Weekly Musings 41 10-21-11
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Special Market Report
Those of you with of little interest in global markets may want to skip this report and go directly to the many interesting links in "From Left Field."
As I have often noted, global markets for stocks, commodities and currencies are on a simple see-saw: on one end is the U.S. dollar, and on the other are all other major currencies, all global stock markets, commodities, etc.
As I write this Friday mid-day, the U.S. stock market has surged on hopes of a comprehensive settlement to the European debt/banking/euro crisis. Technically, this surge exceeds the recent trading range, and thus is seen by many traders as a valid breakout, i.e. the signal a new Bull market is about to launch.
This aligns with the views of many experienced technical analysts, who expect a strong rally to start from here and last into early March. The reasons many expect such a rally, despite the headwinds of global recession, are seasonal and cyclical: stocks almost always rally strongly in Nov.-Dec.-Jan., and the third year of the presidential cycle (2011) is generally positive for stocks. In addition, various timing tools and indicators can be interpreted as supportive of a major rally from this point.
A much smaller number of analysts see increasing probabilities of a global stock market crash. If this were to occur, the DXY U.S. dollar would soar, as it is on the other end of the see-saw. In other words, calls for a dramatic, sustained Bull market in stocks suggest an equally dramatic, sustained rise in the euro and an equivalently massive decline in the U.S. dollar.
As you know, I have made the technical case for a long-term advance in the dollar index DXY (and its proxy, the UUP etf). A dramatic stock market rally and matching dramatic drop in the DXY would mean I was wrong. Every trader is wrong at times, and the only way to advance as a trader is to be aware of this and exit trades that didn't turn out as expected.
I've assembled a few charts to see what technical evidence there might be that the dollar has broken its recent uptrend. Since the DXY and stocks are on a see-saw, then each is the inverse of the other: a breakdown in the DXY is the flipside of a breakout of stocks, and vice versa.
In other words, technical evidence for a breakout in stocks should reflect evidence of a breakdown in the DXY.
In a global context, a bet on a rally in the euro and global stock markets is a bet that the Eurozone's fundamental financial contradictions and instabilities will be resolved next week. It is difficult to see how the euro and stock markets could rise for 4 months if the finances of the world's largest trading block, the Eurozone, unravel.
Expectations of a dollar rally and stock market crash/decline are based on global markets losing faith in the the phony "fixes" presented as "comprehensive solutions" by EU leaders. In other words, markets finally accept there is no magic wand: unpayable debts must be written off, insolvent banks must be dissolved and bondholders must accept reality, i.e. massive losses.
In this daily chart of the USD, we see the current retrace off its early October highs have bounced, in classic fashion, off two key levels, the 50-day moving average at 76.35 and the lower Bollinger band. Such a retrace would be expected in a sustained uptrend.
In a weekly chart, we see that the retrace returned to a band of support/resistance between 76 and 77. Note also how it tested the strong support/resistance of the 200-week moving average (MA) and then fell to test the 50-week MA at 76.60. Though the breach of the 50-week is noted, over both timespans we might say there is a band of support between 76.35 and 76.60 which would have to be broken decisively to negate the uptrend.
Turning to a chart of the USD proxy UUP, we see that the Fibonacci retrace numbers of the rally off 9/29 lows to the 10/3 high align extremely well with the 20-week MA at $21.50 and the 200-week MA at $21.92.
Such a test of upper resistance and a return to previous support is a hallmark of an uptrend and to be expected. Indeed, a rally with no retraces is worrisome to technicians, as it suggests manipulation that never lasts or a "blow-off top" that collapses.
Similar alignments of Fibonacci retracement levels and moving averages can be found in the DXY.
Experienced technicians eventually find that there is no magic indicator or level: every potentially significant level (moving averages, for example, or "death crosses" of moving averages) can be violated by false breakouts/breakdowns or render false signals. Thus the more signals and levels that align with others, the higher the confidence we can place in the significance of those levels.
The same sort of bounce between key levels of support/resistance can be seen in the Dow Jones Industrial Average (not shown), which bounced off its 200-week moving average at 10,633 and is now reaching for its 50-week MA at 11,863. Interestingly, its current level around 11,740 aligns with a line of resistance going back to January, 2000, when the DJIA first breached 11,700. This level might be a curiosity or it might be significant; we can only tell after the fact, and in conjunction with other levels, such as the 200-day MA, which lies above at 11,965, near the "whole number" of 12,000.
All this boils down to a simple proposition: can Europe resolve its debt/banking crisis next week? If it can, and does, then the euphoria of that "saving the Status Quo" could spark a multi-month rally in the euro and stocks and crush the U.S. dollar.
The problem in this scenario is two-fold: expectations of a "real solution" are now so lofty and so priced into global markets that any failure to truly resolve the banking/debt crises could send the markets into a tailspin.
Why? For 19 months, the leaders of the EU have played a game called "we'll really, really get this solved next meeting." The charade continues in Month 20, with more meetings and deadlines announced. Will global markets ever lose faith in this kick-the-can-down-the-road game? Perhaps not, but risk spreads in various debt instruments suggest that bond players are losing faith.
Secondly, many analysts see the Eurozone debt/banking crisis as unresolvable: there is simply no way to paper over monstrous, crushing debts by issuing more debt. Put another way, the cultural and financial differences between the debtor nations and Germany cannot be bridged, and France's banks are being revealed as wobbly/insolvent despite assurances to the contrary.
Here is a short but powerful analysis which identifies four reasons no "deal" is possible:
We might also ask: if the Powers That Be are intervening in the markets, as we know they are, what would their goal be? The answer is: a breakout of key technical levels that would trigger massive computer buying. This would turn a manipulated "rally" into a "real rally" as buyers would pile in to catch the "risk-on" rally.
With this is mind, we have to view today's "breakout of the trading range and 100-day moving average" with a tad of skepticism, for this sort of breakout on no news could well be a false signal.
The leaders of the Eurozone will certainly announce a "fix" by next Wednesday, and whether the global bond market accepts that as reality or merely perception management ("we're really going to tackle this next meeting") may well set the course for the next few months.
Massive rally or crash? There is vanishingly little real estate left between these binary scenarios.
From Left Field
86% of Workers Obese or Have Other Health Issue
Thanks for reading--
charles
