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Chart Advisor | Focus on the Price

Monday, September 21, 2020 Headlines

1. Stocks fall further as Nasdaq extends its correction
2. Sectors break bullish trendlines
3. The can't-carry trade

Market Moves

Stocks opened today's session with heavy selling. Bargain shoppers entered the markets later in the day, but couldn't erase the overnight gap. The Nasdaq 100 index (NDX) hit a low of 10677 today, which represented roughly an 18% correction from its high-water mark on September 2nd. Most buy-and-hold investors tend to close their ears when they hear that label, because it is their strategy to ignore the noise and hold on through corrections. However, active traders recognize such moves as a signal to act.

The chart below shows that the U.S. Dollar index (DXY) rose to the level of previous resistance, while Gold Futures (GC) closed below recent support. This action takes place as interest rates and bond prices remain range bound. Such moves seem to indicate that investors aren't merely moving money from one asset to another, but rather they may be simply moving out of stocks and into cash. That behavior is often associated with nervous investors who simply want to pull back from the markets altogether.

Sectors Break Bullish Trendlines

What had begun as profit-taking behavior over the past three weeks seemed to imply that an inevitable sector rotation would follow. It may still happen, but if it did it may not begin to take place until the last two days of the month at the earliest, when hedge funds can count new trades as part of the next quarter. For now, the weakness is spreading from the tech sector outward as more sectors show stocks breaking trendlines.

The chart below shows four sector index funds from State Street: Financial (XLF), Industrial (XLI,) Basic Materials (XLB) and Commercial Real Estate (XLRE). These sectors are heavily connected to large-scale construction projects. It is interesting that the charts show all of them making a significant break of trendlines and support levels. Such breaks usually indicate the beginning of a change from upward trends to downward trends.

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The Can't-Carry Trade

The weakness isn't limited to U.S. based stocks either. The most important currency pair to gauge global investing sentiment is the Australian Dollar paired with the Japanese Yen (AUDJPY). This pair is known nowadays as the carry trade because large institutional traders can use it to gain positive interest payments on a daily basis by going long on the pair. It is a relatively safe trade so long as one can put up with the fluctuation inherent in the price moves.

When institutional investors recognize the risk that this pair may trend lower for an extended period, they pull money out of this trade. That is why downward movements in this trade that coincide with the beginning of stock market corrections are likely to be a good indication of a change in global investor sentiment. Consequently, such signals also tend to forecast diminished returns in the weeks ahead.

The Bottom Line

Stocks sold off again today as the session opened. The signs of weakness were broader and seemed to show up in several sectors, not just technology. Another indicator of declining investor sentiment showed up in the price action of the AUDJPY pair as it broke support today.

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