Blame it on the Weather

So, it was a really amazing weekend in New York and I was out and about, which explains the absence of my weekly summary/forecast post on Sunday. I have been pretty disciplined about writing my weekend review so I almost forgot how important it was. It is absolutely imperative to review the week that was, study the weekly and monthly charts, take into account recent fundamental developments and anticipate the markets direction based on the charts and calendar of economic events. Then, it is important to take all of that and formulate a working hypothesis for the week - a set of assumptions to frame our trading decisions. Personally for me, it is also important to do all of this on the weekend, when the market is closed and after spending at least 24 hours away from my monitor.

Well, better late than sorry so in lieu of the Sunday review, here's a little mid-week recap - a sort of Tuesday night quarterbacking, if you will. Here we go:

S&P 500 
The S&P finished last week above 1150. This was largely seen as a bullish sign with a Friday confirmation close above a strong resistance level. However, until today (Tuesday) the S&P was not able to close above 1166, the resistance level we've identified days ago. Today's break above 1166 was decisive and happened toward the end of the day. It definitely looked like a good number of stop entries triggered on a break above 1170. At any rate, the next short term support/resistance levels for the S&P are 1175 and 1150. A break below 1150 might accelerate selling pressure with support seen at 1130 and 1115. This means that we are currently just a fraction of a point from another resistance level. A pullback at this point is all but certain. But hey, I could be wrong. The question is, what is the catalyst to push the market up or down. For sure, the Fed's commitment to keep rates low is a major factor. On the other hand, the Fed will end its MBS (mortgage backed securities) purchase program this month. No one knows for sure how it will impact mortgage rates and, in turn, real-estate prices but we already know that uncertainty and risk appetite do not go hand in hand. At any rate, if I set my bearish bias aside and just look at the chart, it looks like S&P is set to drift higher to 1200.

USD Index (DXY)
The strong inverse correlation that dominated the relationship between the USD and the S&P for much of 2009 seems like a distant memory. The relatively strong  US recovery stands in stark contrast to the situation in the EU and the UK. This macro environment allowed US equities to rise to new monthly highs in tandem with the US dollar. One can only imagine that in a risk aversion scenario, the gap between the USD and the euro/GBP would be even greater - arguably, in such environment, the USD will stand to gain not only against the weak euro and GBP but also against the strong loonie, aussie, and Swiss franc.
As previously noted, the euro and GBP make up nearly 70% of the basket of currencies against which the DXY is calculated. This means that most of the recent strength in the DXY is due to weakness in the euro and pound, both of which face lingering issues and may suffer further weakness.

Euro - Greece
Germany's Merkel changed her stance a couple of days ago when she asserted that the IMF may be the only way to extend help to Greece. At the time the news came out, I thought a good chance for some relief to Greece and the euro was on the cards but that was not the case. A new round of political bickering commenced which helped push the euro even lower. The euro declined to new monthly lows against the Aussie and Swiss franc. As I write these lines, EURUSD is flirting with its 1.3450 support. A break below this level will most certainly trigger some stop sell orders waiting to be activated and send the euro even lower.
Only a clear plan for Greece and a cohesive EU stance can save the euro from sliding further. Euro sentiment remains bearish until then.

British Pound
The GBP suffered a massive slide on the backdrop of a weak UK economy coupled with an upcoming elections and accented with dovish BoE comments. At one point the pound even weakened against the euro. New economic data released today didn't help. Technically speaking, the pound looks the most vulnerable for further decline. At this very moment (3/24/09, midnight), GBPUSD seems well on its way to retest recent support at 1.4880 - 1.4800.

Japanese Yen
The yen maintained most of its strength despite the new highs in equities. As previously noted, at least some of the yen's strength should be attributed to repatriation which should abate by the end of the month, leaving the yen (risk appetite permitting) vulnerable.

Commodity Currencies
The loonie and Aussie continued to dominate the scene, with the loonie outpacing its Australian counterpart. The thought her is that the Aussie is vulnerable to further Chinese tightening but the Canadian dollar is less so. In addition, BOC has yet to raise interest rates while the RBA may not be willing to go much higher at this point.

OK - That's all for the time being. To be continued tomorrow....

Mixed Economic Reports Hold S&P at Current Resistance

Thursday, Feb 18th, 11:30

Mixed economic readings -worst than expected unemployment report, better than expected Philly manufacturing index - kept the S&P looking for direction. While the market took the bad unemployment numbers in stride, it could not find the momentum it needed to hop above its 1100 resistance.

-forexRoy

Filling In the Gap

No, not the price gap - the blog gap!
It's been a while since my last post so it's time to fill in the gap. Luckily the themes we've touched upon in the last several posts have played out nicely over the last couple of weeks. They are: (1) Dollar strength, (2) Euro weakness, (3) Equities weakness. So let's examine each theme in light of recent events. Since so much of the market's action has been determined by the Greek crisis, let's begin with taking a look at Greece and the Euro.

