Sunday, November 1, 2009

Technical Update 42.09

Today will be a more in-depth post covering the equity and currency markets.

The largest one week decline since early May and the breaking of numerous important trendlines has shifted the odds in favour of the bearish camp. While near term technicals provide good cause for an early week bounce, last week's change in character suggest that this should be used to lighten long positions as opposed to the previous norm of buying dips. The list of indicators I have been using to confirm this move is not yet complete, however. There remains a few holdouts. Presumably, a significant push below the early October lows (1019) or the September lows (991) would satisfy these requirements.

First, the list of indicators I have been tracking, posted as it has been for the past few weeks:

1. Consecutive daily declines of 2.5% or more. This hasn't happened since the rally began (if so, only marginally).
2. Weaker internals than previously displayed during the rally via 10 day moving averages of a) put/call ratio b) advance/decline issues c) advance/decline volume.
3. A considerable increase in the US Dollar Index. A crossover of the 20 day EMA over the 50 day EMA is something that has not yet occurred since early April.
4. Divergence between major indices. Dow, S&P, Nasdaq, Transports, Banks. We should see significant divergence between some of these indices at a major top. There have been divergences present at various points, but they have quickly resolved themselves. Specifically, I am looking for underperformance in the transports, banks and/or the nasdaq.
5. A complete Elliott Wave '5' down on more than an intraday basis.

Below is a weekly chart of the S&P 500. It has breached its trendline from the March lows significantly. However, it is common practice for price to test the underside of that line once broken. Notice the negative divergences on the RSI. Also note the imminent MACD crossover.

Weakness in the secondary indices is one of the signals I have been watching for at a market top. We had a failure in many of these indices to surpass their September highs, even as broader indices did so. And now we have these same indices underperforming on the way down. This is textbook relative weakness. And it is exactly what one would expect to see at a top. In addition, we have RSI divergences, MACD crossovers, trendline breaks, increasing volume and important moving averages being broken over the past week. I don't know how much more clear-cut this could be. In order of appearance below we have Dow Transports, Dow Utilities, Russell 2000 and the Semiconductors Index.

Please do not read into this that a crash is imminent. As we have seen countless times, such divergences can persist for longer than most expect. Throughout the 2007 topping process, we had such persistent divergences in many indices even as the broader indices continued higher. Each push higher resulted in even stronger divergences while slowly convincing people that they were not important. As soon as attention dissipated, only then did they manifest into significant declines.

As for market internals, we had been experiencing progressively weaker market breadth and advancing volume as the indices marched higher from their July lows. As expected, many of these indicators are now displaying their weakest readings since the March lows. Below see the put/call ratio, advancing/declining issues, advancing/declining volume and daily closing TICK (the lone holdout).

The confirmations I have been expecting in the currency markets have been mixed. The USD strengthened by over a percent this week and trendlines were only moderately violated. Continued weakness in the Canadian Dollar and the Euro are the keys to confirming a bottom in the USD. Support for these currencies is wearing thin, however, and failing a swift turnaround, the stage will be set for an unwinding of the "US Dollar carry trade" that would eventually send it significantly past its March high.

The Canadian Dollar specifically appears to be at a very important crossroads. It has experienced some of the most speculative flows during the so-called 'recovery.' As this hot money unwinds in the stock and commodity markets, the Loonie could get hammered significantly. I am using the Loonie as a barometer for risk appetites and watching closely.

The Euro, as I have repeatedly mentioned before, does not have any better intrinsic value than the US Dollar. Yet for some reason Dollar bears have latched on to the currency as some sort of safety hedge. In my opinion, this is quite ignorant to the enormous problems present in the European banking system, their exposure to risky loans in Eastern Europe, and the political issues between the more stable Northern European government balance sheets and those in Ireland as well as the PIGS (Portugal, Italy, Greece, Spain) all of whom are running massive deficits in violation of the Maastricht Treaty.

Technically, it has only marginally broken its trendline, a situation that upon reversal could become a "pinocchio" buy signal. Again, increased attention is warranted.

Good luck next week!

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Roger J said...


Perhaps not that important, but I guess it's kind of interesting to note that CAD/AUD ratio generally goes lower when speculative mania is in place.

It made a significant bullish divergence in February for the March bottom. It bears some uncanny resemblance (not exactly "identical") to the dollar index... at least on the daily charts.

I'm not sure what kind of mechanics work behind this ratio, but it looks very interesting. It peaked in October 2008, during perhaps the apex of panic.

Any thoughts & insights on this, Matt?

Occdude said...

Early in the momentum shift cycle, I see things "shaking out" a bit around this level (GS doesn't like anyone frontrunning THEIR frontrunning) but shortness is in the air and you should at least be raising cash (something I did a bit prematurely) and sharpening the spears for this trend reversal.
Feeling a little bit over anxious though and need to check that and pick my price points.

I plan on getting ever more agressive as the trend gets more established. Time for "Mr. Spock" to take over my trading account.

Matt Stiles said...


Can't say for certain, but it is likely that the AUD is even more leveraged to the perception of being a commodity based currency, thus leverage to global economic growth and growth in Asia especially.

But that's the perception. I have a feeling it has more to do with interest rates.

Willy2 said...

Australia is - most definitely - suffering from the "Mayhem producing printing press" located in D.C. The US has been running Current Account Deficits since the 1960s. Countries outside the US have accumulating USD since then. China is spending those USDs on buying commodities from e.g. Australia. This flood of USD coming into Down Under pushes up the money supply. As a result the
RBA is forced to increase interest rates in order to stave off the next real estate bubble Down Under. But when the AUD/USD goes down again then we'll know the carry trade starts to unwind in earnest.

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