Technicals point down

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In today’s charting post, I’ll cover some of the key markets to explain the context of last night’s breakdown in risk and possibly where we are heading.

Currencies
The AUD/JPY cross is closely correlated with the S&P/ASX200 and begins my analysis. This 18 month daily chart explains what has happened to the Yen from before the “first” European crisis back in May 2010, QE2 and the resultant crack-up rally, the dreadful tsunami in March and of course the recent de-risking.


The Yen has rolled over and is nearing the tsunami low again and is heading for target level of 76 – the mid point of volatility from May to September 2010.


Going to a longer term chart, incorporating the GFC low, bullish traders are expecting a similar pattern to repeat itself with a trading range between 76 and 80 (the right hand orange bars) as for last year, on expectation of “milkie wilkies” or QE3.

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If this is not forthcoming, the next target is 70 and then quickly 60. This equates to approx. 3500 then 3100 points on the ASX200.

EUR/USD is the most important currency to watch now and this very simple short term chart below explains it all.


The Euro has formed a reversal descending triangle pattern – in non-tea leaf reading terms it means it has likely hit a top, is slowly losing validity, but support is coming in to buy at what is perceived “value” at approx. 1.40 USD. A break below this level is critical.

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A longer term view of the Euro puts the current ruction in context with a rectangle pattern at the top of the GFC, pre-Lehman, a head and shoulders foretelling the Greek crisis of May 2010 and the descending triangle of now. Overall a triple top has formed, with lower highs. This all adds up to a bearish stance, with a terminal target near parity of 1.20, seen just before QE2 last year.

Which brings me to the US Dollar Index, which is acting how I (and countless other traders and institutions) expected, but its short term pattern is intriguing.


The current pattern since mid April – the end of the risk rally worldwide – has morphed from a reversal rectangle or flat base (formed between support at 73 and resistance at 76, as zero-risk bulls and hyperbears battle it out) into a descending triangle or pennant pattern.

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A break below 73.5 would foretell a run away from the USD and could explain why gold – usually in a corrective phase during risk-off conditions – is now moving to new historic highs.


But looking at the more important long term charts, note how a run to the USD (i.e risk off) results in a new lower high until a QE event is launched. The reversal patterns at these bottoms are clearer than the current version and is likely to be repeated.

US Bonds
The harbinger of deflation – super low bond yields – is bearing down on the US. Here is the short term chart of the US 10 year Treasury Note, which dropped to an intra-day low of 1.97%, closing at just above 2% yield.

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The T-note has closed below the pre QE2 level and as I evaluated earlier in this weekly chart, is on track to close below the GFC low in December 2008.


Remember, the flow of investable assets around the world moves from risk to (perceived) zero-risk, or from shares, non-USD currencies and commodities to USD and T-notes and T-bills.

Equity Indices
Let’s look at stocks – mainly I want to focus on the Dow Jones and an explanation of where we are and a controversial expose of where we might be heading.

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click to enlarge

This chart illustrates the rhyming that is occurring in markets today. The top of the artificial 2007 stock market boom – the red uptrend line – formed a pennant before rolling over in early 2008. A relief or rebound rally attempted to restart the boom as bad data pointing to a recession was absorbed, spun, spruiked and rejected by the market as the Dow moved into the northern summer, breaking down into a normal bear market.

Before the collapse of Lehman Brothers, the Dow was in a trading range (horizontal orange lines), ready to deflate slowly over time (1-3 years usually – note the direction of the lower red trendlines as the market should have deflated).

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However, the failure of Lehman lead to two major perversions of this trend. First, a liquidity crisis caused all risk markets to implode (when they didn’t need to), which then second, caused central banks to inflate via monetary stimulus (QE etc).

Now what are we experiencing?

  • the end of an articifial stock market boom (no different to the 2003-07 fake boom)
  • a rollover in the form of a pennant
  • a relief/rebound rally in an attempt to restart
  • data showing recession in the US (and Europe)
  • a possible and avoidable liquidity crisis (this time in Europe – the Marx Brothers?)

I’ve marked on the chart the zone where the likely action for a new artificial support of the market would take place – a band between 10000 and 11000 points on the Dow, before QE3 (or ECB QE/bond selling) re-commences.

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However, what is as likely is a return to the natural level on the Dow – some 20-30% below at approx. 8000 points as the new recession in the US is priced in. How we get there is now up to the policy “leaders” (sic) who must accept the fundamentals that were glossed over 3 years ago and have lead to this market volatility.