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Weekly Preview: Nov. 8-12

November 7, 2010 Leave a comment

Equities:

Heading into last week, despite bubbling optimism for stocks, consensus had grown widespread amongst market participants, even in the bull camp, that profit taking would set in once the FOMC outlined their intentions for QE2 (sell-the-news). Indeed, thus far, this has not been the case. Financial stocks have benefited the most, shooting up over 5.5% during the two days following the meeting. The size of the LSAP program was within market expectations, however, the average maturity of the new purchases was not. The average maturity will be between five and six years; thus putting the curve steepening trade back in play, helping boost bank's profitability.

At some point this week I expect weakness to develop in the 'risk trade'.  I am by no means calling for THE top to take place, but risk appears to be strongly favoring a pullback. On two prior occasions during the month of October I anticipated a pullback in equities, but to no avail. This time, however, the market is demonstrating signs of "blowing-off" with the most recent surge appearing to be coming from capitulating bears and panicky bulls. The S&P may hold below the top-side of the multi-week rising channel, providing a backstop for bearish bets. Once markets pullback, we can access the damage and get a better idea as to whether the pullback is the beginning of a larger reversal or simply a healthy correction.


Es

Commodities:

Commodities have been the hottest game in town. Both industrial and precious metals have been racking up huge gains while agricultural sectors have been acting simply outrageous. Cotton and Sugar have been leading the speculative frenzy with price charts bending back to the left – registering multi-month percentage gains in the triple digits. For those with the intestinal fortitude, a high yielding short set-up is in the making.

In the months to follow, it will be interesting to see how much of an impact the rising cost of raw materials will have on profit margins. To what extent will businesses be able to pass through rising cost to a consumer stuck in a balance sheet recession? This will be, to say the least, an important development to pay to attention to. If the economy can take the torch from the Fed and grow on its own, then this may turn out to be a non-issue, however; if the economy continues to muddle along then an unintended consequence of QE2, squeeze on profit margins, could rear its ugly head. As they say – only time will tell.

Currencies:

On Friday the Dollar Index (DXY) bounced off a long-term trend-line. My bias since mid-October, based on historically extreme pessimism, has been that the downtrend in the Dollar is closing in on a reversal, however, price action — the final arbiter — has yet to cooperate. From a pure risk/reward viewpoint, establishing a long position off the long-term trend-line makes a lot of sense; regardless of the outcome. Presently, I am leaning towards short positions in EURUSD, GBPUSD, and long positions in USDCHF, and possibly USDJPY. I will follow up with more details surrounding these pairs as the action unfolds.


Dollar

Interest Rates:

I don't see a particularly strong edge in making any moves against the short to intermediate term maturities, however, a rally in rates would be consistent with the before mentioned biases. The 30-year could become an interesting trade in light of the fact that the Fed isn't going to be focusing their purchases on the long end of the curve. A bearish topping pattern is in the cards for the 30-yr futures (US) which will further support this idea.

Bottom Line:

Dollar bullish trades look to hold very favorable risk/reward opportunities as long as the long-term trend line holds. In addition, purchasing puts in Index ETF's, considering how inexpensive volatility is, looks like a solid risk/reward play off the upper band of the rising channel. Also, on the radar are a pair of short set-ups in individual equity names –NFLX, LVS — click here for the NFLX trade outlined late last week, and check out the chart below for details regarding LVS.

 

Lvs

 

 


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AUDUSD, Emerging Markets – The Correlation Is Striking!

November 2, 2010 Leave a comment

Since the global reflation trade began back in March of 2009, the synergy of 'everything-is-macro' and hedge fund herding has on one hand made analyzing multiple asset classes simpler by creating the –'risk-on','risk-off' trade– but at the same time it has made portfolio diversification, on the Macro level, more difficult. Below, is a great example of this "all-the-same-markets" theme at work. The correlation between the Emerging Markets ETF (EEM) and the Aussie (AUDUSD) is striking.

In the graph below, 20-day correlation, as represented in the lower pane, has ranged between 20-90% since March of 2009. Statistically, this is a pretty sound correlation factor; basically you could express your view about one market in the other, and still have the same outcome. Now only if determining the direction was as simple!

Fxa vs eem

FX Land – A Look At The Technical Landscape

October 31, 2010 Leave a comment

Consensus is growing that the 'risk-on trade' has gotten ahead of itself in anticipation of another round of QE; setting up a "buy the rumor, sell the news" scenario. This looks very possible due to the excessive bullish sentiment across most asset classes reaching thresholds often seen prior to a reversal.

