Monday, April 28, 2014

Coiled markets and the Dow Theory: A closer look to TLT and IEF ETFs

In my last post, I wrote about consolidations I see occurring in several markets.

Well, let’s take a look at interest rates (TLT and IEF, the 20+ years and 7-10 years bonds ETFs, respectively). It will be a very cursory analysis, as my time remains in short supply.

Here you have the vital chart which spans almost roughly one year of market action (From the end of April 2013 to April 28, 2014).

Coiled interest rates: Which way they will go?
The last recorded closing highs were made on May 1st, 2013 (blue arrows on the left side of the chart). Please mind that these highs were not the highest highs, but merely the highs made on a secondary bullish reaction against an ongoing primary bear market that started in July 2012 (not show on the chart). From that point, a new primary bearish swing brought the both ETFs to new primary bear market lows, and, hence, the primary bear market (which means higher interests rates) was confirmed. TLT bottomed on 8/21 and IEF bottomed on 9/05. Since lower lows were confirmed, the primary bear market was re-confirmed.

From that point (blue rectangles), a feeble (in extent and in time) secondary reaction set in. It barely managed to retrace ca. 23.60% (TLT), and ca. 35% (IEF) of the previous primary bear market swing. You can see the retracements shown as horizontal lines. However, in spite of its feebleness, the movement was confirmed. From that point, the typical Dow Theory pullback occurred (orange rectangle); it was a very modest pullback, and it is debatable whether, at least one of these pullbacks, met the minimum volatility requirements (I did the volatility-adjusted calculations for my internal use, and in one of the ETFs the minimum volatility requirement, which is lower than the 3% required for stocks, given the lower daily volatility of interests rates, was barely met).

More about the volatility adjustments I perform to determine minimum meaningful movements, here and here.

So, albeit somewhat hesitatingly, both interests rates ETFs set up for a primary bull market.

As you can see in the charts, the breakup  occurred, and we can say that since mid October 2013 interests a primary bull market was signaled for interest rates.

However, true to the very feeble setup, soon after being signaled the new primary bull market, both ETFs started to head south.

And here things get interesting. TLT on 12/27/2013 made a lower closing low (that is below the last recorded primary bear market lows of 8/21/2013), whereas IEF did not deign to confirm. According to the Dow Theory, such an unconfirmed lower low meant that no primary bear market had been signaled, and that the primary bull market remained in force. From that point TLT has staged, until now, a timid rally, while IEF has remained stuck in a narrow range unable to better the last recorded closing highs of made in October 2013. Once again, according to the Dow Theory, TLT higher highs, being unconfirmed by IEF, tell us that the current rally is likely to be deceptive.

So what’s my global take on all that?

1)     Even though TLT has very modestly rallied, and has even managed to better its last recorded highs, little progress has made since its 8/21/2013 primary bear market lows. So, on the chart, I basically see distribution (albeit not as apparent as in IEF).

2)     IEF is not confirming TLT’s timid rally, and, hence, confirms that is it very likely that there is accumulation or distribution.

3)     IEF itself is clearly caught in a narrow range unable to either break up or down.

4)     So my global assessment is that interests rates remain caught in no-man’s land, building up energy.

5)     I don’t like to make guesses as to the direction of the subsequent break up/down; however, there is a slight bullish bias, if I am to judge according to the Dow Theory: The test of the primary bear market lows failed, and the primary trend is bullish (albeit it was not preceded by the best setup).

The Dow Theorist

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