A Pragmatist's View: I SPY A Sell-Off

Aug.27.12 | About: SPDR S&P (SPY)

The big story of the past week was the Fed minutes released on Wednesday. The trading blogs were rife with anticipation. Before the announcement traders gleefully traded barbs claiming to know what was to be said and how the markets would react.

The Fed minutes relayed what was initially interpreted as a semi-clear message: If the economy fails to improve the Fed stands ready to ease further, a la QE3. The SPDR S&P 500 Index ETF (NYSE: SPY) performed curiously in advance of and after the announcement.

Unlike GLD, the SPDR Gold Shares ETF (NYSE: GLD), which I believe has bottomed and which traded flat on Tuesday (opened at $158.81, closed at $158.83), SPY traded lower. Considering the recent negative consensus regarding additional Fed easing the fact that GLD was flat implied a good probability of the Fed delivering the kind of message we got, while SPY implied otherwise.

Wednesday saw both GLD and SPY trade higher, although GLD reacted more positive to the Fed announcement. Thursday is where the two ETFs diverged. GLD gapped up significantly from Wednesday's close and closed higher still on the day. SPY meanwhile opened lower and closed lower than both Wednesday's close and Thursday's open.

Friday saw SPY recover all of what it lost Thursday and added a nickel to its share price but still closed lower for the week. GLD closed Friday slightly higher than Thursday and significantly higher for the week. The chart below exhibits the past 10 trading with SPY represented by the HLC bars and GLD the solid line.

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All things being equal (and of course they aren't) I think SPY is exhibiting characteristics of a security in the fading days of a nearly 3 1/2 year uptrend that is rapidly losing momentum. The reaction to the Fed was very different than the expectations of many observers, although I am not surprised.

I wrote a piece for Seeking Alpha earlier this month addressing SPY in reaction to Bill Gross's "controversial" comments regarding the death of the "Cult of Equity". From a fundamental perspective I agree with Mr. Gross. The heyday of growth in the US is behind us and therefore the US stock markets and their representative ETFs will provide lower average returns in the future. Lower GDP and aggregate growth rates for equities should be expected.

It only serves to logic, although I'm sure many will like to disagree. Without all the problems in the US the country is a mature market, not unlike a mega-cap stock in the latter stage of growth. The better growth rates are to be had in emerging markets, now and in the future. For the near term the S&P may drift higher. But I think the charts have been telling a story that many are ignoring but the reaction of SPY to the Fed minutes this week supports my thesis. SPY appears to be at a double-top.

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Early in the week and before the Fed minutes were released SPY was able to exceed the highs achieved at the beginning of April. But those levels were surpassed only by pennies and those gains were lost by week's end. Failure to surpass those levels again will in hindsight allow us to call it a double top. But for now I am treating it as such in advance of additional confirmation.

One recommendation I have for ETF traders is to look at charts for both the ETF and the index. All ETFs perform differently than their indexes and I find that the index can at times provide different and better information with which to trade the ETF.

The one year chart for the S&P 500 index is nearly identical to SPY, with the recent highs slightly edging those made in early April. But the longer term SPX chart is more telling and this is where the weakness is more visible.

The first chart is the six year SPY.

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The ETF is at just about the same level as it was at the peak in October 2007. If my analysis is correct and this is the top then we very well may be witnessing a double-top that took five years to manifest.

But the S&P 500 index chart looks substantially different.

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Again, if my analysis is correct the S&P 500 is peaking, it is peaking at a level measurably lower than when it peaked in October 2007. This is important, because if this is so then another aspect of my thesis will also be verified. The recovery from the financial collapse of 2008-2009 has been fueled predominantly by optimism and government intervention. And if this is correct then the reaction of SPY and the S&P 500 index to the Fed minutes was very informative. The market doesn't think another QE will help move stocks higher.

And all of this will be very problematic. For if this is the top, and the government intervention and the optimism of the markets has run its course, then a retracement of significant proportions may be ahead of us.

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Are we near the top? A generational triple-top, a "Three Peak"? Or is it actually a head-and-shoulders formation? Either of which would be very, very bearish. If this was the one year chart of a stock would the interpretation be the same or different? If we are peaking, how low will it go?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.