EU - On the Horns of a Dilemma
We've already discussed the issues in Greece so a detailed intro is not needed - but here's a brief recap anyway. Grave concerns over Greece's sovereign debt have been at the center of an unfolding drama as of late 2009. The Greek story has dominated headlines and opened the floodgates of fear that came gushing into the markets. Not long after Greece hit the spotlights, concerns over sovereign debt spread like wildfire to Spain, Portugal, Italy (and let's not forget Ireland), wrecking havoc in the "Club-Med" nations' bond and equities markets.

When Greece first made the headlines in November '09, EU leaders and the ECB chose to distance themselves from the center of attention, as Greek officials struggled to reassure nervous markets that everything was under control and that swift austerity measures could rein in a runaway deficit. However, as hopes for quick fix vanished and fears of contagion arose, it became obvious that EU leaders had to step in. But what to do? Each options seemed worse than the next. Letting the IMF step in was just too humiliating. Not doing anything was just too dangerous. Outright bailout posed a moral hazard and opened the door for more bailouts (Portugal, Spain, Italy). The unique structure of the EU, a monetary union with no fiscal or political unity, made the uncertainty even worse. For the first time, the EU was being put to a test for which the Euro was punished severely as traders piled in record numbers to short the single currency.

OK - so much for the "brief" recap. Fast forward to Thursday, Feb 11. European leaders at an EU summit meeting finally spoke up. During a much awaited press conference EU leaders served the markets a big dose of disappointment saying they stand ready to take coordinated action to protect the stability of the EU if such action was needed. At the same time, they insisted Greece did not need external help at this point.

The lack of clarity and conviction projected by EU leaders weighed heavily on the Euro as it plunged to test its recent lows against the dollar and the yen and made fresh, multi-year, lows against the aussie. After its massive slide following the press conference, the Euro managed a small bounce against the dollar and the yen but remained largely in the bears' hands. And in overnight trading, the Euro slid further against the dollar to break yet another level, this time stopping just shy of 1.3500.

Euro sentiment remains largely bearish. So long as uncertainty concerning the Club-Med nations lingers, the Euro will remain under pressure. With so many piled on the short side, it is likely we see some contrarian move to the upside, a move which may provide a profitable opportunity to re-short the Euro.

USD - Raging Bull
US dollar reversed its multi-week slide late last year and has been on tear since then. The initial strength in the dollar was due to signs of a recovering US economy. Since then, however, the rise in the dollar was strongly associated with flight to safety as fears over Greek debt, China's monetary tightening, and pending US banking regulations contributed to risk aversion among traders and investors. In the land of the blind, the one-eyed man is king. And so it is in the forex markets where the USD was the least worse of a pretty bad bunch.

The USD is approaching another congestion area which may act as a temporary roadblock. In the chart below, you can see the DXY reaching a resistance zone between the blue and red lines:

A major milestone for the US economy and the US dollar went almost unnoticed this week as Chairman Bernanke's testimony got canceled due to a heavy snow storm in the DC area. Bernanke's prepared testimony was released to the media. It outlined the Fed's exit plan for withdrawing the emergency measures it had put in place in the early days of the financial crisis. While repeating the Fed's mantra of "exceptionally low for an extended period" referring to the near zero interest policy, Bernanke's testimony definitely sets the stage for tightening. The question is, how will the market interpret tightening moves when they are finally announced? Depending on many factors, markets are likely to have one of two reactions: 1. interpret tightening as a sign of strength (risk back on) or 2. devastating blow to a fragile economy (risk off). A third and least likely scenario is a mixed reaction somewhere in between. Given a mildly positive parade of economic data and earning reports, option one (interpretation of strength) seems the most likely - but not by much.

S&P - a Long Awaited Correction
Most market participants were caught off guard in March of 09 as a massive rally in equities emerged from the rubble of the financial disaster. By the time it became evident that the rally was real, traders were faced with two options - chase the market or wait for a pullback. Well, for those who opted for the latter, a generous amount of patience was needed. The much anticipated pullback stubbornly refused to arrive - that is, until January 2010, when The S&P 500 climbed back to 1150 and finally met a resistance strong enough to send stocks lower.

Concerns over sovereign debt provided a perfect backdrop the S&P's decline. However, it would seem that other forces were in play, specifically, large market participants booking profits for 2009. A quick look at the charts reveals that 09 market leaders such as financials and materials, actually turned lower before the broad market sell off, suggesting profit taking and sector rotation.

