A Fresh Caution Signal for the Stock Market

08/18/2010 12:01 am EST

Focus: ETFS

Corey Rosenbloom

Founder and President, Afraid to Trade

I feel like I’m beating the same drum, but Treasury bond funds, as represented by TLT (20+ year) and IEF (7-10 year) continue to break out to fresh 2010 highs, and yesterday morning gave us another sharp gap up to new highs.

Let’s take a look first at the longer-term fund, TLT:

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This post just shows the specific breakouts, but look closely at the three recent clean price breakouts from overhead resistance.

First, we had the TLT stagnate between $91 and $87 for the early part of 2010 and then break with sharp gaps up as May began.

I know what you’re thinking. You say price broke out because of the flash crash (investor panic), but look extra close. Price broke out before the flash crash, which took place on May 6—it’s that really big bar that goes from $93 to $99 in one day. That was the flash crash!

Notice the price breakout and two gap-up days in a row before the crash. The bond market often has a slight lead on the stock market.

Price broke out above resistance again in late June, but abruptly turned around when the stock market bottomed in early July.

Now, we have another key breakout above clear price resistance at $102, so if anything, it’s a caution signal for the stock market—not necessarily forecasting a crash of course, but certainly signaling caution.

Let’s see the same progression on the shorter-term fund, IEF:

Click to Enlarge

Though I didn’t specifically label it, price broke out of overhead resistance at $89.50 in late April and took off to new highs in early May, gapping up two days prior to the infamous flash crash on May 6—the same as TLT.

Bonds snapped lower during the snapback rally in stocks and then continued higher as the stock market continued lower.

IEF broke out again in mid June, which coincided with the short-term market peak (the first time) at 1,130 on June 21—no lead time there.

Recently, IEF broke out of the resistance at $96 in early August prior to the second retest and failure of the stock market at 1,130, which (short-term) peaked on August 9.

The IEF fund broke out with a gap move as seen here on August 6, three days prior to the stock market peak and downturn (which actually began officially with a sharp selloff day on August 11).

And today, we see a continuation of the break and another gap higher.

What’s the Main Idea?

Sometimes—not always, of course—bond funds will break resistance ahead of short-term peaks in the stock market.

We are seeing strength in the bond market and weakness in the stock market.

As long as this continues to be the case, traders should be aware that the stock market would likely continue to be weak going forward and should use caution in their trading decisions.

And the flip side, any sudden deterioration in the bond market would be likely bullish in the short term for stocks.

Keep watching this situation closely.

By Corey Rosenbloom, trader and blogger, AfraidToTrade.com

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