foxex: Over Supply

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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Wednesday, August 19, 2020 Headlines

1. Too much of a good thing in Energy and Financial sectors

2. Fixed income investors need to be watchful

3. What a mild pullback could look like

Market Moves

The U.S. Dollar index regained its losses from yesterday and then some as traders scrutinized the released minutes from the Fed's recent Federal Open Market Committee (FOMC) meeting. Stocks, which have been inversely correlated to the dollar lately, unsurprisingly lost ground, though not much. These moves reiterate that the available supply of cash is closely tied to share prices in the market right now.

The chart below suggests that this problem, an over-abundance of supply, has plagued two sectors separately, but both for the same reason: pandemic-throttled economic activity. State Street's sector index ETFs for Energy (XLE) and Finance (XLF), have both shown a stunning lag in 2020 behind the benchmark S&P 500 index fund (SPY). In its meeting minutes published today, the FOMC recognized the economy would need a "broad and sustained" level of business activity to correct such problems. Because market participants naturally anticipate the future in the current prices of oil and financial products, it clearly follows that investors have not yet spotted indications of a full economic recovery on the horizon.

Ironically, is seems as though there is simply too much fuel in the tank, so to speak, to jump start the world's economic engine just yet. This could be a precarious moment for nervous investors holding on to bond funds and fixed income allocations in their retirement accounts.

[NEW READER SURVEY: We are running another two-week survey of our U.S.-based readers to gauge your sentiment and see what moves, if any, you have been making with your money given the market recovery, and current economic conditions. We'll share the results, as always, and we thank you for your time and participation.]

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Fixed Income Investors Need to be Watchful

Too much supply and not enough demand for bonds is something that most seasoned analysts and portfolio managers would not have expected to see right now. When markets are worried and uncertain, the safety and predictability of U.S. Treasury bonds is attractive. In such times bonds often trade at a premium. At least so far during the pandemic, this asset class seems to have done so.

However, the chart below displays two signals that may give bond investors a moment of concern. The Moving Average Convergence-Divergence (MACD) indicator shows that the trend in the price of bonds, may be weakening. State Street's 20-year U.S. Treasury Note fund (TLT) currently displays both a bearish divergence with the MACD and a bearish engulfing candle pattern in the last 48-hours of trading. These signals may be warning that bond prices could fall, and conversely, interest rates could rise in the near future.

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What a Mild Pullback Could Look Like

If the oversupply of oil and financial offerings are hampering the recovery of a weak economy, how will investors react now that stock prices have fully retraced their losses, as marked by the S&P 500 index (SPX)? History suggests that investors may take a pause soon.

The chart below displays three previous moments in time when the benchmark index returned to its previous high-water mark. These results are similar to the behavior observed over the past decades under similar circumstances. A five-percent fluctuation of prices would not be a big surprise to any financial professionals right now, except for perhaps those traders who have unwisely leveraged their positions expecting that the market is going to keep moving up with no pullback along the way.

The Bottom Line

As stocks shed some of their recent gains, the U.S. dollar strongly rebounded. This dynamic highlights the connection between stocks and the greenback. It also shows the weakness of sectors (such as oil and financial) which simply have too much of their own product available right now.