It has not mattered much up to this point this year, but at some point (soon?), we may start to see the various asset classes return to their traditional relationships where weakness in bonds and currencies leads to corresponding weakness in equities. The weakness in the Aussie and Canadian dollars, for example, has clearly been matched by weakness in the commodities arena for months now. However, stocks have been immune to the virus in the other asset classes so far. Now that Ben Bernanke and the Fed have uttered some words that are less dovish than normal, perhaps we will get back to “normal” relationships across all
Before I get into my usual fixed income and currency work, I wanted to touch briefly on some economic and market internal “stuff."
Today’s weekly jobless claims and the upward revision to last week’s numbers have created two straight weeks of a rise in the 4-week moving average of claims. As you’ll notice in the graph below (which shows the 4-week average of claims with the adjusted weekly closing value of the S&P 500
(INDEXSP:.INX)), the equity markets (red line) have generally risen as the average claims (blue line) have trended lower. Two weeks does not a trend make, but if the data continues to flow in like it has the last two weeks, we may see a period of consolidation (at best) for the equity markets. By the way, for those sticklers out there, my view is that the 4-week average of claims is a coincident indicator for the market and not a leading indicator – but it is clear that the market does not tend to do well when the blue line is trending higher.
TECHNICAL TELLS FOR THE EQUITY MARKET
Here’s a quick observation on today’s (Thursday’s) action in the equity markets. I view today as being end-of-month window-dressing time and little more. The volume today is very light and is falling in line with the recent pattern of higher volume on down days and lower volume on up days. Notice that the volume on May 22 (a down day) still hasn’t been eclipsed (over the last five sessions). Even the little upswing in volume on May 28 was accompanied by what I view as a distribution candlestick where prices closed out near the session’s lows rather than the highs.
Now, onto bonds and currencies…
Treasury yields have spiked and are overbought, but should have a bit more upside before this correction is over.
Much ado has been made about the rise in Treasury yields over the last couple of weeks. The rise has been sharp to be sure, but the fact that it is rising is to be expected technically. Unless and until the yield on the 10-year US Treasury Note ($TNX.X) breaks and closes above 2.284%, I view this rise as nothing more than the “c” wave of an “abc” upside correction. If 2.284% is broken on a closing basis, I will absolutely be singing a different tune, though.
Junk bonds reflecting the short-term bearish turn in attitude towards risk assets.
High-yield bonds are showing a little short-term weakness currently. In fact, if the SPDR Barclays High Yield Bond ETF
(NYSEARCA:JNK) closes the month out below $40.75, it will be a bearish engulfing candle (a sign of more short-term weakness to come). Based on the chart below, I feel JNK can trade all the way down to around $39.50 without creating any long-term bearish technical signals. Such a pullback would almost certainly be accompanied by a further pullback in stock prices – although it doesn’t have to by any means.
Emerging market bonds are breaking a long-term uptrend line, but may have some support below current levels.
The other key risk measure in the bond markets is the emerging markets debt sector, shown below by the iShares JPMorgan MSCI Emerging Markets ETF
(NYSEARCA:EMB). Clearly, EMB has broken down below the long-term uptrend line – certainly reflective of the run away from emerging markets assets (just as we’ve seen in emerging markets equities via the iShares MSCI Emerging Markets ETF
(NYSEARCA:EEM)). The bulls can still hold out hope, however, that this is all merely a corrective move to the downside in EMB as long as $115.13 (the 100% Fibonacci price projection line for the potential “abc” downside correction) holds up as support. Any break and close below that level (especially on a weekly closing basis) will spell real trouble for EMB. Overall, we can clearly say that emerging markets debt is either foreshadowing weakness in risk assets (at worst) or is at least failing to confirm the upside we’ve seen in other risk assets so far (at best).
The yen’s corrective bounce should start soon if it hasn’t already begun.
Of all of the currencies, the yen may be the best gauge of what’s going on with the risk trade. The Japanese and US markets – along with many of the global equity markets – have been in major rally mode ever since the Japanese yen has been in bear market mode. Well, according to the chart below and the accompanying wave count, the yen may be done going down for now. Based on the wave count, it appears that five waves have either played out or are nearing an end and that a corrective move to the upside is to be expected. I pointed this out last week
, but it bears repeating: If the markets rallied as they have with the yen in a bear phase, will they then decline if the yen goes through a healthy upside bounce? By “healthy upside bounce,” I mean that I am anticipating a potential move from current levels (around 0.9929) to approximately 1.1041 (the 38.2% retracement of the October 2012 to May 2013 bear move).
The US dollar’s outlook is less clear in the short term, but the long term appears to have more upside in store.
The US Dollar Index ($DXY) is shown below on a monthly basis. Notice that even in the more bearish scenario – where the DXY is in a “C” wave of an “ABC” correction to the upside -- there exists nearly 10% of upside potential until the resistance level / ceiling is reached at 91.78. This is not tradable information in and of itself -- we need to see where things are on a daily chart – but it is something worth bearing in mind when formulating your long-term investment thesis.
The daily chart of the DXY is shown below. In this chart, we can see that the greenback is likely in for a little more downside action as wave “iv” plays out. From a current level of about 83.24, I can see the DXY pulling back to either 82.40 or 81.78 without upsetting its overall bullish short and long-term technical pattern. This would likely coincide with bullish action in both the yen and the euro. The yen’s chart was featured above. Now let’s take a look at the euro’s chart.
The euro may be setting up for a bit more of an upside correction in the very short term.
The chart below shows the euro futures contract (@EC) on a daily basis. This price action is playing out pretty much as I have anticipated. I called for a pullback in early May, which was to be followed by a rally up to “right shoulder” resistance level at or near 1.3285. Traders can try to play the remaining upside if they are very, very nimble. However, the next very large move should commence somewhere near resistance and should offer plenty of profit potential for those willing to trade on the short side against the euro. So I’m seeing short-term bullishness for the euro and intermediate-term bearishness to follow.
I must note that both the Aussie dollar and Canadian dollar continue to trade bearishly – although each is reaching oversold levels and could bounce at any point. Those bounces, should they occur, should be used to sell or bet against each of those currencies in my opinion. If I were trading the currency markets directly, I might wait for such bounces to occur in conjunction with the remaining downside in the greenback and then bet with the US dollar and against the risk currencies. If you’re not involved directly in the forex markets for whatever reason, you can just use the CurrencyShares ETF offerings (CurrencyShares Canadian Dollar Trust
(NYSEARCA:FXC), CurrencyShares Australian Dollar Trust
(NYSEARCA:FXA), and CurrencyShares Euro Trust
(NYSEARCA:FXE)) as short candidates.
With only limited downside potential for the US dollar in the near term and the possibility of a pretty substantial corrective bounce in the yen – and the overall bearish charts in the risk currencies and riskier parts of the fixed income arena – I would have to believe that we should see some more short-term difficulty in the equity markets. The caveat, of course, is if the FOMC and its global bretheren continue to keep their collective feet on the gas pedals. If that occurs, much of this well-thought-out analysis is moot. If, on the other hand, they do follow through on “tapering back” on the QE programs, we may finally start to see some more two-directional action. Be ready for some interesting action over the next several months as volume dries up for the summer!
No positions in stocks mentioned.
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