foxex: Betting on a Rebound

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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Tuesday, April 28, 2020

1. Interest rates settle in ahead of Fed meeting

2. Should these sectors be leading right now?

3. Low interest rates help homebuilders hang on

Market Moves

Unlike the last three surprise meetings in March, tomorrow's Fed Open Market Committee (FOMC) meeting is a regularly scheduled one. Nobody expects there to be an announcement about rate changes of any kind. This is good news. While investors and analysts stand ready to parse through the Fed's outlook for the economy when they release their statement at 2:00 pm Eastern Time tomorrow, recent price action in stocks implies that investors do not anticipate a pessimistic report.

Everything the Fed has done so far appear to be working as they would hope. The chart below shows that option traders do not anticipate major moves lower in interest rates. This chart compares the CBOE Volatility Index (VIX) with the CBOE/CBOT 10-year Treasury Note Volatility index (TYVIX) and the 10-year Treasury Note Index (TNX). The volatility associated with the rate on the 10-year note is a good indication of how much fear the market has. (Notice that the price action for the TYVIX and the VIX are very similar.)

It is particularly noteworthy that the TYVIX is trending lower ahead of this meeting. The trend sets the stage for the Fed to make confirmation statements, perhaps even make minor adjustments to their policies, and give investors reassurance that the banking system is in good shape.

Should These Sectors Be Leading Right Now?
Whenever markets rally from a significant low point, such as the close of the session on March 23rd, chart watchers find it useful to examine the relative strength of each of the major market sectors. The point of this activity is to determine which areas of the economy investors expect to do well in the coming weeks. Historically it has been shown that the sectors doing well in any given historic period tend to outperform other sectors over that same period going forward.

The chart below shows that among State Street's sector-tracking ETFs, the ones with the greatest relative strength are the Energy sector index ETF (XLE), the Consumer Discretionary sector index ETF (XLY), and the Basic Materials sector index ETF (XLB). This is a bit surprising.

The absence of the Technology sector or the Financial sector (more typical candidates for relative strength when the market is recovering) is important. Equally important is that the Consumer Staples sector, Utilities sector and the Healthcare sector are not among the top three. Those sectors would be leading if investors thought a new bear market was on the way. The sectors which are leading the short-term upward trend right now are those that were weakest during the market's fall from late February. It is a clear signal that investors are betting on a quick recovery and that the previous fall in prices was unnecessarily panic-driven. That is a surprisingly optimistic position for investors to be taking considering the degree of uncertainty in the world right now.

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Low Interest Rates Help Homebuilders Hang On

Perhaps the most encouraging news item for investors today came from the quarterly earnings report given by executives of D.R. Horton (DHI), the largest homebuiding company in the U.S. This company reported that their profits were significantly above where analysts expected them to be. Officers of the company cautioned that the effect of the pandemic may not be fully accounted for in the current financial results.

The chart below shows that investors didn't seem to mind what might come next quarter. Investors bought up shares of DHI so strongly that the stock closed 11.45% higher on the day. Low interest rates kept demand for homes running high and kept the company profitable through its last quarter. Though the homebuilding industry group has not outperformed the S&P 500 since the beginning of the year, it appears to be gaining ground. This is yet another hopeful sign for a quick economic recovery.

The Bottom Line

Interest rate volatility is falling as interest rates stabilize ahead of the FOMC meeting tomorrow. This should help investors feel reassured even as the markets are beginning to rebound. They seem to be taking the Fed's cue by investing heavily in rebound sectors and the homebuilding industry.