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Currencies Raise a Red Flag; Is It Time for a Pause in the Stock Rally?

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Although currency charts are the number-one concern right now, even bonds may be foretelling a pause in the rally in risk assets.

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Basically, we're seeing a bull market condition in equities, but none of the other asset classes are confirming this action fully. Even with the stock charts, we're seeing great technical positions, but very poor reward / risk ratios for new market entrants. I'm sure everyone would agree that a pullback in stocks would be healthy and welcome at this point.

STOCKS

US large caps remain bullish – even in their consolidation.



The US large cap space – represented above by the S&P 500 (INDEXSP:.INX) -- looks like it is just about at its next projected upside target range of 1,640.69 to 1,646.26 (it finished Monday at 1,633.77 -- less than 1% away from the target). It is clearly in a strong technical position – which makes short-selling against this market a risky proposition. However, having higher-than-normal levels of cash on hand at this point may not be the worst strategy in the world. My current call is for a pullback to occur after resistance is tested. The pullback could theoretically take the S&P back to the November lows, but I wouldn't bet on that happening at this point. The chart above shows the possible pullback targets for the S&P: 1,530, 1,495, and 1,459 (and 1,350 as mentioned).

BONDS

Treasury yields finally have acted as they should in a "normal" market environment. Will that continue?



The yield on the 10-year Treasury Note has risen almost parabolically over the last week and a half. It has bounced right up to the "correction resistance" at 1.928% -- which also corresponds nicely with the 61.8% retracement of the March to May decline in yields. With the Williams %R reading giving an overbought signal right now, it would certainly appear that yields should decline from here. If the wave count on the chart is correct, we should see new lows in yields set on this next decline. That type of action would almost certainly coincide with a decline in risk assets in the short-term.

High yield debt is on the rise, confirming the bullish action in stocks recently.



The Columbia High Yield Bond Fund (MUTF:INEAX) is shown as a proxy for high yield debt in the monthly chart above. Based on my analysis of this chart, it would appear to me that there's much move upside still to come for junk bond prices. With the price currently at $3.08, a rise to the ultimate upside target of $3.63 represents very nice upside potential for this category of bonds in general (and for this fund in particular). Still, though, if there is to be a short-term pullback in risk assets, perhaps you may be able to buy junk bonds a little cheaper in the near future.

Emerging markets fixed income prices are also on the rise and indicate a possible intermediate-term "risk-on" bias.



The iShares Emerging Market Bond ETF (NYSEARCA:EMB) has struggled since late last year -- which was an accurate reflection of the distrust investors have had in emerging market assets in general. Based on the view of the chart above, that weakness may have just been a consolidation wave (iv of 5) leading up to one more rally (wave v of 5) with an upside target of $130.07 (from $119.77 recently). I would be looking to buy into EMB on a further pullback to the uptrend line at around $118 with a stop in place on any close below $117.05.

German Bund Yields

The yield on the 2-year German bund has bounced off of a short-term low of .01%, but it is not exactly setting the world on fire to the upside. I cannot give any real edge to the bulls in this instance.


CURRENCIES

US dollar is in no-man's-land in terms of new entries.



Prognosticating on the short-term movements of the US dollar has been a tough task recently as there have been major cross-currents emanating from the actions of the global central bankers. Both the yen and the euro are major influences on the greenback. The yen is in a historic slide versus almost every currency out there and the euro is oscillating between hopeful strength and more realistic weakness. That has the US Dollar Index (shown above on a monthly chart) stuck in the middle of no-man's-land on a long-term basis. Risk bears out there need to see the DXY take out the long-term downtrend line at about 87 for their macro theses to come to fruition. The risk bulls, on the other hand, need to see the long-term uptrend line broken on a monthly closing basis to be able to claim victory. That level would come in at around 75. So, there's plenty of room in either direction before we would even know who won and who lost this battle. Let's look to some of the other currencies for better clues.

Japanese yen has further to go on the downside before a serious bounce could occur.



The Japanese yen's trip down the ski slope (see the chart above) has been one of the big catalysts for the bullish tone of the equity markets recently. How long will it continue to fall? Well, based on the idea that wave "v" should roughly match wave "i" in magnitude, there still is a little room left for the yen to fall. At this point, I'm calling for a pretty substantial bounce in the yen to begin at or around 0.9618 (the yen closed Monday at 0.9824). There's plenty of downside momentum in the yen right now, though – so be careful about positions size with any bullish yen bets you'd make near 0.9618.

Krona vs. franc indicator breaking the downtrend line – not a deal-breaker for the bears, though.



My firm's proprietary krona / franc indicator is showing potential signs of life (for the bulls). The problem is that we've seen false bullish signals from this indicator before. Notice in the middle of the chart above the downtrend line and arrows which highlight a couple of times when there were false positives from this indicator. Only when a strong re-test of the broken downtrend line occurred was it safe to call it a victory for the bulls. So, as we look to the right side of the chart, we will want to see a successful re-test of the broken downtrend line before I can call it a victory for the bulls. Until then, I'm still inclined to view this indicator as neutral / bearish.



Euro headed lower in the very short-term; direction after that is less clear.



One of the "risk" currencies my firm follows, the euro, is acting less than bullish right now. The chart above shows a potentially very bearish "head & shoulders" top formation developing for the euro futures. There is a chance that the euro has already made the right shoulder top, in fact. However, there's also still a chance that we see the euro make one more shot to the upside (following a little more downside in the very short term. Such upside would be wave "c" of an "abc" correction to the upside -- but there's nothing to rule out that the "right shoulder" peak was already made (at the 1.3215 level on the chart). Overall, this chart cannot be viewed as encouraging for the bulls.

Aussie dollar is breaking down – a bad confirmation / sign for commodities.



The Australian dollar futures only wish they could be classified as "less than bullish" as the euro was in my comments above. After trying to break out above a long-term rising wedge formation, it appears that the Aussie dollar has succeeded in breaking down below the lower edge of that same formation. Not only was that lower edge violated, but the 100% "correction support" level of 0.9973 was taken out as well. That breach further opened up the potential for much more downside to come (in my opinion). This chart, like the euro's chart above, is not good news for the bulls.

Canadian dollar may be setting up for a big fall, catching up with the Aussie dollar on the downside.



The Canadian dollar futures chart is shown above on a daily basis going back to late 2011. It appears to me that the CD futures just completed a short-term "abc" correction to the upside and that the next move should be a "doozy" to the downside. The best case for CD is for a move down to 0.9480 from 0.9879 currently. The more likely scenario would have CD falling all the way down to 0.9292 or 0.9175 for this move (wave "iii"). This, like the other risk currencies, is an ugly chart for the risk bulls to contemplate.

OVERALL

The miserable action in the "stuff" currencies (Aussie and Canadian dollars) has me fairly concerned about things globally. It's hard to believe that the reflation efforts being undertaken by the global central bankers are succeeding when I see those two currencies acting as they are. What will happen if money starts flowing back into the yen once support is tested? That is absolutely something to keep in mind. Bonds are more bullish than currencies at this point, but even Treasuries may be setting things up for a short-term pullback / correction in risk assets.

My firm's long-term portfolios remain unchanged -- fully invested. However, around that "core" portfolio, we are sprinkling in some hedging strategies to buffer the downside of the anticipated pullback.

Twitter: @seachangereport

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