Saturday, November 21, 2009

Technical Update 45.09

The S&P 500 is up a little over 7% since early August. It certainly feels like more. The last 4.5 months have been trying for market bears, sucking out volatility premium and refusing to respond to typical measures of extreme market sentiment. The major indices have again reached a point where they can capitalize on the visibly "weak hands" that are propping up the advance.

Judging from the sentiment on the various "bear blogs" I visit, it seems that most are now unconvinced that a top has been reached. These same venues were all quick to jump on previous declines and tops were called confidently. Now, however, with five distinct selloffs that ultimately failed, bears are more apprehensive. This is typical behaviour and indicative of the market taking the "path of maximum frustration." It seems that it is systematically trying to stretch and squeeze bears as much as possible, making as many as possible insolvent in the process.

But despite the seeming lack of conviction among the bearish camp, progressively more and more evidence is piling up in their favour. Every subsequent leg of this advance has been weaker than the previous and the most recent 3 day decline holds even more potential than was evident in mid-October. See the S&P 500 chart below with the VIX (volatility index) overlaid. It has registered a positive divergence relative to the index. RSI and MACD have each registered progressively weaker readings. And we can also see that volume has steadily declined throughout the course of the decline. These are all classic signals of a bear market rally losing steam.

Also of importance is the non confirmation among secondary indices. The Dow, S&P, Nasdaq, FTSE and Wilshire 5000 have each exceeded their October highs. Every other major index has failed to do so. As I wrote two weeks ago:

Tops are a process, while bottoms are an event. And this topping process appears to be no different. Especially bearish would be for certain indices (like the Dow) to make a marginal new high early next week, while the others fail to confirm. The bearish divergences noted in these pages two weeks ago would become even more pronounced.

This is exactly what has happened. So the appropriate stance would be to become MORE bearish given these developments. But that is not the way sentiment typically works. The emotional "pain" that one experiences being proven repeatedly wrong disables the ability to view market action for what it is. The same was true for bottom callers throughout 2008. By the time they were vindicated, few had the conviction to capitalize.

Below is the banking index. The academic consensus is that banks have recovered immensely since the panic lows of last winter. Naturally, they should be making immense profits with their interest spreads the way they are. But share price action tells a different story. They have been the weakest sector since the early spring rally, and the weakest sector over the past month. Could the market be telling us something different via the underperformance in this key sector? Could the balance sheet issues I have been raising for years continue to weigh on share prices? Or worse, is it possible that as many have alluded to continuously that most if not all of the world's major financial institutions are technically insolvent?

Do note the convergence of the moving averages on the chart below. Typically, when this occurs, a large move in one direction or another is imminent.

The terrible performance of small cap stocks should be worrying for bulls. In a healthy advance, small caps typically outperform larger cap stocks as smaller companies are more leveraged to prospects of future growth. With big cap names like IBM, MCD and JNJ leading the way with small companies lagging way behind, the hesitancy of bulls in this recent rally becomes easily apparent. Big name money managers have been distributing their shares of small companies to retail holders while they accumulate shares of safer names. We've seen this game before, and we know how it ends.

This can also be illustrated by the relatively few stocks that made new 52 week highs in November compared to those that did in October. Plotted on the chart below and smoothed as a 10 day moving average, the weakness be seen clear as day.

On the currency front, we see similar divergences. The Canadian dollar has backtested its rising trendline and turned back down. This is textbook Elliott Wave behaviour, with the break of the trendline being wave 1 and the retest of the underside being a wave two. So long as the trendline is not regained, the bearish case remains intact.

A similar case can be made for other currencies that have benefited the most from the US Dollar Carry Trade. Most notably the Aussie and Kiwi Dollars, the Brazilian Real and to a lesser extent the Euro. They are all in rather precarious positions, and a technical breach of very obvious support levels will most likely illicit further selling and an unwinding of these speculative positions.

