Are Risk Assets on the Verge of Melting Up? 25 comments
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After a 56% rally in the S&P 500 (from the March lows to the August highs) and similar rallies across global equity markets, wondering whether risk assets are about to melt up now might be precisely the kind of (recency bias) sentiment that defines market tops. And, admittedly, only a day or two ago we would have thought such a question silly. But after Friday's close, a cursory look at various charts spanning multiple asset classes strongly suggests that an intense rally in risk assets may be right around the corner--that is, if textbook chart patterns resolve in textbook ways (if not, then financial market are deviously setting us up with one extremely impressive head fake).
We'll begin our tour of risk assets with the U.S. dollar--for no other reason than the fact that the direction of the dollar will likely drive the direction of all other asset classes, should recent market correlations continue to hold. With that in mind, taking a look at the chart of the dollar index, we see what appears to be a descending right triangle formed over the past several month, with support in the vicinity of 78 and successively lower highs:
Click to enlarge:
Such a pattern suggests there is demand for the dollar index in the neighborhood of 78, but that supply is steadily coming online at lower and lower price levels after each successive bounce off 78. Because the successively lower highs indicate increased selling pressure, a descending right triangle generally indicates a bearish bias. Consequently, despite the relatively extreme bearish sentiment on the dollar (as delineated here), the chart pattern of the dollar index seems to indicate that the dollar could quite easily break below 78 and potentially below its interim low of 77.428 relatively soon. Of course, the dollar breaking to new lows would likely jumpstart risk assets worldwide and potentially cause panic buying in hard assets such as gold, silver, and crude oil.
If we're being honest, the descending right triangle in the dollar index isn't the cleanest of descending right triangles--and until recently one may have construed the chart as having formed a descending wedge--a pattern that has bullish implications. So perhaps our bearish interpretation of the dollar's chart is flawed. One way to corroborate this interpretation is to look at additional assets that would benefit from a weaker dollar and see if their charts are unambiguously bullish. To that end we will look at gold, eur/usd, and crude oil--and it's in these charts that we see the strong potential for a rally in risk assets.
Let's start with gold. Gold has the exact opposite pattern as the dollar (that is, if we accept that the dollar is in a descending right triangle), i.e., it's in an ascending right triangle, as one can see from the following figure: (Click to enlarge)
From the figure we can see that gold has resistance at 1000, but is successively making higher lows on every pullback, suggesting increased buying pressure on every retreat. The textbook interpretation of an ascending right triangle is bullish--once the supply at 1000 gets absorbed, gold is likely to continue higher.
Moving on to the euro, we see a similar ascending right triangle pattern: (Click to enlarge)
In the above chart, we see that resistance for the euro resides in the neighborhood of 1.44, and the currency has been tracing out successively shallower pullbacks each time it flirts with the 1.44 level. Again, if one buys the standard textbook interpretation of ascending right triangles, the outlook for the euro appears to be bullish.
Turning to crude oil, we see that, as with gold and the euro, the October contract is in an ascending right triangle: (Click to enlarge)
Unlike gold and the euro, however, crude oil is not knocking on the door of its resistance at $75, rather it's making a successively higher low from its recent drawdown from the $75 area. One additional (moderately) bullish overtone for crude oil is that the October contract printed three straight doji candlesticks from Wednesday to Friday of last week after a short-term downtrend. Such a pattern is referred to as a bullish tri-star pattern and, according to candlestick charting lore, has bullish implications as a reversal pattern with moderate reliability.
Consequently, in light of the rather unambiguously bullish chart patterns for gold, eur/usd, and crude oil, we feel a bit more comfortable with our prior bearish interpretation of the dollar's chart pattern (despite the potentially extreme bearish sentiment for the dollar). What's even more impressive, however, with respect to a potential melt up in risk assets is that the bullish charts don't end there. In fact, the Nasdaq 100 may have the most bullish chart of any right now.
With little fanfare on Thursday and Friday, the Nasdaq 100 broke through what market technicians would almost surely have to consider major resistance (and that might even be an understatement). Which resistance would that be? None other than the primary downtrend line that connects the all-time high in March 2000 with the highs in October 2007, March 2008, and August 2008. Here is the long-term view: (Click to enlarge)
Here is the close-up to show the trendline break: (Click to enlarge)
One has to wonder: if such a dominant, primary trendline for the NDX cannot contain this rally, what can?
