WAS THE SELLOFF THE START OF SOMETHING BIGGER?
An overview of the technical, fundamental evidence pro and con, and conclusions for traders of stocks, forex, indexes and other asset classes
The following is a partial summary of the conclusions from the fxempire.com weekly analysts’ meeting in which we share thoughts about the big market drivers and current state of the risk asset rally after last week’s pullback.
Here we look at the evidence, both technical and fundamental, for where US and global stocks and other risk assets and currencies are headed.
TECHNICAL PICTURE: Uptrends Break Key Support – Normal Correction Or Harbinger Of Worse?
Global risk appetite as represented by major stock index uptrends dating from the summer of 2012, did not break but it certainly bent, generally dropping between about 2-3% overall.
WEEKLY CHARTS OF LARGE CAP GLOBAL INDEXES WITH 10 WEEK/200 DAY EMA: LEFT COLUMN TOP TO BOTTOM: S&P 500, DJ 30, FTSE 100, MIDDLE: CAC 40, DJ EUR 50, DAX 30, RIGHT: HANG SENG, MSCI TAIWAN, NIKKEI 225
FOR S&P 500, DJ EUR 50, AND NIKKEI WEEKLY CHART OCTOBER 2012 – PRESENT:10 WEEK EMA DARK BLUE, 20 WEEK EMA YELLOW, 50 WEEK EMA RED, 100 WEEK EMA LIGHT BLUE, 200 WEEK EMA VIOLET, DOUBLE BOLLINGER BANDS NORMAL 2 STANDARD DEVIATIONS GREEN, 1 STANDARD DEVIATION ORANGE
04 jan 271205
As of the end of last week (second candlestick from the right), the longer term uptrends are all intact, but even a simple visual inspection shows they are clearly losing momentum. In addition:
- The indexes are at or near their red-line 20 week or 200 day support levels.
- All three samples that we display with double Bollinger bands show the indexes now well below the upper quartile, thus suggesting upward momentum is gone for now. See here for details on understanding double Bollinger bands.
As the small rightmost candle shows (is as of 5 am EST, 10 am GMT, Asia and the start of the European session show little change.
So what caused the selloff, and what does that tell us about the coming week and beyond?
- Indexes were already high and thus prone to some kind of correction at any sign of trouble. So what was the trouble?
- Worsening China data, rising credit rates, raise raises fears of harder, faster landing than previously expected
- The WSJ’s John Hilsenrath brings rising fear Fed could taper faster than expected
- Per Citi’s Steven Englander, investor fear of tightening has additional sources beyond the Fed taper. He notes that the central banks of the UK, Japan, and Switzerland have all made recent moves that raise liquidity concerns at the same time that the Fed and PBOC are tightening.
- Emerging Market (EM) Currency Selloff: Why? Although badly exacerbated by worries about China and Fed tightening, some emerging mark had already started due to local factors like unrest for Turkey (political) and South Africa (mining workers), unrest and credit market weakness in Ukraine, and the devaluation of the Argentinian peso. The combination of a concern over China and a faster Fed taper exacerbated the EM currency selloff because:
- -A China slowdown hurts EM exports
- -An accelerated fed taper hurts risk appetite, which hurts higher yielding, riskier EM assets. It also suggests higher US bond rates, which increase EM borrowing costs that are denominated in one of the major currencies, typically (still) the USD.
- The following chart (tweeted via Bloomberg LP Chief Economist Michael McDonough) shows the correlation between US 10 year note yields (a decent gauge of taper sentiment) and EM currencies.
(via businessinsider here)
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But wait, one could argue that weaker currencies help EM economies, which tend to be export oriented and their exports now become cheaper. Hey, what happened to the fears of currency wars? Didn’t all those EM export-oriented economies WANT cheaper currencies? Actually, they do, as long as they somehow don’t cause inflation in the cost of living that outpaces inflation in wages. When that happens, living standards fall, and citizens already on the brink of subsistence get restive.
Was Last Week the Start of a Bigger Pullback?
Based on the technical and fundamental evidence we have seen thus far, no.
We note in particular:
- Technical Picture: As noted above support at the 10 week EMA/ 200 day EMA held. Nor do the weekly charts betray any bearish breakdown in our momentum indicators. Upward momentum is gone, but downward momentum has not yet started.
- Fundamentals: Whatever complaints one has about the fundamentals outlook for global growth, they’ve not materially changed over the past week. The blemishes have been present for some time now.
- Fear Levels Not High Per Currency Markets: As we noted here, currency markets can tell you a lot about other markets. The fact that the leading safe haven currencies like the USD and JPY did not rally strongly (indeed the USD index was down last week and the EURUSD – a risk pair – was up) does not suggest any material shift to risk aversion. Thus far the pullback is a normal bull market correction until the balance of evidence says otherwise. See here for the best guide to reading the hints currency markets send us. You can use the Look Inside feature to scan much of it for a free sneak preview.
That said, we DO note that our real time sample long/short EURUSD positioning of retail traders (average 8 week holding period) via forexfactory.com has swung back from last week’s even 50% split to a 36% long, 64% short positioning, which does suggest risk aversion in this group)
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What could Turn This Into A Bigger Correction?
A few obvious catalysts for a bigger selloff include:
- A surprise taper acceleration beyond the $10 bln anticipated.
- China lets the ICBC $500 mln default happen without at least a partial backstop and starts China’s very own Lehman moment. See here and here for details. We doubt China’s leaders are unaware of the dangers and would take such a chance. However the final decision is ultimately political and thus unpredictable.
- See here for more on the lessons all must know for the coming week and beyond.
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DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.