But all of these currencies are moving inversely to the US Dollar Index - whether they are part of the index or not. So it is the big kahuna. And when it breaks above, we can be assured that the rest will break below in sympathy. Below is a chart of the US Dollar. Most notable is the trendline dating back to early March. It has been briefly exceeded twice this month (Nov 3rd and last Friday) but failed to close past that mark. Also of note is a parallel trend channel dating back to June. The upper band of this channel correlates roughly with that Nov 3rd high, giving us a fairly good idea of where resistance resides. 76.81 is the number to beat. If we get two consecutive closes above that number, I'd have a high degree of confidence to call the bottom for the dollar. A spectacular advance would be the result.

That's all for now.

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Roger J said...


Among the currency setups, we may find the long side of USD/JPY to be the most attractive trade coming. I remember you mentioned JPY several times at Kenny's. I'm not sure what you're observing. It could be that we're observing different things and come up w/ similar conclusions.

Here's what I find from EUR/JPY:$XEU:$XJY&p=D&b=3&g=0&id=p33654762768&a=184084277&listNum=1

Note: it may appear to have an error w/ oversized labeling & lines. Just update the chart size to 1280, it should fix the problem.

1. Vicious 5 wave down from Aug 08 to Jan 09.
2. Followed by a 5-wave up until June & a triangle starting early June. Triangle not that obvious... mainly because it's length & mild nature. But oftentimes the not obvious ones work really well, don't they?

That suggests we're in a primary up wave as a ZZ, with C leg up coming.

If the count is right, we're looking for a 5-wave up here. With EUR/JPY likely going up & EUR/USD likely ready to go down, we have a potential double down on JPY/USD.

USD/JPY is a bit confusing. $XJY showed 5 down after the most recent mid 113 high. The current wave-up now looks wedging but not that clear... I have a hard time finding USD/JPY intraday charts, too. I guess w/ currencies we can just look for clues from the pairings if the chart isn't clear, right? In this case, I think EUR/USD & EUR/JPY provides important clues to where USD/JPY maybe heading to.

This is a much less obvious trade than the normal risk aversion trade (short EUR/USD & the likes). So, perhaps it just may provide the best opportunity among the major currencies. If the wedge is right, this should be a low-risk entry w/ stop loss at the mid 113 highs.

Your thoughts would be much appreciated.

Adam Luper said...

Just wanted to say that your blog is extremely informative for me. As a college Finance student from the Kelley School of Business at Indiana University, I am really learning a lot from following your posts. Thank you for taking the time to share your thoughts!

Anonymous said...

It has been briefly exceeded twice this month (Nov 3rd and last Friday) but failed to close past that mark.

What is your take on the cancellation of DXY trades by ICE - which occured on each of those days?

On Nov. 3 8000 trades were cancelled - no reason given but it climbed well past 76. On Thurs/Fri 4000 trades were cancelled on claims of 'suspicious trading' - DXY at that point had rocketed up past 82 but all trades above 76.5 were subsequently cancelled.

No other disclosure.

Willy2 said...

According to Bob Hoye the USD is about to turn a corner. Source:

And a USD going up means markets are going to down in the next days, weeks, months.

A lot of folks have gone short the USDX and when those shorts are being covered the USD will go up sharply.

Anonymous said...

Dubai made the headlines last Thursday and inmediately all the currency crosses showed the appropriate response, i.e. what one would expect. EUR, AUD down. USD, JPY up.

Anonymous said...

Dubai made headlines and all the currency crosses responded in the way one would expect in the current situation. i.e. Eur & AUD down, USD & Yen up.

Steven said...

I think what the US government (and other govt's that have followed in their footsteps) has continued to do to try to support the economy is very misguided. They have wasted trillions of dollars bailing out creditors and shareholders of failed institutions with broken business models rather than addressing the structural flaws in the system of too much debt. And this is going to lead to massive problems down the road with regard to our currency and interest rates, in my opinion. And I think that the gold price breaking out to a new high is a strong indication of the reduction in faith and confidence that people have in governments and their fiat currencies. I recently read a good article called Gold Price Hits Record as Gold Fever Grips Wall Street that discuss the Federal Reserve's easy monetary policies in order to try to prevent any sort of deflation from occurring and to try to reflate assets prices. I think this article is very helpful for any investor to read because they help to explain the investment implications for the dollar, the gold price, and gold mining companies who I believe will continue to benefit from central banks' inflationary programs.

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