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Dangerous Divergences Cast Doubt on Risk Rally-A Repeat of Late January Coming?

Market Overview

The S&P 500, our key risk asset barometer, like other major stocks, stuck at / near the resistance of new 12 month highs, with considerable uncertainty from events noted in the market summary yet markets continue to drift higher.

Amazingly, this is happening despite no noteworthy positive news, no improvement in Greek debt crisis, cautious words from the Fed. Risk trend remains higher though we don’t trust it as long as there is no remedy in sight for Greece. That means we’ve a continued risk of Greek default that could spark an historic wave of defaults throughout the EU and surroundings, as scared bond markets raise rates beyond what the troubled economies can afford, effectively shutting them out of the bond market and sending them into default.

Negative Divergence Between Stocks, Forex, and Commodities


Most worrisome in the very near term: While stocks continue to rise, risk forex and commodities are flat, whereas they should be rising along with stocks.

This negative divergence casts further doubt on the rally in global equities, and we see higher probability of near term downside. The same divergence occurred before stocks pulled back in late January. See How to Use Forex and Oil Trends to Predict Market Direction.

EUR/USD: Updated trade outlook



Currently around.1.3670 As noted above, it retreating in the face of strong resistance in the 1.3700-1.3800 zone, which is crammed with strong long term resistance points including a down trend line over 4 months old AND its 50 day SMA which is already in a widening 'death cross' having crossed under its fading 200 day SMA, suggesting more downtrend ahead over the longer term. Likely long term pressure on the Euro from the EU debt crisis confirms the logic behind the technicals.

EU finance ministers again refuse to commit cash to keep Greece out of default, Germany reverses policy and is now willing to let the IMF (i.e. US and others) share in the cost – as we suggested months ago,[ 10 Reasons  Why There Will Be an International Solution for the PIIGS ] EU leaders would be committing political suicide if they commit their taxpayers’ cash to subsidize Greek mismanagement, tax dodging, corruption, sloth. Yet Greek default could ultimately spark a wave of defaults in the EU and elsewhere in the region, as it would drive up borrowing costs so high on rising fear that the rest of the PIIGS would be unable to afford further bond sales.

Thus we suspect EU leaders will try to get international help via the IMF (aka Fed East) in order to justify their own participation, saying they got the best deal they could and avoided a possible crash (at least until Spain tries to sell 30bln euros in bonds in July).

Trade Ideas:

Short: At current levels, profit taking target just above the 1.3600 level in the near term, with stop loss just above the 50 day SMA and less than a third of the distance to your profit target for a 2/1 reward/risk ratio. NB be ready to exit if any concrete details about a Greek rescue emerge from the Monday-Tuesday EU finance ministers meeting. Likewise, if no such news emerges AND the Fed is unexpectedly hawkish, increase profit target to just above the 1.3500 level

Long: Only on decisive breach over the 50 day SMA AND some underlying positive news on the EU debt crisis or deeply negative USD news. This is a well entrenched downtrend, caution trying to fade it at this time.

Beware the Ides of July: Twin Debt Bombs Set To Detonate

Regardless of the coming weeks, our big concern is about July, when 2 major events hit: Spain needs to sell about 30 bln euros in bonds AND a massive wave of US mortgage rate resets not seen since 2007 begins. The last time we saw this magnitude of rising mortgage rates markets stalled out and ultimately crashed. Markets are more vulnerable now than they were then, and governments more indebted than ever. Assuming much of the EU isn’t already in default by then.

 More on this in a post coming to you soon – stay tuned