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A Correction After a Breakout in Risk Assets Shows Why It Pays to Be Patient


Some of the anticipated monthly breakouts did occur -- and the bulls were rewarded with the current pullback.

Usually, I look to currencies to confirm breakouts / breakdowns in equities. Last week, however, we saw successful monthly closing breakouts above resistance in the "stuff" currencies of the Canadian and Aussie dollars – but we did not get a confirming monthly closing breakout in the S&P 500 (nor in the Brazilian equity market for that matter).

It's a bit of a circle, I know, but we really need to remember to look for moves to be confirmed across asset classes – regardless of which is confirming the other's move. It was notable, although completely expected, that US bond yields never confirmed any of the bullishness we've been seeing in risk markets. Clearly that's a result of external forces (rather than traditional market forces), but it's a factor nonetheless. After all, if things were that great globally, would just about all the central bankers in the world be maintaining a dovish stance? I think not.

Let's take a look at what's happening now…



"Risky" high-yield bonds reacting to credit concerns in Europe.

Summary of last week's observations:
  • iShares High Yield Bond ETF (JNK) was working its way higher up to what I thought would be a wave v and 3 peak at around $40.40.
  • From there, I thought JNK would consolidate a bit before making another push higher to the wave c target at $41.62.
  • Even higher prices were possible if this (the October '11 – Februrary '12 rally) was more than just a correction.
  • JNK was looking good, but needed to close above $41.62 to provide a truly bullish signal.
Here's what JNK is looking like now:

Click to enlarge

JNK has begun to correct sharply in the short term. Under normal conditions, that would come as a bit of a surprise because there was no technical signal that would have told us that a correction was coming.

However, with Europe's difficult situation continuing, these types of credit concerns cannot catch any of us off guard – it's part of the landscape now and will likely continue to be so for quite a while.

Whenever a top (short- or long-term) is in place, the task becomes to identify potential downside targets. Based on what I'm seeing on the chart, I'd say that there's room for JNK to fall all the way down to $38.55 (from $39.32 at 11:57 a.m. Wednesday). That level is where the uptrend line comes into play and is where some horizontal line support exists.

The RSI for JNK is shown on the chart as well. Maybe by the time the downside price target is tested, the RSI will reach oversold territory – making JNK a nice buy candidate at that point.

Surprise! 10-Year Yields stuck in a trading range under 2% for now – the Federal Open Market Committee's dream scenario.

Summary of last week's observations:
  • 10-year Treasury Note (^TNX) yields had actually started to decline and move further away from testing resistance (at 2.08%).
  • Support for the 10-year yield came in at 1.9%.
  • My ultimate price targets remained down at 1.44% - with some stops along the way.
Here's what the 10-Year T-Note Yield is doing now:

Click to enlarge

Not much to share regarding the TNX this week. It has basically oscillated between 2.08% on the upside and 1.9% on the downside.

Presumably, there will be a flurry of technical buying or selling if the TNX breaks out of this range – so get ready to act appropriately if either of the boundaries are approached.

My feeling remains that yields will break down below 1.9% and will eventually end up down in the 1.4% to 1.5% area.

Overall from bonds, the picture is more one of caution rather than frothy optimism. Even the bullish patterns are taking on more bearish characteristics in the short term.


The Aussie / yen cross is in correction mode in the short term – after posting a nice breakout to the upside last week.

Summary of last week's observations the currency markets:
  • The Aussie / yen cross (AUDJPY) worked it's way all the way to its "correction" resistance level at the 100% Fibonacci price projection line.
  • Early in the week, it peaked above that line (at 86.787) on a daily closing basis but then quickly traded back below it the next day.
  • The cross actually managed to close the month out (last Wednesday at 5 p.m.) above that level to confirm that an upside breakout had occurred.
Here's what the Aussie / yen cross looks like now:

Click to enlarge

Like I noted with the JNK analysis, when tops occur, we must then work to identify how far the next move lower may be.

Based on what I'm seeing on the AUDJPY chart above, there are two possible support levels that the cross may test. Both are horizontal line support levels – one of which comes in at 84.707 and the other at 82.649.

Given the fact that AUDJPY put in a monthly break above the 100% Fibonacci price projection line as noted last week, I have to believe the correct stance on the AUDJPY is to buy the dips. So, I would be using either of the two support levels to attempt some long-side trades (while honoring stop losses, of course).

The Canadian dollar is correcting after a breakout as well.

Here's a summary of last week's observations on the CADJPY :
  • The Canadian dollar / Japanese yen currency cross (CADJPY) was also threatening to break out above its key "correction" resistance level on a monthly basis.
  • We'll need to see CADJPY close out Wednesday (at 5 p.m. EST) above the 81.137 level to confirm a breakout to the upside.
Here's what the Canadian dollar / Japanese yen looks like now:

Click to enlarge

For the CADJPY, I'm using Fibonacci price retracement levels as potential entry points for long-side trades.

The two levels shown on the chart above are 79.649 and 78.670. As with the AUDJPY, given the monthly close above the critical "correction" resistance level, I would be in the mode of buying dips down to support with the CADJPY cross. Don't be shy about taking small losses if the stop loss triggers, however.

The media would have us believing so, but is the euro currency the real tell for the risk markets? Take a look at the action in the euro, the German equity market and the US equity market:

Click to enlarge

The chart above shows me that there are certainly times when the euro (shown here by the CurrencyShares Euro Trust (FXE) exchange-traded fund) was a very good directional guide for European equities (represented here by the iShares Germany ETF (EWG) and US equities (represented here by the S&P SPDR ETF (SPY)).

However, notice the period from November of last year to mid-January of this year. The FXE basically trended lower that whole time. The EWG and SPY, on the other hand, dipped initially, but then put in their respective lows in late November and rallied all the way until February.

Clearly, the last few days have seen the FXE decline pretty sharply – and the EWG and SPY have begun to follow suit.

What all of that action tells me is that the euro currency may not be a truly reliable tell for risk assets all the time – despite certain periods to the contrary. What the chart also tells me is that it may be more important for US investors to key off of Germany's equity markets instead (and vice versa).

The bottom line is to never follow one indicator blindly – always test the validity of the indicator in the current market condition.

Overall, we seem to be in correction mode and that we may have some more work to do on the downside before this phase of the market is done. Taking a bullish stance in certain areas of the risk markets may be appropriate – but not necessarily across the board.

Twitter: @tttechnalytics

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