This is a tough week to be a trader.
The S&P 500 is about 5.5% off its high, which is sure to give an itchy trigger finger to those trained to buy the dip after a multiyear bull market. On the other hand, this selloff has led to more severe technical damage on the charts than we’ve seen in past downturns, with the S&P 500 breaking its lower trendline and the Dow Jones Industrial Average violating its 200-day moving average.
So what’s next? The key levels that traders are watching on the S&P 500 are support at 1730 and the 200-day moving average at 1707. However, with the S&P 500 at 1750 as of this writing, that leaves room for more damage before the next alarm bell sounds.
Traders might therefore be well served by adding three indicators beyond U.S. large caps:
Vanguard Total World Stock ETF (VT)
Click to Enlarge The current selloff is a global problem with its roots in the emerging markets, so the best gauges right now are those that provide a global perspective. In this sense, Vanguard Total World Stock ETF (VT) is poised to provide an earlier warning than any of the U.S. indices.
The VT gives a proportional weighting to all global equities; as such, it incorporates all regions and market cap tiers.
Right now, VT is perched directly on top of its 200-day moving average. As the accompanying charts show, VT broke its 200-day MA at various points within the past two years and went on to recover the majority of its lost ground in fairly short order. This indicates that a break of the 200-day isn’t a guarantee of disaster. However, it also should be noted that the two-year support line currently terminates at $54.30 — not far below the 200-day.
VT therefore is in a position at which even a modest additional selloff will create a troubling technical picture. Watch this Vanguard ETF’s charts for a clue as to whether the S&P 500 will be able to hold its support levels.
The 10-Year Treasury Yield
Click to Enlarge Global equities aren’t the only asset class at key support. The selloff in higher-risk assets has fueled a flight to quality into Treasuries, driving yields down to levels last seen in autumn 2013.
The 10-year, for its part, put in a double-top near the 3% level and is now hanging precariously above both its 200-day moving average and a key support line. Note that the 10-year yield traded above its 200-day MA for most of 2013 — a period that also brought a 32% gain in U.S. equities.
As a result, a break below the 200-day MA here would signal an important shift toward an environment of slower-growth expectations, greater investor risk aversion and — possibly — renewed inflows into bond funds. What’s more, falling Treasury yields signal demand for dollar-based assets. This is potentially (but not definitively) a sign of continued outflows from emerging-market currencies.
The 10-year is often one of the best barometers for market conditions, and that’s even more true today given its close proximity to important support levels.
The Japanese Yen
 The dollar-yen exchange rate is another critical indicator, since the yen has established itself as a key measure of global risk appetites.
A weak yen has gone hand-in-hand with stronger performance for risk assets, while a strengthening yen typically has been accompanied by selloffs. Now, the yen is again moving higher in conjunction with the stock-market weakness of the past month, and it is in a position to break out into territory that could signal additional trouble for equities.
The easiest way to keep track of this is to watch the charts of the CurrencyShares Japanese Yen Trust (FXY). The ETF, at just above $96 at mid-day Tuesday, is closing in on its 200-day moving average — a level that it last surpassed in autumn 2012. If the yen moves above this level, it would be the clearest sign yet that the current downturn in equities could morph into more than a garden-variety correction.
The Bottom Line
Is this correction a buying opportunity or just the first sign of larger issues to come? Nobody can say for sure just yet — but the charts of these three indicators are traders’ best bet for an early warning.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.