The recent surge in the S&P 500 has largely been as a result of the promise in fiscal stimulus by the Trump administration and the resulting expectation of inflation, followed by Fed hikes.
If that sounds like a lot has to happen for the S&P to continue its surge, you're correct. In this analysis, we'll compare the S&P 500 to the dollar vs. the yen and the 10-year Treasury yield since they have all been moving in tandem since the Trump election win.
The correlation between currencies, yields, and the S&P 500 can help ensure you get in when market momentum is in your favor and not only avoid a bad trade entry, but also the resulting heartburn that typically follows.
S&P 500 Daily Chart:
We're currently stuck in a range leading up to the inauguration.
If the S&P breaks the current range, the chart shows potential targets. The market may move the length of the current range in either direction, following a break.
Resistance would come in at 2320 while support would come in at 2190. There will likely be a large number of trade stops and take profit orders at these levels, so be careful and tighten up your stops as we approach these volatile zones.
S&P 500 Daily Chart with MACD and RSI added:
The MACD momentum indicator is still in bullish territory.
However, the moving average lines turned lower while the S&P was hitting new highs.
This divergence can signal a possible correction. However, countering the MACD divergence is the strength in the S&P price action.
The S&P has not retraced with MACD and may signal that buyers are in control and pushing for a possible move higher.
Watch RSI for the S&P to surge; we will need to see the RSI stay and hold above the 50 level.
10-Year Treasury yields:
Since the recent rise in yields has helped propel bank stocks, lifting the S&P in tandem, we must watch for any correction lower in yields.
Lower yields could lead to a sell-off in dollar denominated investments as foreign investors go elsewhere in search for higher yields; putting pressure on the S&P.
So far, we've seen a shallow correction in yields (23% Fibonacci level).
This scenario may indicate we have more room to run for yields and would translate to a further bond market sell-off.
MACD & RSI are in bullish territory, although RSI is approaching overbought territory.
The daily chart is signaling that 10-year yields are likely to stay bullish, although I wouldn't be surprised if we see a deeper retracement before any move higher.
The two key levels to watch are the 50% retracement level of 1.979% and the 78% retracement level of 1.598%. If yields break the 50% Fibonacci level, expect increased volatility in the S&P 500 due to much lower stock prices for financials.
Watching the dollar vs. the yen:
Why is the yen important? The yen is a funding currency. Many investors borrow in yen to fund investments around the world. The yen is also a safe-haven investment (similar to gold) when there's uncertainty in the market.
If the dollar is rising against the yen (the exchange rate is going up); this signifies a risk-on environment. If the dollar is weakening against the yen, this signifies that investors are jittery and we have a risk-off environment. (for example when the USD/yen traded at 100 yen to the dollar).
As a result, watching the yen can help you identify whether international investors are bullish and aid you in your entries into the S&P 500. Don't worry; I'm not suggesting you become a currency expert for this analysis. Just keep an eye on the yen before your trade entries into the S&P 500.
As we can see the dollar/yen has retraced even though the S&P 500 has not.
We need to see the USD/yen rate go to 117 to 118.50 to ensure that the S&P 500 to remain bullish.
For those not familiar with exchange rates, the yen is quoted in terms 115 yen to the dollar (NYSEARCA:USD). For 1 dollar you receive 115 yen. If the dollar to yen rate goes higher, this means you would receive more yen per dollar (dollar strength). And if the dollar to yen rate goes lower (i.e. 108), you would receive fewer yen per dollar (dollar weakness).
If nervousness overtakes the market and the USD/yen falls further, signaling a risk-off scenario, the S&P 500 will struggle to hold onto its gains and may correct lower.
In other words, if the dollar weakens or the USD/yen rate goes lower; (i.e. to 108); this would signal that investors are pulling money out of dollar-denominated investments and putting their money elsewhere.
A break of the 108 level (the 50% Fibonacci retracement level on the chart), would indicate a more intense correction and would likely lead to the S&P 500 falling in sympathy.
MACD & RSI Indicators:
Momentum indicators are moving lower for the USD/yen. However, we are still in bullish territory, although just barely. I'll be continuing to watch this scenario for indications as to the global sentiment in the market.
Avoiding a bad trade is just as beneficial as a winning trade. Correlating instruments can help give you a better assessment of the overall market before jumping in; especially since most investors are in ETFs and mutual funds which track the overall market.
- Upon a break in the current range, watch the S&P 500 at 2190 on the downside and 2320 on the upside for key levels and potential targets.
- Watch the 10-year Treasury yield for moves higher if bank stocks and the S&P is to continue its surge. A break of 1.97% in yields would likely signal a correction in the S&P as well.
- Watch the charts for the dollar vs. the yen. If we see the dollar weaken whereby the exchange rate breaks the level of 108 yen to the dollar; a risk-off scenario may be developing.
Ideally, for the S&P 500 to break higher with conviction and stay above 2320, look a 10-year Treasury yield above 2.5% and a dollar to yen exchange rate above 119 yen to the dollar.
Disclosure: I/we 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.