Correction In Risk Assets: Is There Still More to Go?

By Tim Thielen  OCT 11, 2012 9:25 AM

Downside targets have yet to be hit in the euro and the Aussie dollar, and the bond markets aren't telling us anything bullish to counteract the negativity in currencies.


MINYANVILLE ORIGINAL My narrative over the last several weeks has been that we should be seeing downside in equities develop to match the bearish divergences we were seeing in the “risk” currencies.  Finally, the equity markets have begun to pull back for more than just a day or two. 

Critical support levels will be approached soon on the major US indices and many will be watching to see if those levels hold up.  I, on the other hand, will not only be watching 1,417.42 on the S&P (INDEXSP:.INX) and 3,034.07 on the Nasdaq (INDEXNASDAQ:.IXIC), but I will be monitoring the key support levels in the currency and bond charts. 

Today, I am just covering currencies as there has not been much movement / change in the bond charts since my article last week.  Let’s go to the charts to see if we can identify the key levels in the currency markets.
The euro / US dollar cross may be on the verge of more of a short-term breakdown.

Over the last month or so, I have put forth the idea that the euro / US dollar cross (EURUSD) would come off of its September high and trade all the way down to 1.23843 (a wave “b” move in my opinion).  Then, the EURUSD should, in theory, experience a wave “c” thrust to the upside that will eclipse the September highs and reach all the way up to around 1.34520.  All the while, the other risk markets like the equity markets should move in tandem directionally with the EURUSD. 

So, if I’m correct on my call for the EURUSD, we should see weakness in equities for a while longer – perhaps well below the S&P and Nasdaq’s support levels mentioned above. 

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The Aussie dollar crosses still have more downside to work through.

Recently, I have been highlighting the deteriorating technical condition of the Aussie dollar currency crosses and pointing out that it may be a leading indicator for other risk assets.  Now, we’re seeing the downside action in stocks that one would expect given the weakness in the Aussie crosses. 

Now that we’re seeing the decline in risk assets, I want to see if the Aussie crosses are telling us there is much more weakness to come or if support will come into play soon. The daily chart of the Aussie dollar / Japanese yen cross (AUDJPY) is shown below.  From just over 80, the AUDJPY still has room to go lower before the first possible wave iii target (the 138.2% Fibonacci price projection line at 78.236) is tested.  If that level of support does not hold up, then the next support level would be the 161.8% projection line at 77.409.

Something to keep in mind is that this wave iii move lower (see blue Fibonacci labels and lines) is merely a part of a larger wave C move to the downside.  There’s much more room to go lower before the wave C target at 70.944 is approached.  Can other risk assets hold their macro bullish patterns if this type of move in the AUDUSD occurs (open-ended question)?

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At 1.02590, the Aussie dollar / US dollar cross (AUDUSD) also has a bit more room to the downside before its short-term wave ((iii))) target range (1.00435 to 0.99570) is tested.  Like the AUDJPY, AUDUSD is also in a bigger picture “c” wave to the downside.  So, even when the downside target range is hit, don’t look for a major upside move.  Rather, we should expect to see some sort of “flat” correction as wave ((iv)) plays out.    

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So, the Aussie crosses are telling us to expect a bit more downside in risk assets in the very short-term.  Once that move is done, the Aussie crosses are further telling us that we should see a modest move sideways to higher (fourth waves) and then another move lower (fifth waves). Remember the franc / krona indicator I mentioned last week?

As I mentioned last week, we got a bearish signal from the ratio of the euro / Swiss franc (EURCHF) vs. the euro / Swedish krona (EURSEK).  Once the ratio of EURCHF / EURSEK turned lower (meaning relative strength in the Swiss franc – see the red lines), we should have been looking for a correction in equities to begin 45-75 days afterward.  Well, at the end of September we entered the target date range for the correction to begin. 

Now, it appears clear that we are seeing that correction unfold as predicted.  Based on the last two corrections following the beginning of Franc strength, we should expect the correction to last anywhere from 30-75 days.  We are less than 30 days into the correction thus far.   Keep in mind that there are no rules here – I’m just trying to use history as a guide.  In terms of magnitude of the correction, I would hesitate to give an estimate based on this indicator alone. 

I would just note that if the S&P and Nasdaq support levels given earlier in the report fail to hold up, there will be much more downside potential opened up for the equity markets. 

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Wrapping It All Up

There’s no way to sugarcoat it – things are going to get a bit worse in the very short-term and will get even worse after some modest sideways to upside counter-trend moves occur.  The EURUSD has much more room to go before I foresee another sharp upside move occurring.  The Aussie currencies are confirming the weakness in the euro – although they are closer to short-term support than the euro is. 

Finally, the new franc / krona indicator I introduced last week and the history around that indicator tell me that we’ve got some more time before we should start looking for a change in direction (meaning krona strength).  So, be patient and wait for the rest of the correction in risk assets to play out before getting too aggressive on the long side.

Twitter: @tttechnalytics

No positions in stocks mentioned.

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