesitation and/or level from which sellers could emerge, as this represents double the 2020 closing low and is just below the 4,500 half-century mark. The top of the channel ranges between 4,480 at the start of this week and 4,498 at week’s end. 

If sellers do emerge in the areas discussed above, I think it will take a lengthy period in which the SPX trades below its bullish nine-month channel for even more damage to occur in equities. This coming week, the bottom of this channel ranges between 4,345 and 4,360, and the popular 50-day moving average sits below this area in the 4,300 zone. Its 80-day moving average sits at 4,250 and marked the trough in March. In other words, it is likely to take more than a 4% pullback to below 4,250 to shake out the long-time optimists.

As it stands now, the technical backdrop is supportive of the optimism that is present. 

SPX 50day

Todd Salamone is Schaeffer's Senior V.P. of Research

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