Keep Your Eyes on the Four Horsemen

The market was up big on Tuesday, and down big on Wednesday. This kind of back-and-forth in equities is, I suspect, a harbinger of things to come over the next quarter. I think that we have to face the fact that buyers and sellers are going to do battle for the heart and mind of this market, and though I can’t predict with certainty which camp will win over the short term, I can tell you to keep your eyes on four specific indicators that can let you know just where the hottest battlefronts are.

I call these indicators the “Four Horsemen,” and by regularly watching a chart of each, you can get a very good sense of what the smart money out there is doing. Now, let’s take a quick look at each of these four key indicators.

1) The S&P 500 Index

This index is the best overall measure of the equity market. As you can see by the chart here, the S&P 500 still is in a strong uptrend, and it’s still more than 15% above its 200-day moving average (red line).

On Tuesday, the S&P 500 pushed to a new high, and that means it’s not really a great time to add new money to broad-based domestic equity funds. If we see the S&P 500 Index fall below the 50-day moving average (blue line), it could be a sign that a wider correction is on tap.

2) 30-Year Treasury Bond Yields

Rising bond yields equal falling bond prices. And as stock prices rise, generally the taste for bonds diminishes. But when stocks get out of favor, many investors seek the safe haven of Treasury bonds.

By keeping a close watch on yields, you can ascertain the market’s general bias toward Treasury bonds — and, in many cases, towards stocks.

If bond yields continue rising as I expect them to do in 2010, it could mean a solid opportunity for you to profit from investments directly correlated with falling bond prices, i.e., rising bond yields.

3) US Dollar Index

We talked about the idea of currency upheaval two weeks ago in the Alert, which basically means the fate of the U.S. dollar vs. rival foreign currencies. Measuring that fate is easy with the U.S. Dollar Index.

As you can see by the chart here of $USD, there was a lot of currency upheaval in December, as the greenback fought its way back from multi-year lows. If we see more of this kind of movement in the U.S. dollar, it could translate into a decline in international equities, gold and other hard assets.

4) iShares FTSE/Xinhua China 25

This is an ETF that tracks the top 25 stocks traded in the Chinese equity market. I call it China’s Dow because, like the Dow, it’s a good measure of the overall health of the market.

As you can see, China’s market has enjoyed a great run higher since March. But just recently, FXI broke below its 50-day moving average and now seems headed for its 200-day moving average. Does this mean the run in China is over? We don’t know yet for certain, but by monitoring FXI each day, you’ll be able to tell precisely when the bulls have exited the China shop.

These Four Horsemen are great tools that you can consult on a regular basis to see for yourself how and where the money is flowing. And, while they don’t represent a complete picture of the market, being intimately familiar with these four indices’ machinations is a great way to develop a keen sense of the market’s next moves.