3 Critical Charts To Understand The Market Right Now…

Last week, I wrote about the Federal Reserve and how their plans to buy bonds was a form of quantitative easing that should boost the economy. Since then, some new economic data has shown that this may be just what we need.

Retail sales slipped in the latest data release. Sales declined 0.3%, the first drop since February. CNBC reported that this is “raising fears that a slowdown in the American manufacturing sector could be starting to bleed into the consumer side of the economy.”

I believe the most important part of the news was how wrong analysts were. They had been expecting an increase of 0.3%. Analysts seem to be out of sync with consumers, and that tends to happen at important turning points in the economy.

For now, this is news to watch. One bad month for retailers isn’t something the Fed (or investors) should act on. But the Fed should be worried that this weakness comes at the same time as manufacturing is showing cause for concern.

Data from the manufacturing sector continued to show weakness. The Wall Street Journal noted that overall industrial production — which includes output at factories, mines and utilities — dropped 0.4% in September and declined 0.1% from a year earlier, the first year-over-year decrease since 2016.

Analysts had been expected a smaller decline of about 2.5%. They remain optimistic, even as the data deteriorates. The Fed, on the other hand, seems to be taking a realistic view of the data and is acting to prevent additional weakness.

Rather than just ramble on about the economy and monetary policy, I recently shared a few charts with my Income Trader readers explaining why I find this concerning.

An Economic Turning Point? Here’s What The Charts Are Saying

Let’s start with industrial production. At the bottom of the chart is the six-month rate of change (ROC).

In the chart, I chose to make the ROC look like a MACD indicator. Technical analysts call this style a histogram, and I like it because it shows the trend clearly.

Notice that the indicator was negative in 2015 and 2016. This wasn’t a bear market, but it did coincide with a 15% decline in the S&P 500 and a 22-month period of sideways action in the stock market. This tells me that it can be useful to look at this indicator in a little more detail.

The next chart takes a longer-term view.

You can see the negative periods are relatively rare but occur at some important points in the data. Declines seem to coincide with weakness in the stock market.

Now, I’m using six months to calculate the ROC because the stock market reacts quickly to changes in the trend.

Monetary policy can take 18 months or longer to affect the economy. That’s why the Fed and economists can consider year-over-year changes. Stock prices can react in minutes, and a six-month ROC can highlight trends in the stock market.

The next chart shows the S&P 500 instead of industrial production and uses red bars to highlight those times when the indicator is negative.

It’s not a perfect indicator, but it is useful. And right now, it is warning us that a decline is possible.

But, even so, I’m bullish.

Why I’m Still Bullish

I’m bullish because the Fed is acting on the data instead of waiting for the downturn to be confirmed. This is unusual in Fed history. In the past few decades, the Fed has generally followed the market rather than trying to lead it. Chairman Jerome Powell seems to be taking initiatives to lead the market and, as we saw last week, the Fed drives the direction of major trends in the stock market.

The Fed is providing fuel for the bulls in the stock market, and the next chart shows the recent price is bullish.

Since June, the S&P 500 has been in a trading range. This is highlighted by the rectangle on the chart above.

There are also two trendlines that have formed. The lower one is the “line in the sand” that must hold. A break of that line will negate my current opinion of the market. The second trendline, the dashed line, shows that bulls have been buying in the past few weeks. Demand has been accelerating as each pullback ends sooner. This is bullish and shows that excitement is building.

The pattern is about 205 points from high to low. Technical analysts believe a breakout should result in a price move at least equal to the dept of the trading range. That provides a target of about 3,232, and I expect momentum to carry the index to at least 3,300 before this move ends.

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