A Bubbling Cauldron: Eurostoxx Faces Witch's Hat Formation

It was triple witching day on Friday in equity land, and on the evidence so far the old crones have cooked up a stonker. The bubbling witches' cauldron has been aided by a rather amusing game of banking "nickie-nickie-nah-nah," wherein one troubled institution downgrades another: UBS lowered Citi (C) on Friday morning, while the embattled Lehman has downgraded Deutsche (DB), Credit Suisse (CS), and - you guessed it - UBS (UBS).

So there's been a few fireworks in Europeon Friday morning, which no doubt left various holders of index option positions either celebrating or gnashing their teeth. The morning action in Eurotstoxx was pretty mundane leading up to expiration (the settlement time is marked by the arrow in the chart below), after which the index fell off a cliff.

From a longer term perspective, the Eurostoxx is at pretty crucial levels. On the weeklies its sitting on the neckline of a head-and-shoulders pattern, a formation which also happens to resemble a witch's hat. A weekly close below the 3440-ish level would theoretically target the low 2000's eventually. Yowsah!

While the SPX doesn't have such an obvious witch's hat formation threatening to cast a hex, it, too, is at pretty crucial levels. While logarithmic charts aren't really used in day-to-day charting, they are pretty handy when looking at long time frames of data. And as UBS's Andy Lees has pointed out recently, the SPX is basically sitting on the uptrend from the (in)famous 1982 Granville bottom on the logarithmic monthlies.

A conclusive monthly close below this trend line at 1330 would be fairly ominous indeed, and threaten to turn the SPX into a pumpkin. Thursday's Philly Fed, which showed weaker activity, higher input costs, and lower prices received, provided a heady witches' brew for the macro equity bear.

Of course, the trick in this game is to avoid Macbeth's fate and follow the witches' guide to one's doom. Then again, badly limping financials, a struggling US consumer, and rampant global headline inflation are substantially less formidable an opponent than Macduff. For now, Macro Man is content to follow the witches' prophecy but not force the issue; if the brim of the witch's hat gives way, there will be plenty of opportunity to add risk.

Comments

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