Given today's fun filled market action, currency chaos, and roasting PIIGs, it's probably important to put some things into perspective. Let's start by taking a look at major stock markets around the world. You should see a trend here...
First, the S&P, which over the last few weeks has fared better than most of the other global equity indices.
As we discussed last time, the S&P has not had more than a 9% correction this decade, with the exception of the 2007-2008 crash. Can it crash again? Of course, but there will be signs again. More on that top spotting a bit later on.
Let's zoom out a bit.
Note a few things on this chart. First, from the bottom in March of 2009, the market has retraced 61.8% of it's crash from October of 2007. That's a key Fibonacci retracement level. At the same time, the market is overbought and overextended. We can expect the technicians to sell the market here. The real question is whether or not this is a correction, or the beginning of something much more damaging.
This brings us to the second point on this chart. Note the red line. A very important characteristic of markets is their behavior around this average. Bull markets tend to correct to the line, with some possible overshoot, but do not stay below it for long (look at the July 2009 and February 2010 corrections as examples). Here's the important premise:
as long as the 150 day moving average is pointing upward, the bull market is intact. Once the 150 day moving average slopes downward AND the closing price of the security falls below it, a full blown bear market begins. For the most part, market tops don't just happen immediately. Topping is a process, not an event (some rarities, including the 1987 top, are exceptions).
So, at this stage the bull market is intact. The burden of proof is on the bears to take control. They have failed to do so in the last year. It appears they will have their chance again now. What transpires over the next week will be particularly important. Why? The US markets have been lagging, not leading, the global "recovery" for some time now. When the US markets bottomed in March 2009, most global markets had bottomed in October, 2008. The US had underperformed most global markets until the last few months. Again, we do not believe this is a US leadership issue--US markets are just last on deck, so to say. Let's look at several major global market indices as signs of what's to come.
Note the same behavior in the Shanghai Composite regarding the 150 day moving average. Once it flattens and prices fall below it, you're in a bear market. Since the bottom in October 2008, the SSEC topped out in August, 2009. Below is a shorter term view from the August 2009 highs.
The SSEC is in an intermediate term corrective cycle, noted by the blue rectangle. Prices have fallen below the 150 day moving average, but the 150 day moving average has not rolled over. It will be critical for the SSEC to hold the 2639 level and then rise to break to the upside, above the 150 day moving average before it rolls over. It probably has at least 3 months to do this. If, in that period, it does not rise above the 150 dma and begin an upward trending pattern, ultimately breaking out of the consolidation zone to the upside, then this will probably forecast another round of market sell-offs, commodity price crashes, and the like.
Using this similar criteria and mode of thinking, take a look at these key markets and note the trend...
Australia has begun its consolidation as the pace of the rise of the AORD has failed to keep the 150 day moving average rising faster. Australia is not going to help itself out by taxing miners more, but then again, when has government ever done much good for anything or anyone?
At first glance, you might think it's the AORD again, but it's not--it's Brazil's Bovespa. It exhibits the same pattern as the AORD.
Canada is looking like the best of the resource-based economies out there. If the rest of the global markets move into consolidation regions, along with oil and gold, the TSE will likely have a strong sell off. Longer term, this market should remain in a bullish trend, but we may have a few months of weakness and a shocking sell-off ahead.
Interestingly, the DAX (Germany), CAC (France) and FTSE (UK) are generally showing the same patterns as the S&P.
Japan tends to move to the beat of its own drum, and we'll cover it separately another time.
In digesting all of this information, here's what's important. We are likely entering a period, globally, where we trend sideways in global equity markets. As the situation evolves, we'll be looking at changing our trading strategy to be less position-oriented and more frequent. Expect choppy, sideways markets for some time to come.
Expect gold to do well here after this initial sell-off. Again, note the consolidation pattern in gold, the breakout, and what we believe will be the subsequent pullback/retest of the consolidation rectangle:
We should see gold hold today's lows. A closing price back within the rectangle signifies a false breakout. Honestly, it's textbook at this point. It may not move much in the next few days, but we anticipate it will challenge the highs soon.
A final note of possible interest. One of the indicators we use takes the market date, mathematically derives a signal from it from which short term cyclical turns can be forecast. It has an uncanny way of calling countertrend moves. For example, if the markets are above the 150 day moving average (bullish), this indicator tends to call any sell-offs to within 1-2 days. Each market moves somewhat to its own rhythm. Interestingly enough, there are a series of upward turns forecast to begin (with Japan--actually it will turn down) on Friday through Tuesday of next week. If we are still expected to maintain bull market territory in these averages, we should see markets flat to down most of this week with upward turns starting with a downward turn on Friday in Japan and other markets reacting opposite it next week.
The TED spread is up, but not in any zone to be concerned with. Markets are anticipating problems, but no REAL liquidity crisis yet exists.
One final comment. Most of the extremely negative news currently revolves around how much each European country owes the next European country. That is, as they say, a paper problem with a paper solution. If for some reason debts are allowed to be defaulted upon, then you can expect another return to the 2008 global meltdown world of counterparty risk. If the PIIGS are removed from the eurozone first, the euro will benefit. If Germany steps away from the euro, the euro is toast. We still expect a bailout of some form as soon as politicians realize that a default creates a chain reaction that will plunge the global economy into depression. That's not good for their reelection chances. Thus, if Europe comes up with a paper solution to a paper problem, you can expect the markets to go on an upward tear. If they do not, they risk plunging their own countries, and the globe, into another crisis. The markets are now telling them to print money to bail out the PIIGS or otherwise contain the contagion. They will likely be pushed into doing something soon.
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