How Much More Downside Will We See in Risk Assets Before We Get a More Tradable Bounce?
An analysis of key risk indicators.
The key currency risk gauges are telling me that some more short-term weakness may be in store for risk assets. Unfortunately, this idea is not being disputed by any evidence coming from bond-land either.
Let's take a look at how things are looking right now:
The euro / Japanese yen currency cross is going to head lower – but when?
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The chart above shows the euro / yen cross (EURJPY) on a daily basis going back to the beginning of the year. Based on the wave count on the chart, the EURJPY appears to either have completed wave iv (higher) of wave 2 (lower) or it may still have some more work to do before wave iv is completed.
With the EURJPY at just under 106 currently, the downside target for wave v (based on wave v roughly matching wave i in magnitude) is down at around 104.80. The question is whether there is one more short-term spurt to the upside before the downside target is reached. This morning's action may give us the answer. I will be confident in saying that EURJPY's next move is lower (not higher then lower) if 105.807 is breached on the downside. A decrease in the EURJPY in the short-term would be a short-term win for the risk bears out there.
The EURJPY is one of two key "risk" gauges that I use. The other gauge is the Aussie dollar / Japanese yen cross (AUDJPY), which will be covered later. Before I get to the AUDJPY, I wanted to check the other key cross for the euro: the euro / US dollar cross (EURUSD).
The euro / US dollar currency cross should also see lower levels -- but it, too, may have some upside first.
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The chart above shows the EURUSD on a monthly basis instead of just a daily basis. My motivation here is to get an idea of where the big picture forces may be pulling the EURUSD. Based on my wave count on the chart, the EURUSD appears to be in a correction higher as part of a bigger-picture move lower (wave c & ii of wave 3 lower). The upside target for wave c & ii will be 1.38561 (from its current level of 1.32321 as of 10:48 a.m., Monday, April 30).
So, is it worth it to try to play for the upside from 1.323 to 1.385? Support for the EURUSD on the daily chart comes in at 1.30. That's quite a bit of room to the downside before even the first technical level of support is reached. To me, it's a bit too much of a risk (especially with the chance that any day can bring about new scary headlines). I would rather play the upside in risk assets that should accompany this type of rise in the EURUSD by owning stocks (US stocks would be my preference). Once the EURUSD makes it up to resistance at 1.385, I would actually feel comfortable selling the EURUSD short in anticipation of the powerful wave iii of 3 that should follow.
For right now, based on the EURJPY's short-term chart and potential break of support at 105.807 and the room that the EURUSD has before its nearest support is tested, I'd have to be leaning towards safety.
How about our other risk gauge -- the Aussie dollar / Japanese yen cross (AUDJPY)?
The Aussie dollar / Japanese yen cross is pointing to more downside in the short-term.
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The AUDJPY appears to be in wave v of A lower with a downside target of 82.301 from the current (as of 11:12 a.m., Monday, April 30) level of 83.138.
This downside projection matches up with the short-term picture that the EURJPY is giving us. It is also likely that both the AUDJPY and EURJPY will see a corrective bounce higher once the downside targets are tested.
So, we may see some more short-term weakness in risk assets, which should then lead to a tradable bounce. I would be looking to add long exposure to risk assets in general as the downside targets in key gauges like the EURJPY and AUDJPY reach attractive reward / risk entries.
Now, are the bond markets echoing this short-term caution? Let's take a look...
The yield on the 10-Year US Treasury Note still has plenty of room on the downside before my downside target is hit.
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Not much has changed in my overall analysis of the 10-year Treasury yield. My call is for a move down to around 1.5%. Yields have, in fact, drifted lower since my last report on April 19 even as US equity prices have risen.
At this point, I'm not very happy to see such bearish technical evidence coming from the Treasury market. This tells me that one or both of the following is coming to fruition: There is major trouble coming in the economic and/or geopolitical news flow; and/or the FOMC is doing anything and everything in its power to juice asset prices up further (which clearly could have negative long-term ramifications even if the short-term picture is rosier).
In terms of how all of this fits into today's report, the likelihood of lower Treasury yields and the potentially bearish message that sends falls in line with the weak short-term picture coming from the AUDJPY and EURJPY. While various technical indicators indicate stocks will rally, nfortunately, the currency and bond markets are much bigger than that sector and tend to be more reliable so you can count me as being cautious on risk assets for the short-term despite any very short-term bounces that may occur.
Before I wrap up, here's a check-up on the key European sovereign debt yields:
There's been a noticeable decrease in yields for the high risk countries over in Europe. Normally, that should mean good things for equity prices over there (and possibly here). Since our last check-in on April 19, the iShares MSCI Italy Fund (EWI) is up over 4%, the iShares MSCI Spain Fund (EWP) is up over 3%, and the Dow Jones Wilshire Portugal Index is up over 2%. The only one of those returns that doesn't seem to make sense is the Portuguese index; one would think the equities would rally more than just 2% with a substantial decline in yields like that.
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