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Risk Assets Bounce After Last Week's Breakdowns (Sonny's Giving You the Chance to Leave On Your Own)


Bounces following breakdowns typically should be sold into, just don't overstay your welcome.

Just as with Sonny and the bikers in the great film A Bronx Tale, the market gods may be giving those overexposed on the long side of risk (the bar – in the movie) a chance to lighten up on positions and raise cash (walk out of the bar voluntarily). Remember what happened next in the movie? The bikers acted foolishly by spraying the bartender with beer and acting rudely towards Sonny. Sonny follows by telling the bikers "Now yous can't leave." Click here for this classic scene.

I've been down this road with the market many times. Yes, there are a few instances where breakdowns below support aren't followed up with more downside, but those are typically the exception rather than the rule. Unless you've got a very long time horizon and are willing to stomach the 5% - 10% declines that occur from time to time, warning signs like these are to be respected.

Let's take a look at how things are looking right now:

The yield on the 10-year US Treasury Note broke my support from last week – time to re-evaluate things.

Click to enlarge

I certainly didn't foresee the breakdown in yields on the Treasury curve that has occurred over the last week. I thought for sure that either 2.145% or 2.087% would have held up as support.

Since both of those levels were broken rather easily as money flowed out of risk and into safety, we must re-evaluate what's going on with this chart.

A monthly chart of the 10-year Treasury Note yield is shown above. There are a couple of things to notice:
  • Yields are at or near all-time lows – lower than the 2003 recession bottom, lower than the 2008 - 2009 crisis bottom, and lower than the 2010 "Flash Crash" bottom. Given that our deficits are at all-time highs and that rates should be moving higher logically, what does the fact that yields are this low tell us about the severity of the issues percolating over in Europe? I'm thinking we haven't seen all there is to see with that mess over there.
  • While I'm less certain about where the TNX is on the long-term wave count, I'm fairly certain that we're seeing the beginnings of a wave 5 lower in the short-term that should take yields down to around 1.5%.

The high yield bond ETF (JNK) broke its "dual" support and is catching a bounce in the short-term.

Click to enlarge

The SPDR Barclays High Yield Bond ETF (JNK) easily sliced through both its uptrend line support and 100% Fibonacci price projection support mentioned here last week.

The updated daily chart of JNK is shown above. I've counted out the waves on the chart and am thinking that the current upside is wave [iv] (higher) of wave iii (lower). The max upside for wave [iv] is the lowest close of wave [i] which comes in at $39.41.

The downside target for wave [v] and iii will be the 161.8% Fibonacci price projection line at $38.33. From there we'll likely see another upside correction / consolidation.

Notice also that JNK has resistance just ahead in the form of the underbelly of the broken uptrend line.

So while risk assets may be rallying / bouncing in the short-term, JNK is indicating that it is nothing more than a bounce and that there's more downside to come before the larger correction lower is finished.

Emerging markets bonds can re-take a bullish posture if current levels hold into the close today

Click to enlarge

  • The iShares JP Morgan US Dollar Emerging Markets Bond ETF (EMB) also broke and closed below the support I identified last week (again, it was an uptrend line and the 100% Fibonacci line).
  • The EMB is failing to give me any reliable wave counts off of which to base decisions right now. This happens from time to time in less liquid markets / securities. When the waves aren't helping me out in terms of giving me a backdrop for other chart analysis techniques, I move right to the rest of the tools in the toolbox.
  • The chart above shows the EMB on a daily basis going back to late 2011. Take quick notice of the break of the uptrend line that occurred over the last week. Notice also that EMB is on the verge of re-taking that trend line. That would be a nice short-term win for the bulls if that action sticks into the close today (or on a closing basis at any point in the near term).
  • I've also overlaid a couple of moving average lines (the 14-day and the 300-day) which have acted as good support and/or resistance in the short- and long-term respectively.
  • Notice that the 14-day has recently been a good average off of which to key for buy / sell decisions (see the circles). Notice also that as of early this afternoon EMB is making a bid to re-take the 14-day average on the upside. EMB re-taking the bullish posture above both the broken uptrend line and the 14-day moving average line would be an interesting bullish sign. I would love to see confirmation from some of the other indicators I follow.

The Aussie / Yen cross is bouncing after a breakdown of its own

Click to enlarge

The Australian Dollar / Japanese Yen currency cross (AUDJPY) is one of my favorite gauges of the global appetite for risk. The chart above shows the AUDJPY on a daily basis going back to late 2011.

First of all, the AUDJPY broke and closed below the 100% Fibonacci price projection line (which was at 83.951) convincingly. That doesn't happen if a corrective move is finishing up. The fact that the Fibonacci "correction" line was broken almost invariably means that there's more to the correction to come.

So the labels in bright red that would have read a, b and c now read i, ii, iii and iv. It looks to me that wave iii finished up over the last couple of days and that the corrective wave iv is under way. How high wave iv goes is anybody's guess, but the maximum upside (if the wave count is accurate) is 85.745.

Meanwhile the downside target for wave v – once it commences – will be somewhere around the low that was put in the other day (at around 82.700). So, right now, there's not a great upside / downside ratio working for either side.

I think the play here is to wait to see how high wave iv takes AUDJPY. If it stalls out here and moves down to support, then buying at those levels would be a lower-risk entry. If it moves up to near 85.745 before this upside is done, then selling / shorting would be the "lower-risk" entry.

That last strategy may accurately sum up where we should be with respect to all risk assets. Assume that there's more downside to come, but don't sell short just yet. Don't overstay your welcome on the long side either, though, or ol' Sonny will end up telling you, "Now yous can't leave."

Twitter: @tttechnalytics

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