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Are Stocks in the Last Stages of This Rally or Is This Just the Beginning?


Bonds and currencies are sending us clues.

As the media convulses over the idea of the Dow (INDEXDJX:.DJI) hitting new highs, it behooves us all to keep a clear head and to formulate our investment theses with intelligence and a wide lens.

Messages from stocks are one thing. Messages from stocks that mesh with positive messages from bonds and currencies are much better – for the risk bulls out there. Are we getting such confirmations from the bond and currency markets? Today's report will cover just that.

Before I jump into my fixed income and currency material today, I want to remind everyone what my current call on the market is (and has been). The chart below shows the S&P 500 (INDEXSP:.INX) on a monthly basis going back to the 1990s. My theory is that the S&P is in the final stages of wave "B" of the macro "ABC" correction to the downside. This macro correction follows what I feel may have been a wave V peak in 2007. The upside target for wave "c & B" is the 1,563.92 to 1,576.09 range on the S&P.

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Why do I feel this may be the reality? There are a couple of reasons. First, when I count out the waves and sub-waves, it just seems to make more sense that this is the case. For the 2008 - 2009 sell-off to have been wave "C" of a large "ABC" or "zig-zag" correction to the downside – as many believe – the 1999 - 2002 decline should have been five waves and the 2003 - 2007 rise should have been three waves. I don't see that as being the case. Another school of thought out there is that the 1999 - 2009 period was one big 3-3-5 "flat" correction. That holds more water with me than the "zig-zag" theory – but I'm not yet convinced of that scenario being the reality.

The way I have the chart above labeled seems to me to have merit. I will change my tune, of course, if the 1,563.92 - 1,576.09 resistance range is taken out on the upside on a monthly closing basis. Anything shy of such a breakout occurring will keep me in my current (bearish) stance.

If the S&P can follow the Russell 2000 (INDEXRUSSELL:RUT) and Russell Mid-Cap Index (INDEXRUSSELL:RMCC) to new all-time highs and take out my resistance range, I will be on the 1999 - 2009 "flat" correction bandwagon and will set my upside target for this market at 1,775 (the 138.2% Fibonacci price extension line for this (current) third wave higher).

All of that being noted, why am I still a reluctant / skeptical market participant? It's not just the read of the stock charts. It's what I'm seeing in the other asset classes as well. Let's take a look at bonds.

Treasury yields are not ripping higher as they should be given the rally this week.

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The yield on the 10-year US Treasury Note (INDEXCBOE:TNX) did bounce off of the lows late on Tuesday, but they've only rallied to the 38.2% Fibonacci retracement (of the 2/25 - 2/26 down move) line. Meanwhile, the SPDR S&P (NYSEARCA:SPY) Depository Receipts have already nearly retraced all of that down move. The bond folks just aren't buying into this stock rally – or the Fed is just that involved in the bond market. In the latter case, I would be concerned as to why the Fed is still in there messing around. What do they know that we don't (regardless of what they say in front of Congress or on CNBC)?

Emerging market bonds still lagging.

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So are we seeing any more bullish signs in other parts of the bond universe? The iShares MSCI Emerging Markets Bond ETF (NYSEARCA:EMB) remains stuck below its 14-day moving average today. I personally believe EMB can make it up to the $120.75 level and still be in a bearish overall technical posture. The fact that it has not even rallied past the 14-day average is pretty telling of the weakness overseas.

High-yield bonds have rallied, but something ominous is developing on the chart.

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The SPDR Barclays High Yield Bond ETF (NYSEARCA:JNK) has (unlike EMB) been rallying over the last several sessions – so that's good for the bulls. However, one look at the chart shows a potentially scary "head & shoulders" top formation developing. As a matter of fact, the JNK is right at the "right shoulder" resistance level as I type this article. If JNK fails to convincingly eclipse the $41.00 level, I will be operating under the assumption that the H&S formation is coming to fruition. In that case, my downside target (based on H&S measuring techniques) will be $39.66. That's not disasterous my any means, but it will be sending bearish directional messages to the rest of the risk assets.

