Risk diverges from Macro

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Good news for a change in risk markets over the past 24 hours. The Shanghai Composite index is up well north of 5% in the past two days, European bourses were up 2 and 3% the US markets are a more circumspect half to one percent, the Australian Dollar is back above 1.03 and things like iron ore 12 month forwards are positive once again.

The key to the next phase of this rally is likely that it is a surprise to most and that, for me at least, sets up the potential for further positive moves in coming days and weeks.

How can this be if it’s still all doom and gloom out there in the global economy and the Australian economy still looks weak?

While I was away I formed the view that there was a real chance that 2012 saw a divergence between economics and markets, particularly risk assets, in the first half of 2012. The reason I thought that was possible was not only cyclical – the first few months of the year seem to consistently be the best performing parts – but also because I thought that traders and investors had probably built up a tolerance to all the bad news from 2011.

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The world didn’t end last year, the Euro didn’t implode, markets were certainly in a funk but they stepped back from the precipice and even regained all of their selloff (for most markets anyway) in that terrible period in the middle third of 2011. So I figured that if it can’t go down it must go up.

Not terrible insightful analysis but rather a product of my experience and market history.

Indeed market history (as told by the guys from the Stock Trader’s Almanac in the US) is really positive for a rally in 2012 after the positive start to the year. They said just yesterday that,

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The last 39 up First Five Days were followed by full-year gains 33 times for an 84.6% accuracy ratio and a 13.6% average gain in all 39 years. In presidential election years this indicator has a solid record. In the last 15 presidential election years, 13 full years followed the direction of the First Five Days.

But the weak economic outlook remains even though it won’t be viewed in every single economic release. So we could see a de-coupling between economic outcomes and market performance particularly should quantitative easing recommence in the US, Europe and the UK. Good news for a change.

Here is a look at some of the market price action:

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Shanghai – looks to me like it is still in a bear trend and needs to decisively break up through 2390 to push higher. Positive short term nonetheless.

S&P 500 – last night’s close was right on the high from last October and above a resistance zone (green line) I identified last year that I thought was important.

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CRB – I mentioned yesterday that I’d be watching the CRB for signs of a turn in the outlook for risk assets more broadly and this chart suggests it has broken the downtrend from the start of the market ructions in April 2011.

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AUD – not broken yet and hasn’t been above the 200 day moving average at 1.0415 since November last year. this is the critical level for the AUD/USD outlook. A failure would signal a retracement but like Iron ore below the AUD is forming a wedge for a breakout. 1.0415 is the key upside resistance.

Iron Ore – moving higher, broken wedge time for a run north by the looks of things.

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The USD is trying to breakout and the EUR is trying to break down. This relationship is important for many commodity and currency markets because the USD is the other side of the pair and if the USD does move higher then it is possible that commodities and so-called commodity currencies underperform equities for a little while. Time will tell.

www.twitter.com/gregorymckenna

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Please remember these are not recommendations for you to trade these are my views and I have my risk management tools and risk parameters that you do not have access to. Thus, this blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.