foxex: Tiny Red Flags for the S&P 500

Chart Advisor | Focus on the Price

By John Jagerson, CFA, CMT

Thursday, February 21, 2019

1. Homebuilders shrug off Existing Home Sales report

2. Slight stochastic divergence on S&P 500

3. 30-year Treasury yield breaks higher

How can we improve the new Chart Advisor? Tell us at chartadvisor@investopedia.com

Major Moves

Economic announcements are tricky. You see, they have one glaring problem they will never be able to overcome. They only look into the past.

While this may seem like an incredibly obvious statement, it's true. Economic announcements, no matter how much they can tell us about what happened during the past month, quarter or year, can't predict the future.

This is an issue because traders are always trying to peer in to the future to see if they can determine what is going to happen, and then they act accordingly. If they see bullishness on the horizon, they buy stocks. If they see bearishness, they sell.

We saw a great example of this today when the National Association of Realtors (NAR) released its Existing Home Sales numbers.

For the first time since 2015, the annualized home sales numbers dipped below 5 million – coming in at 4.94 million in January. At first blush, this would seem like negative news. And on its own, it would have been. However, traders were looking at something else.

Declining Existing Home Sales numbers have been exacerbated by high mortgage rates. The higher mortgage rates are, the more expensive buying a home becomes and home sales numbers suffer.

During the past few months, mortgage rates have been declining because Treasury yields have been falling. This trend of declining Treasury yields and mortgage rates has traders convinced homes will become more affordable and home buying will pick back up in Q1 2019.

This belief in a bullish recovery spurred traders in to buying Residential Construction stocks like Lennar (LEN), D.R. Horton (DHI), PulteGroup (PHM) and Toll Brothers (TOL) today after these stock had initially gapped lower at the opening bell.

Each one of these stocks continued the up-trend it has been in during 2019 and closed higher for the day.

We'll have to see if the trend of falling yields (read more about Treasury yields below) continues long enough to keep pushing Residential Construction stocks higher, but it was enough of a factor today to push these stocks into positive territory when most of the S&P 500 components were pulling back a bit.

S&P 500

The S&P 500 took a break from closing at new highs today.

This normally wouldn't be much to pay attention to as the size of the pullback is so small. However, this pullback has caught my attention because the index has also formed a slight bearish divergence with the stochastics oscillating indicator.

A bearish divergence forms when the index, or stock, forms a higher high while the indicator forms a corresponding lower high.

In this case, the S&P 500 formed a high of 2,738.98 on February 5th and then formed a higher high of 2,789.88 yesterday on February 20th. This higher high was confirmed by today's pullback in the S&P 500.

The stochastics indicator formed a high of 97.8 on February 6th and then formed a lower high of 96.62 yesterday on February 20th. The lower high was confirmed by the bearish crossing of the %K line below the %D line on the stochastics indicator today.

Just because we are seeing this bearish divergence today does not guarantee the S&P 500 is going to start moving lower. It does tell us momentum may be fading and that we should watch for a potential pullback.

Read more:

Top U.S. Housing Market Indicators

Why the Housing Market Won't Crash Like 2008: Robert Shiller

6 Signs Of A Healthy Real Estate Market

Risk Indicators - 30-Year Treasury Yield

After dipping briefly below 3%, the 30-year Treasury Yield (TYX) has jumped back up to 3.05% and has completed a bullish continuation pattern in the process.

The TYX hit a multi-month low of 2.9% on January 3rd. After an initial bounce higher, the indicator started stabilizing in a down-trending channel that held firm for more than a month.

Today's bullish bounce caused the TYX to break up through the down-trending resistance level that formed the top of the channel, completing a broadening wedge bullish continuation pattern.

This move may not be good for housing stocks as rising long-term Treasury yields tend to push mortgage rates higher, but it is a good sign for bond investors and for those analysts who are looking for confirmation that traders are becoming increasingly confident in the strength of the U.S. economy.

Long-term Treasury yields typically rise when traders anticipate economic growth and start to demand higher yields to compensate them for the time risk they are exposed to by buying Treasuries.

On-The-Run Treasury Yield Curve

What is a Curve Steepener Trade

Bottom line: Tiny red flags

We saw a few red flags today with the lower-than-expected Existing Homes Sales number from the NAR and the stochastics divergence on the S&P 500.

However, I would consider those red flags to be tiny red flags based on the reaction we saw from Wall Street today. Sure, we need to pay attention to them. They are red flags after all. But they appear to be tiny because traders didn't start running for the exits.

Had traders started selling off Residential Construction stocks or abandoning their bullish positions on the S&P 500, I would be more concerned. But for now, I'm simply making note of the tiny red flags and watching to see if the rebound is just around the corner.

Why Active ETFs Are Soaring in Popularity Amid Upheaval

Learn the basics of investing