So, the overall message from bond land right now (and yes, things can change quickly) is "risk off". Now, I want to check out the action in currencies to see if there are any bullish signals being sent from that arena.

The euro chart is setting up very bearishly for the intermediate to long-term.

The chart of the euro futures (@EC) below is busier than I would normally like it, but I have to show you several things that have already occurred, are occurring now, and that may still occur going forward. First, EC seems to have completed an "abc" upside correction at the end of January (see royal blue lines and labels). What has followed since may be the beginning of the next big wave lower, which would make the bears happy. Or, if the 1.3030 "correction" support level can hold up, maybe this is just a short-term correction lower in the euro. Much of the overall risk trade will depend on what happens at this fork in the road on the euro chart, so pay attention to the action here over the next several sessions.

Then again, even if support holds up temporarily here in the short-term, the bounce that could occur may just be a "right shoulder" of a "head & shoulders" top formation. See the obvious labels on the chart below. So what the bulls need is for EC to hold support here at 1.3030 and for EC to break and close convincingly above the 1.3321 resistance level ("shoulder" resistance and the underbelly of the broken uptrend line). If the euro futures can do both of those tasks, I'll be the first to turn more bullish. However, a failure at either / both of those could mean a decline down to 1.23000 for EC – and bad news for the risk bulls.

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The Aussie dollar is also trying to hold up above support.

The Aussie dollar futures (@AD) have traded a bit more bullishly than the euro, but not by much. AD is sitting right at key horizontal line support at 1.0190. Any breakdown there on a closing basis will likely mean that AD is headed at least down to 1.0006 – and this will spell bad news for risk bulls. For the bulls to win this battle, just as with the euro, they need not only a hold of support, but also a break above resistance at 1.0353. At this point, I wouldn't be banking on the latter occurring, though (not with the action we're seeing in China and Canada).

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The Canadian dollar is on the verge of yet another bearish technical development.

The chart below shows the Canadian dollar futures (@CD) on a daily basis going back to mid-2012. The recent trading here has been abyssmal. First, we had the September failure at the upper edge of the pennant formation. Second, we have the breakdown below the lower edge of that same pennant – strike two. Now, CD is right on the verge of breaking down below the "correction support" level at 0.9731. If that occurs, it's strike three for the Canadian dollar and the risk bulls out there will have lost this battle. Whether that translates to the Aussie and euro breaking down as well is obviously not known at this point.

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The US dollar has been ripping higher, but the bears need it to do a bit more work on the upside.

The greenback futures (@DX) have clearly been on a short-term tear to the upside thanks to the craziness going on over in Europe, and Italy in particular. I guess the globe really feels like we have our act together over here, which I find laughable. Regardless, for the bears to claim victory here, they will need the DX to break and close above 82.340. So they really need the euro to break down and the greenback to break out.

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The Japanese yen has bounced meagerly, but still may have more room to the upside in the short-term.

The Japanese yen futures (@JY) have "bounced" if you want to call it that. If there was ever a picture of a "dead cat bounce," this may be it. The Fibonacci lines tell me that the yen can and should bounce further, but will the Bank of Japan allow it to do so? A rally in the yen despite the BoJ's wishes would be quite something – for the bears. Nothing would surprise me here – so take everything you see on the yen chart with a grain of salt.

Click to enlarge

Overall for currencies, things have been bearish recently, as readers of these articles know. But the euro, Aussie dollar, and US dollar are all at important potential inflection points. A breakdown in the euro and Aussie will obviously be bad news for the risk bulls out there. On the other hand, a hold of support by either will have the bears running for cover – even more than they have over the last two days.

So what's the overall message from the markets?

Watch carefully to see what happens as stocks test their key resistance levels. At the same time, we need to monitor whether we are getting confirming messages or divergent messages from the bond and currency arenas. Right now, bonds are divergent and currencies are teetering on the fence. Stay tuned!

Twitter: @seachangereport

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