Over the course of the past two weeks the Dollar has showed signs of stabilizing, which could be confirmed if market participants take off risk after the Fed's announcement, however; the pause in downward momentum could be just that – a pause (consolidation). If the result after the pause is another thrust lower, provided how heavily everyone is betting against the Dollar, it would seem likely such a move would be the final leg before finding a meaningful bottom.

EURUSD – There is potential for a 4th-wave triangle, and a breakout of a fully developed pattern could take the Euro up to a very important downtrend line extending back to the peak in 2008. If the 4th-wave triangle comes to fruition, in accordance to Elliot Wave Principle, the thrust higher will represent the fifth, and ultimately, the final leg up since the June low. It would also satisfy an a-b-c corrective pattern. However, before reaching that conclusion, we must remain flexible; allowing for the possiblity that we have already seen the peak of the rally with ther recent high representing the end of a C wave. This week is likely to go a long ways towards validating either scenario.

  Eurusd

GBPUSD – Currently this pair is testing a 16-month trend-line extending back to August of 2009, after bouncing sharply last week off the 50-day SMA/EMA and a 5-month uptrend line.The two trend-lines are quickly converging on one another, and thus put Sterling in a make or break situation. A 3-month triangle is also in the works with the apex falling near the convergence of the two before mentioned trend-lines.

Gbpusd
AUDUSD – The Aussie broke a steep channel back on 10/19 after being rejected at the key psychological level of parity, but since then has become rangebound. At this juncture, it is unclear as to whether this will turn out to be a topping pattern, or a consolidation before making another attempt to blast through parity.

AUDUSD
USDJPY – This has clearly been the weakest link amongst the majors. The close this past week was below the previous all-time low made back in 1995. Looking at the historical picture – the Dollar has been in a downtrend versus the Yen since the end of the Bretton Woods system back in 1971. As the weakest pair on the board  I would like to see selling pressure in the Yen accompany any broad based rally in the Dollar.

Usdjpy

Bottom line: There aren't any distinctive set-ups before Wednesday, but afterwards the muddy waters should clear up, providing solid risk/reward opportunities going forward.

FX Charts In The Spotlight – USDCHF, AUDUSD

October 22, 2010 Leave a comment

With the stage set for an explosive Dollar rally (Dismal sentiment + Long-term support). I am turning my attention to a couple of short-term charts which offer low risk set-ups. First, the USDCHF is breaking out of an inverse head-and-shoulders pattern. The near term projected price target is 0.9975-1.00.

              DOLLAR INDEX     Usdchf

The next chart is of the AUDUSD, where pent up volatility is taking the shape of a triangle and quickly closing in on a breakout. For now, if the pattern breaks the underside trend-line, the resulting move will be viewed as the C leg of a correction with a short-term target of 0.9550-0.9575.

AUDUSD 240

GBPUSD – Keep An Eye On Trend Support

October 21, 2010 Leave a comment

GBPUSD (British Pound vs. Dollar) is currently testing its intermediate term trend-line extending back to the middle of May, after being rejected by a long term trend-line late last week.  There is a chance it could hold trend support, but given the potentially explosive situation brewing in the Dollar (everyone, and I mean everyone hates it click here, scroll down to U.S. Dollar Sentiment) coupled with the relative weakness in the Pound vs. other currencies ,  it seems unlikely.  My philosophy with trend-lines is this: 'Trust Until Broken". With that said, I will not be looking for lower prices until a confirmed break is in place, but to be certain – my trust in Sterling is on thin ice.

Gbpusd

Sentiment In Equity Markets Flashing Signs Of Caution

October 21, 2010 Leave a comment

Earlier in the week, I highlighted the bullish extremes present across a wide spectrum of asset classes, and expressed my bearish tilt on certain FX pairs and precious metals. However, I only briefly touched on equities, and so it seems prudent given the current sentiment levels that I delve more into the situation brewing in equities.

Before getting started, I want to point out that simply identifying extremes in sentiment, in of itself, does not warrant a trade, at least not by the rules from which I operate. Sentiment indicators are powerful tools for identifying  price points where reversals are more likely to occur due to herding behavior. It provides the initial edge, but what sets the trade in motion is price action, by providing confirmation of trend saturation and reference points for assessing risk.

Sentiment Indicators In Focus:

AAII (American Association of Individual Investors) – Mom & Pop investors have been warming up to stocks quite a bit lately, in fact, so much so that the 4-week average of the AAII has extended towards the highest levels seen in half a decade.