This breakout for the NDX also raises the question as to whether the S&P 500 is corroborating this move. While perhaps not having as overtly bullish a chart as the Nasdaq 100, the S&P 500 also has some very interesting recent patterns that suggest further upside.
For starters, the S&P formed a "morning doji star" last week, a bullish reversal signal with strong reliability: (Click to enlarge)
Second, the S&P 500 has essentially changed its behavior since about the middle of July. Prior to that time, the index had reliably behaved in a mean-reverting way since the early 1990s (that is, up days tended to follow down days or at the very least, oversold and overbought conditions tended to generate short-term countertrend rallies). However, since July 13th, when the ominous head-and-shoulders pattern was demolished, the index has been behaving in a clearly persistent (i.e., momentum-driven) way.
For example, during the most recent four consecutive down days for the index (spanning August 28th to September 2nd) , the first three of those down days saw larger drops on each subsequent day (see the chart below). When the index rebounded on September 3rd and 4th, the rally on the 4th was larger than the rally on the 3rd. Without getting too technical (though one could indeed quantify these assertions with the statistic called the "variance ratio"), this is the hallmark of momentum-driven markets. Even visual inspection of a chart of the S&P 500 will show that prior to the middle of July, the chart was decidely jagged (indicating continual short-term reversals of each interim uptrend and downtrend), whereas from the middle of July onward, the chart has been excessively smooth (indicating up days are begetting up days and down days begetting down days). The upshot here is that if recent patterns hold, the S&P 500 may be in for a rally on Tuesday that ends up being larger than the rally on Friday. (Click to enlarge)
Finally, turning to the VIX: if one is generous, it also appears to be tracing out a descending right triangle, suggesting further downside: (Click to enlarge)
Of course, should the VIX break decisively below 25 with the S&P 500 Index continuing to behave in a momentum-driven way, higher equity prices are almost certainly on the way.
Thus, regardless of what one thinks of the fundamental situation with respect to the economy--and there are certainly very strong bearish arguments in that regard, which we subscribe to--if one only considers the broad technical situation of financial markets as illustrated by the preceding charts, it's hard to escape the conclusion that risk assets priced in dollars could very well be on the verge of a melt-up.
One caveat to an unrestrained bullish tilt, however, is that last week the equity markets saw a high volume selloff early in the week and a subsequent low volume rally to end the week (presumably many traders were taking time off before the unofficial end of summer). As a result, should market participants come back in full force after Labor Day thinking markets have moved too far, too fast (a not unreasonable belief), we may see moves that obviate the aforementioned bullish patterns--indicating that what we've just witnessed may have been nothing more than a head fake; albeit one that would make Larry Bird proud.
Disclosure: Author is long gold futures.
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This is what the SS wants, Secular Socialist rule.
On Sep 07 05:53 AM Roger Knights wrote:
> Fresh thinking, nicely argued. The up-moves in Asia and Europe this
> Monday morning, including S&P futures, are supporting your interpretation.
No kidding... especially Europe. But I can't help myself... I'm thinking it's a blow-off top we're witnessing.
Oil and stocks seem to be rolling over, but those are not clear cut and could go either way.
I've been doing that mostly since June when I went mostly to cash. Missed some upside, but I am at peace.
Better sitting on cash watching a rise that sitting on a stack of stocks and getting that sinking feeling. ;-)
HardToLove
On Sep 07 11:52 AM Albertarocks wrote:
> <snip>
> but I just can't bring myself to be long this market. The
> contradictions are just too excruciating.
On Sep 07 05:53 AM Roger Knights wrote:
> Fresh thinking, nicely argued. The up-moves in Asia and Europe this
> Monday morning, including S&P futures, are supporting your interpretation.
> Assume the Lotus position. Touch thumb to index finger. Now, intone
> "Ooooom", "OoooooM".
>
> I've been doing that mostly since June when I went mostly to cash.
