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Risk-On / Risk-Off Be Gone! More Targeted Trading and Investing May Be the Way to Play for Now

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MINYANVILLE ORIGINAL The lack of uniformity in the movements of various parts of the markets recently could be taken as a one thing not confirming the other.  Or it may just be a situation where more targeted investing in what’s working and avoiding what’s not is back en vogue.  We must be ready for either reality. 

The Aussie dollar was rapidly approaching key resistance heading into today.

My key gauge of risk appetite in the currency markets, the Aussie dollar / Japanese yen currency cross (AUDJPY), had a huge day Friday and gapped up on Sunday night bringing the cross very close to the maximum upside target for this up move (wave iv in my opinion).  That target comes in at 82.653 and closely corresponds with the 100% Fibonacci price projection line at 82.940 for what appears to me to be an “abc” correction. 

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If 82.653 is conquered on the upside, it will signal to me that something more serious to the upside is brewing under the surface.  Until that happens, we have to be ready for a wave v move lower that should take the AUDJPY back down to the June 1 lows and possibly even down to 74.069. 

Although the action Friday and Sunday was impressive, the reaction to the weaker-than-expected ISM number here in the US sent the AUDJPY down sharply.  However, as the chart below shows, the decline merely brought the AUDJPY down to a projected support area (for wave (iv)) and has not lessened the likelihood of one more try for the upside targets. 

Take another look at the chart below -- using the Elliott Wave principle of “5 = 1” where the fifth wave in a sequence will roughly match the first wave in a sequence, I came up with an upside target for wave “v” & iv of 82.395.  So, with the three possible upside targets given from the two AUDJPY charts, we have an upside target range of 82.395 to 82.940.  With the AUDJPY trading at around 81.30 as of 12:20 p.m. Monday, that gives bullish traders a potential 1000 to 1600 pip move to try to catch with support at 81.142 – a pretty good upside / downside ratio for the trade. 

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The Aussie dollar has also been trading well versus the US dollar over the last month or so.  The daily chart of the AUDUSD is shown below.  The corrective rally since June 1 appears as if it may have run its course.  If this upside is actually something more than a corrective rally, then the 1.02477 level will be taken out to the upside.  As long as it isn’t taken out (on a closing basis), the correction theory for the AUDUSD is still viable and likely. 

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Rates on the 10-year Treasury are testing support.

There was a lack of convincing movement to the upside in Treasury rates on Friday – even as stocks and the risk commodities were ripping higher.  You know what they say about the folks in the bond market – they’re usually the smartest ones in the room.  Well, today’s ISM numbers validated the opinion of anyone who was stubbornly cautious Friday. 

The action thus far today is as one would expect with rates headed lower in response to the ISM number.  However, I will point out that rates have not yet – and will not unless they close below 1.564% – broken technical support.  I’ve been operating under the assumption that Treasury yields will at least head up to 1.809% and possibly even higher.  The only way I can see that happening is if risk assets continue to rally.  We are seeing that in several parts of the equity market – like mid, small and micro-cap stocks.  However, I for one will want to see the Aussie currencies breaking out above the nearby resistance levels as confirmation of the bullish action in equities. 

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While emerging markets equities have yet to light things up for the bulls, emerging markets debt is attracting money flows.

Sometimes, it helps to pay attention to parts of the bond market for more clues as to how global players are thinking about risk.  The chart below shows the iShares JPMorgan Emerging Market Bond ETF (EMB).  I’ve shown this chart before to highlight the fund’s behavior around the 14-day moving average (green line). 

Clearly, by observing the green circles, you can see that the EMB is typically in bull mode when trading above the 14-day average.  It tends to hold that support level over and over again as long as things are good in risk land. 

Well, it broke out above that resistance line in early June and just re-tested it successfully last week.  Based on the Fibonacci extension lines shown on the chart, EMB has room to run still.  Since EMB has already taken out the May peak, this move is likely not corrective in nature.  Assuming that’s the case, then the nearest Fibonacci target for EMB is 116.66 with 117.53 just above that level.  So far, I’m not seeing unbridled enthusiasm for emerging markets equities.  However, this chart of EMB tells me that emerging markets aren’t dead; it’s just that global players are looking at other ways of participating besides the stocks in those markets.

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The bulls have some seeds of hope planted and some sprouts are starting to appear in the form of bullish action in certain markets (EMB, mid, small and micro-cap stocks).  However, we’re not yet seeing strong confirmation of that bullishness from other asset classes (lack of breakout in Aussie currencies) and even from some other parts of the same asset classes (bullish EMB vs. stubbornly low Treasury yields; smaller cap US stocks vs. larger cap US stocks).

For now, the habit we’ve all gotten into of playing the “risk on” or “risk off” trade may not be the ideal way to look at things.  It seems to me that rather than going all into or all out of risk, it would be better to be long of what’s working (IWC, IWM, IWR, and EMB for example) and underweight what’s not working / leading (SPY, QQQ, and EEM were mentioned here today). 

Whichever way you choose to play things, do so while observing proper risk controls and discipline.  As Todd-O shares so frequently, you can try anything as long as your risk is defined and your stops are honored (forgive me for paraphrasing there).
Before I wrap up, here’s a check up on the key European sovereign debt yields:

This is getting to be routine now -- two of the three European sovereign debt yields I follow go down for the week while one spikes.  It seems to happen every week, but the countries take turns in terms of who’s in the soup for the week.  This week, Spain and Italy have seen their yields tumble (good for them) while Portugal has seen the cost of its debt move back up above 10%.  Why would Portugal’s yields spike when all of Europe is trying to put their best dovish foot forward regarding sovereign debt problems?  Maybe I’m overreacting to what amounts to a small move in interest rates there in Portugal.  We’ll know more by watching for a continuation of that higher rate trend. 

That’s it for now!  Have a great week!

Twitter: @tttechnalytics

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POSITION:  No positions in stocks mentioned.