Image2
Source: Sentimentrader

II (Investor's Intelligence – (or lack of))- Newsletter writers are also showing some love for equities, not to the degree as individual investors, but none the less they are still climbing aboard. This week the II Bull Ratio rose to an overbought reading of 67.1%, but still well shy of the 75%+ readings seen back in April and January.

Composite Model by Sentimentrader This model is a compilation of various indicators including sentiment surveys, Commitments of Traders data, put/call and open interest ratios, volatility indices, breadth ratios, TRIN, and several unpublished indicators, which Jason at Sentiment has under lock and key. As one can imagine, with all those inputs, it gives a pretty well rounded view of what is going on under the market's hood.

On 10/14 the reading for the Composite Model dropped to 23%, which is only the 11th time since the data began in 2000 that a reading fell below 25%. As you can see from the table below, when the indicator fell below 25% the market had a tendency to struggle in the next 2-4 weeks, and in a few instances much longer.

For this study, I outlined the number of days it took to reach a peak, which I defined as a price high proceeding a decline resulting in a close one month later that is lower than the peak price. The peak dates were also determined by looking at the first day the model pivoted higher after crossing below 25, which is consistent with mybelief that contrarian trades shouldn't be taken until there is a pause or shift in momentum. Furthermore, I also calculated the return of the market over a two week and one month period. 

If you throw out the three occurrences which occurred at the very beginning of the 2003-2007 cyclical bull market, the market folded in the near term 6 out of 7 times by an average of 3.4% vs. the one time the market rose by 2.1%. The reason I am discounting the 2003 occurrences is due to the extreme nature of sentiment and price at that time, similar to what the markets experienced in the spring of 2009. (Surprisingly, the monster recovery in early 2009 did not push this model below 25%.)

Also, take notice in regards to the amount of time it took for a price decline to materialize. In two instances the peak was 2-3 days prior to the turning point in the Composite model, and in 4 other instances the peak was seen inside of 9 days. This means that if the current extremes are indeed creating an inflection point, then the market should begin to experience weakness very soon.  (The turn date was Monday October 18th.)

  Composite Stats
source: Sentimentrader

U.S. Dollar Sentiment – The inverse correlation between the Dollar and Equities has been a considerable focal point for both technical and fundamental traders alike. The prospects of more QE has created a "what's good for risk assets is bad for the Dollar" mantra, and everyone is buying into it. The Daily Sentiment Index, as seen below, has recently registered pessimistic readings indicating that only 3% of traders are bullish, which is below levels seen in August just before a 4%+ rally ensued, and worse than the levels seen at the 2009 trough.

US dollar DSI sentiment Oct 2010
source: Elliot Wave International

The inverse correlation between the two assets has been extraordinarily strong, and like most correlations it will eventually experience a reversion, that time could be now. With that said, a reversal in the Dollar doesn't necessarily mean equities will also reverse, however; it does suggest some caution is warranted until the Dollar begins to make adjustments to correct the high level of pessimism.

Quick Glance At The Technicals:

Chart #1 – ES contract carving out a possible Reverse Symmetrical Triangle (RST), or a megaphone, depending on who you are talking to.

Chart #2 – EURUSD looks to be rolling over and forming the right shoulder of a H&S pattern.

 
                      Es megaphone
   Eurusd 240
 

In conclusion, equities, like other risk assets, look poised to retrace in the near term. I am not as keen on being short equities as I am on remaining bearish on Precious metals and certain FX pairs. On another note, the EURGBP triggered stops at 0.8830 – that's trading, moving on.

 


EURGBP – SHORT: Solid Risk/Reward Set-up

October 19, 2010 Leave a comment

The confluence of bearish technical factors present on multiple time-frames creates an excellent risk/reward opportunity in the EURGBP (Euro vs. Pound).

Here are the details:

1. Long-term trend-line extending back to the end of 2008 touches off on peaks formed  in 10/2009, 03/2010, and now.

2. Daily 14-period RSI has hovered above overbought for an extended period of time, and rolling over now as price stalls at trend-line resistance.

3. Head-and-shoulders pattern developing on the 240 minute chart.

EURGBP LONG TERM     Eurgbp 240

The projected price target, based off the range of the H&S pattern, is 0.8550-0.8600, to occur sometime in the next week.  An entry here at 0.8750 with a stop above the right shoulder pivot of 0.8823 provides this trade with a risk to reward ratio of better than 1:2.