By Chris Becker
Here’s my roundup of what happened this week in major macro markets. Remember, the following views are my own, do not constitute advice and are for information purposes only. I may have positions in any or all of the below and their associated markets both long and short, on an intra-day, daily and weekly basis for my own account. Please seek advice from a licensed adviser before making any investment decisions.
A discussion earlier in the week with my colleague Greg McKenna (Deus Forex Machina) immediately focused on the CBOE Volatility Index – or VIX – which I use as my first filter for capital management decisions. Greg has mentioned the extreme low levels of the VIX before and why fund managers are discounting risk by pushing the cost of protection (via put options) down to very, very cheap levels.
Here’s the major reason why its so “cheap”, the recent Merrill-Lynch Fund Managers Survey, recently shown on Tiho Brkan’s Short Side of Long blog:
In case you’re wondering what those other peaks of hubris correspond to in risk markets and the short term thereafter, it was the largest corrections since the GFC (Euro Crisis Mk1 in early 2010, which required QE2 to rescue risk, then Euro Crisis Mk2 in early/mid 2011, requiring the ECB LTRO). Also note the troughs of despair (yes I’m reading this upside down) also correspond with the lows in short term equity values.
But like all components of speculation (or investing if you prefer the PC term), cheap doesn’t mean “buy now and miss out” – although the VIX is quite low, trending lower, and could go lower still, it is rightly in the “danger zone” as Tiho puts it. Here’s my chart with an oscillator I use below:
The chart needs some explanation, particularly those who are unfamiliar with Hyman Minsky’s theory of instability. Higher VIX equals higher perceived risk (or “risk-off”) with major equity markets and associated securities (e.g the AUD/USD, AUD/JPY, copper, gold) falling in value, and usually (but not always) the USD rising.
Lower VIX values which trend down as volatility gets lower and lower are “good” for risk – until it’s not. As Minsky has shown, periods of tranquil volatility beget high volatility, and we are seeing that now with fund inflows, a “switch” to equities from cash and bonds, and the usual hubris that the permabulls articulate as a new “permanently high plateau” (just read the major bank economists/marketing talking heads for the mainstream view here).
So I’ll end this diversion on volatility here by saying that this lower levels could actually continue lower for longer, thus pushing up risk markets even further (in the past we’ve seen risk markets go up another 10-20% from these levels before topping out dramatically), but a warning not to ignore the only truly proven theory in finance – that stability breeds instability.
Currencies and Gold
Let’s now look at the next clearest barometer of risk, the US Dollar Index (DXY). This index is made up of a basket of major currency pairs against the USD, but mainly the euro. For a while now it has been the major “risk on/risk off” indicator, with a lower USD usually meaning higher risk as US stock markets rise and push other risk assets higher, such as our own share market.
I always take a fractal view when looking at markets, even with trading hourly charts, starting with a very long term picture and then drilling down. Here’s the monthly chart going back 12 years showing each iteration of easing – both interest rate and quantitative or “QE” – and how the latest round has not been as effective in weakening the USD as in the past:
Switching to the weekly chart you can see that in comparison with QE2, where the DXY declined some 12%, QE3 is slowly becoming more “successful” as the USD slowly “wins” the currency wars. Last week I pointed out that on a weekly basis, while the DXY is below its 200 day moving average (the red line in all charts) it had found strong support at the 79 level. But that support is appearing tenuous as risk-on moves further:
Because of its composition, the general opposite of the DXY is the euro (EUR/USD). The long term monthly chart since inception of the union currency shows its overwhelming strength, although a series of lower highs since the GFC continues to find strong support at the 1.20 level against the USD and is slowly approaching the trend line (terminus around 1.40):
In my last Technicals report at Macro Investor, I noted that after its break of the year plus down trend in August this year, the euro had broken out above resistance (former support) at the 1.31 level on the weekly chart. It has continued this trend, albeit after a hiccup during the US fiscal cliff saga, but going by the monthly chart above and the inability of the DXY to capitulate should provide heavy resistance overhead:
Giving weight to that thesis is the current over-bought status on the daily chart, with a pullback to 1.32 on a more sustainable trend preferred to the current trajectory, reflecting the “foolish” bullish mood:
Instead of Yen this week, I want to have a look at the AUD – and not just the “battler” (AUDUSD) but some of the other crosses. First, here’s the battler longer term chart for some perspective, with a series of declining highs since mid-2011, but a bullish sideways mood for now:
And the daily chart below (Note: I do not trade the AUDUSD, for a variety of reasons) where the sideways bullish condition (prices above the 200 day moving average, which is slowly rising) evident. Not a time to short just yet for the bears (or for the bulls to gloat):
But’s here’s something more interesting. The Kiwi is bashing the Aussie! Not good for those of us who like to travel/spend in NZ, and neither is it good for their trans-Tasman trade. Here’s the weekly chart of the AUDNZD, where the uptrend from the GFC (more of a rounding top, if you look through even the weekly volatility) has reversed, with a possible target at 1.19 or even – shut – parity!
But beyond the ANZAC connection is the worrying correlation with a similar pattern that preceded the 2001-2003 bear market:
The euro is also strengthening against the Aussie which is good news for our exporters (what’s left of them that is) . But is this the start of the repatriation of “safe” money from the Australian safe harbour? Or something else?
I’ll finish the currency section with the undollar currency, gold (USD).The main precious metal (I also trade silver, but palladium and platinum also as since the correlations are not as close) continues to confound the gold bugs and bears alike.