> Missed some upside, but I am at peace.
You know what? That piece of advice just might be the smartest idea I've heard in a good while. I haven't been at peace because I'm so intense in my belief in logic... yet I see logic no longer working in this world. It's as though there's a tear in the matrix or something.
I must have some sort of character flaw. I no longer use alcohol and I've never used any other drugs, not even prescribed drugs. Yet I feel like an addict. The higher this illogical market goes without anything even remotely resembling a correction, the more insistent and stressed I become. I really do need to turn my back on the markets for a week, as difficult as that's going to be.
I'm going to take your advice H.T. Love. Thanks!
"Ooooom", "Oooooom"
Your comments only indicate your political agenda and indicate little to no knowledge of the history of fiat currency including the US dollar.
What is much more likely to be the cause of the ruination of America is the pseudo-capitalism (really oligarchies) that dominates the US today and results in the politicans, lobbyists, and corporate elite capturing the vast majority of American wealth today. This process has accelerated over the past two decades in the US. Dollar debasement is but one tool they use. Much more important are fraud, misrepresentation, regulatory capture, lobbying, politican capture, and a host of other techniques designed to maintain and accelerate the wealth transfer to a tiny segment of oligarchs and public corporation executives. It really makes no difference whether the politicans are Democrats or Republicans, both are part of the regulatory and political capture of the oligarchs.
On Sep 07 12:44 PM johnmorrison9 wrote:
> Obama destruction of America, with the aid of those who hate us,
> will cause a debasement of the dollar. Thus we can look forward to
> higher oil, and imported goods inflation, as well as domestic shortage,
> and higher poverty levels.
> This is what the SS wants, Secular Socialist rule.
> I haven't been at peace because I'm so intense in my belief
> in logic... yet I see logic no longer working in this world.
> It's as though there's a tear in the matrix or something
The hardest thing I think, is when you are being logical but have incomplete information, to an excess. That then introduces an emotional component to your thinking as your rational side experiences confusion when trying to resolve the apparent irrationality of what you observe.
Since I was new on the learning curve, I had been watching the charts as part of learning something about TA. When I observed the fairly consistent drop in volumes (using SPY as a proxy, 2/10 volumes of around 564MM, if I recall, to volumes in June/July(?) down around 136MM) but the price of the market kept rising, I experienced that confusion too.
Here's a later version of the chart showing what caused me that confusion.
static.seekingalpha.co...
But being studious, I kept glued to SA and learned about the Plunge Protection Team (not a myth!), HFT, flash orders, the history of the Fed, existence of an "oligarchy" etc. I became convinced that we (retail investors) were being set up for a fleecing again. This was supported (in my mind) with GS calling for 1060 one day and then another GS hot-shot call for 1100 and higher later, when no fundamentals in the economy seemed to support such calls. S&P P/E up at 130 (?), earnings reports beat but the majority with top-line reductions around 22% average (if I recall correctly).
I concluded that I didn't know what was going on (and other very powerful forces *did* know) and my "risk management" technique should kick in.
In this case, I exited all but a gold miner and a couple of small positions in a couple of small-caps and went to fast in-and-out trades.
The relief was absolutely *palpable*. When the "head and shoulders" pattern appeared and everybody (so it seemed) was expressing angst and worry about if it would be broken or completed, I just sipped some more coffee and continued making my small trades.
The real key for me was having learned in the past to not get greedy. I take small profits and enjoy them. And I view the big profits I missed as just part of the risk management.
When a nice correction comes and some *real* believable numbers about the economy surface, I can start easing back in as an *investor*, rahter than just being a trader.
I hope you get the same peace I that I found that way.
HardToLove
On Sep 07 12:44 PM johnmorrison9 wrote:
> Obama destruction of America, with the aid of those who hate us,
> will cause a debasement of the dollar. Thus we can look forward to
> higher oil, and imported goods inflation, as well as domestic shortage,
> and higher poverty levels.
> This is what the SS wants, Secular Socialist rule.
On Sep 08 10:48 PM Paul_L wrote:
> Hi Raymond, what reasons would cause USD to reverse except a descending
> wedge and extreme bearish sentiment? Thanks.