foxex: Cross-Market Consolidation

Chart Advisor | Investopedia

Focus on the Price

By John Jagerson, CFA, CMT

Tuesday, January 29, 2019

1. Crude oil is consolidating

2. Russell 2000 vs S&P 500 relative-strength chart is consolidating

3. VIX is consolidating

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Major Moves (or Not)

Sometimes the global financial markets thrill investors with euphoria inducing rises. Sometimes they scare investors with panic stoking drops. Sometimes they lull investors to sleep with mind-numbing consolidation ranges.

We're in one of those consolidation ranges right now, and it's impacting a wide variety of asset classes.

These boring consolidation ranges often develop before important economic announcements, like the release of tomorrow's Federal Open Market Committee (FOMC) monetary policy statement. In the calm before the announcement, investors tend to reduce their trading volume and volatility as they settle in to await the news.

In this instance, analysts are waiting to see if the FOMC is going to clarify not only its intentions regarding raising interest rates during 2019 but also its plans for winding down its balance sheet through its quantitative-tightening program. Basically, the FOMC could signal any one of four different monetary policy combinations:

1. It could continue raising rates and keep the pace of its wind down unchanged

2. It could continue raising rates but slow the pace of its wind down

3. It could stop raising rates and keep the pace of its wind down unchanged

4. It could stop raising rates but slow the pace of its wind down

Option #1 would likely cause investors to start selling stocks as fear of an economic slowdown and continued pressure on the bond market would reduce investor confidence.

Option #2 or Option #3 would likely prolong the consolidation as they would leave investors uncertain about the future.

Option #4 would likely cause investors to continue buying stocks as hope for prolonged economic growth and continued stimulus in the bond market would increase investor confidence.

You can see current investor uncertainty in the strength of the global economy by looking at the price chart of crude oil.

When investors anticipate growth in the global economy, they tend to push oil prices higher with the expectation that a strong economy will bring strong demand. Conversely, when investors anticipate slowing growth, or contraction, they tend to push oil prices lower.

Crude oil has been consolidating for three weeks in what may become the right shoulder of an inverted head-and-shoulders bullish reversal pattern.

Maybe tomorrow's FOMC announcement will be enough of a catalyst to force a breakout in crude oil.

S&P 500

During the first week of the year, the S&P 500 had been under-performing the Russell 2000 as investors were moving more money into small-cap stocks than large-cap stocks with the hope that growth was going to accelerate during 2019.

Small-cap stocks typically outperform large-cap stocks during stock market rallies.

However, during the past three weeks, the relative-strength chart of the Russell 2000 vs the S&P 500 (RUT/SPX) has been consolidating in a smaller broadening wedge pattern within a larger broadening wedge pattern as investors have gone back and forth in their enthusiasm for the growth potential of small-cap stocks and their desire for the added stability that usually comes from large-cap stocks.

Maybe tomorrow's FOMC announcement will be enough of a catalyst to force a breakout in RUT/SPX relative-strength chart.

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Risk Indicators

Even the CBOE Volatility Index (VIX) has been consolidating in what could turn out to be the right shoulder of a head-and-shoulders bullish reversal pattern. (It would be a bullish reversal pattern on the VIX because the VIX is an inverted indicator. It moves higher as investors become more bearish and lower as investors become more bullish.)

Investors just can't seem to make up their minds on whether they believe the FOMC is going to boost the stock market or bludgeon it.

One thing we can tell from the VIX chart though is the current consolidation range has a support level that is higher than both the support level that interacted with the chart in November 2018 and the support level that interacted with the chart from August through early-October 2018.

This tells us that investors are more nervous about a potential pullback due to a disappointing announcement from the FOMC than they have been in the past.

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Bottom line: Tomorrow could change everything

Consolidation ranges that lead up to major economic announcements are often followed by sustained breakouts in the aftermath of the announcement.

Interestingly, the initial knee-jerk reaction of the market to the announcement is often incorrect. Prices will quickly move one direction immediately following the announcement only to just as quickly turn around and start moving the opposite direction.

When the FOMC releases its monetary policy statement at 2pm EST tomorrow, watch for the market to react, sort itself out and then start moving in its new trend.

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