The medium term frustration can be seen on the weekly chart, with a sideways move for nearly 18 months with resistance at $1800 and support at $1560 per ounce providing the boundaries amongs some big daily and weekly moves:
But the short term position remains bearish with August’s breakout nearly reversed as a series of lower highs and an inability to translate monetary fear – and USD weakness – into reality. A short-term move above $1695 an ounce may excite some if USD breaks support more cleanly, but for now, I remain short:
Bonds, Credit Markets and Housing
After currencies, the next market to watch is debt, which includes both credit markets and housing. This week I’ll only look at the 10-year US Treasury note (TNX) but I will update my technical charts on Australian house prices soon.
It must be remembered that T-notes are in a secular bull market (lower yields mean higher bond prices), but move with the cycles of risk, just like the US Dollar Index (note the chart below is linear scale):
I said last week that now could be the time for the permabond bears to get excited? The medium term weekly chart has indicated a possible large scale reversal under way from late last year, with a bullish falling wedge pattern now completed in the affirmative with a breakout above resistance at 1.84:
A move up to 2.4% means many things – I’ll leave it to the macro pundits to work out what could happen next – but with the weight of US deficits and endless bond buying by the Fed (and a certain Japanese precedent), the probability of further rises are low (note how yields rolled over at the end of QE2).
For newcomers, there’s three major commodities to watch – crude oil, copper and iron ore. I’ll leave the last to Houses and Holes (it’s non tradeable for retail/private investors anyhow – although FMG/AGO are excellent proxies), but crude oil is a great barometer displaying both demand and US Dollar weakness.
There are two markers in crude, Brent and WTI. This week I’ll look at ICE Brent Crude, with the weekly chart of the spot price providing some key context:
Prices are now moving higher on the weekly chart, a rounding bottom pattern established at $106 per barrel, as seen better on the daily chart with the spot price now above the 200 day moving average. I’m long here on my weekly system, but resistance overhead at $117 USD per barrel does not shape up for a high risk/reward:
Copper is the other significant marker that is facing more resistance from overhead than Brent. Indeed WTI Crude has a more similar pattern to copper than its heavier brother. Dr Copper is behaving weak overall compared to the significant move during QE2, but a series of higher lows with rising support from June last year is mirrored with lower highs, showing an equilibrium of sorts in the medium term:
On a shorter time frame the metal remains volatile as seen on the daily chart, where the reversal of the August breakout last year has been completed as it looks like spot price has broken above the 8100 key level. I have no position here (copper is one of my less successful securities to trade!) but am watching closely, particularly that upper trend line. But again this all goes back to the US Dollar Index (DXY):
Again, I’m going to look at three stock markets this week – the NASDAQ 100, the US S&P500 and our own, the ASX200.
The NASDAQ is interesting for several reasons, least of all Apple’s (AAPL) fall from grace (if ever there was a case for why capital management matters in “investing” in tech stocks…). Unlike the S&P500, German DAX, Hang Seng, Nikkei, it has a bearish outlook.
The weekly chart below shows a classic bearish reversal head and shoulders pattern forming, with the right hand shoulder forming now just below 2800 points:
The setup here is easy: the pattern fails in the short term if it breaks above the top horizontal line (but is then open to a possible double top pattern if it can’t breach the “head” level), but succeeds if it goes no further, then breaking below the “neckline” (the other horizontal line just above 2400 points) and its trend line from the pre-QE2 lows. The NASDAQ is a risk mover, not follower (usually), so this would not bode well for other bourses.
Here’s the monthly chart of the S&P500 index since The Great Recession. Each uptick in prices has largely been because of monetary intervention, with QE3 finally pushing it above pre-Lehman crisis levels. The historic pre-GFC high at 1550 points has always been my target, but I’ve been surprised – post fiscal cliff frivolity- with the speedy moves so far in the new year.
The weekly chart shows how the series of higher highs is smaller on each up cycle and a bearish rising wedge pattern (similar to pre-GFC) continues to form, but each fall has been a dip exciting the bears (to their chagrin) and enticing the bulls to take prices higher. But can this continue?
My main concern is that this price movement – another Minsky stability/instability paradox – is precisely the type of last hurrah moves we see at the end of bull markets. Don’t let the pundits fool you with “another grand bull market” – we are still in a secular bear market (six years for ASX200, 13 years for SP500).
But when in Rome! Just watch for a break of support at 1470 points, and then again at 1380 points – for now the target remains at 1550:
We finally get to the S&P/ASX200 index now in a cyclical bull market amid its secular bear market and faces its biggest test as January closes out the month just below my original target of 4900 points on the monthly chart. Note these key levels carefully at 3900-4000 (strong support), 4400 (intermediate resistance and the outer edge of the index’s real value), 4900-5000 (strong resistance) and 6900 (the former high of the 2003-2007 bubble).
There’s a lot to look at in the weekly chart – but most important that this has been a financials led rally – i.e Megabank (in green – over 42% of the ASX200) which is nearly at its 2009 highs (before a premature rate tightening took the winds out its sails in 2010). The RBA rate cuts, a Chinese rally and the weakening Yen (note the correlation between AUD/JPY and the ASX200) have all helped pushed the bourse up, but in my mind, too far too fast. Note the actual trend line trajectory, which allows for a correction ahead:
A correction back to 4600 points would provide greater strength for a rally to break through 5000 points and further this year, but as I said last year, it will take the materials sector to provide that push, as financials are extremely over-bought. Industrials (which are now outperforming financials in the last 4 months) can also help here as the AUD falters against the majors, helping what’s left of our export industry.
As you can see in the chart above, the Hang Seng China Enterprise Index (HSCEI) is leading the ASX200 Materials, now above its early 2012 highs, unlike the latter which is approaching resistance, former support just below 11000 points.
Going into mid-year reporting season next week, we will see if the industrials are worth their price, the financials can continue to breathe profits out of thin air and if materials can catch up to the Chinese and Japanese equity surges. February and March are going to be fascinating for the local bourse!
That’s all, see you next week.