Keeping Things in Perspective
With all the gloom out there, one must keep things in perspective. For example, fourth quarter earning season has been, thus far, quite positive with most companies meeting or beating expectations. Jobs, unemployment, and inventory numbers also continue to show signs of improvement. Greece is unlikely to default on its debt. And China's monetary tightening is a response to a booming economy - not exactly a bad thing! Moreover, companies have reduced bottom line costs and are well positioned to show bigger net income gains as top line   revenue streams return to normal levels. That is not to say everything is rosy. Of course there are lingering concerns (record foreclosures, commercial RE, weaker consumer demand, to name a few) but on the whole, a double-dip recession seems a less likely scenario than a moderate recovery and a range bound equity market.

A quick look at a weekly chart of the S&P 500, shows that the weekly uptrend, while losing momentum, is still intact and that the 1250 (generally accepted) target is still in sight.

Thoughts for the Week Ahead
Subtle disparities in market action on Thursday and Friday, may hold some clues for the week ahead:

1. Euro pummeled as US equities rise - we are used to seeing US equities and the Euro trade in tandem. However, last week saw a rise in US equities and a slumping Euro. 
2. Yen easing against the Canadian and Aussie dollars and, to a lesser extent, against the USD- this is another sign of risk abating to some degree.

Given last week's market action and news coming out Europe, we may begin to see Greece's problems contained within the EU, keeping the Euro depressed. In this scenario, we should continue to see the S&P basing around its recent levels and the yen easing further against the Aussie and Loonie. The US dollar is likely to see some consolidation this week as it hits a new level of resistance. Any further comments from the Fed regarding its exit strategy should help maintain dollar strength, especially vs. the Euro and British pound. 

Ladies and Gentlmen, Santa Has Left the Building

A dramatic three-day decline in the S&P brought the index down to pre-"Santa Rally" levels. The sell-off was broad and volume was high across the board as stocks were unable to fight a barrage of disappointing earnings mixed with general uncertainties in the marketplace and tossed with the certainty of an eventual pull back. Leading stocks and sectors (Financials: GS, JPM. Tech: GOOG, APPL, Industrials: X)  turned low before the S&P 500 signaling distribution and possible shifts in money allocation among the big players in the market.
A quick recap of what's weighing down the market is in order:

1. Sovereign debt - sovereign debt concerns continue to linger as Greece struggles to dig itself out of a hole and  mounting pressures elsewhere (California, Spain, Italy, Dubai, East Europe) continue to linger.
2. China - concerns over China's latest steps to curb its booming economy.
3. US bank regulations - talks about new bank regulations, designed to limit the risk big institutions can take, have been  major drag on finanacials and the broader market.
4. Uncertainty regarding the futures of Mr. Bernanke and Mr. Geithner have also contributed to the general lack of enthusiasm in the markets. 
5. US Earnings - a mixed bags of earning reports left the market underwhelmed and served as yet another indication that we are still in recovery mode.
6. S&P break trend lines and key support levels - nothing sums everything up better than price action and a quick look at the S&P is quite revealing. The broad index busted though major support and fell decisively below its 50 day MA, a prior support.
   

So what's next for the stock market? and why should we care? after all this is a FX blog, isn't it? well, the pullback in the stock market is a long awaited one. As such, we can assume that many investors who had their money in stocks were dancing close to the door, so to speak, ready to sell on a short notice. At the same time, we can assume there are many out there with dry powder who have been patiently waiting for a chance to get in. How far down will the market go is anyone's guess. However, it is unlikely to test the March lows. Instead, it is more likely the S&P will find a new, more relevant, support level from which it will trade sideways in a range until new catalysts (e.g. more stimulus, lower unemployment rates, etc) can send it higher. In my opinion, the S&P will find support around the 950-1000 level. We care about the stock market because its direction is indicative of risk tolerance/appetite and because the perception of risk has played such a dominant role in the foreign exchange markets, particularly since the beginning of the financial crisis.

The Beginning of a Beautiful Friendship? Well, Maybe

For the better part of 2009, the US dollar and the S&P 500 were on pretty bad terms - as one went in one direction, the other took off in the complete opposite direction. In other words, a strong inverse correlation dominated the relationship between the two. In April 2009, George Soros succinctly described the dollar as the "fever chart" of the economy. Indeed, as the US economy recovered from near-death experience, the fever chart (i.e. dollar strength) went steadily down. Recently, though, the US dollar has been seen walking hand in hand with the S&P, signaling a break from the inverse correlation and a possible, new, positive correlation.

Market correlations form, and fall apart, as dictated by shifting market dynamics. For example, most of the time the correlation between the USD and the price of commodities is inverse. However, in some situations one can observe a positive correlation between the them. Such was the case earlier this year when the dollar and gold rallied at the same time. It is important to take note when a well established correlation breaks or reverses, as it may signal changing market dynamics.

The dollar and the S&P are like a celebrity couple and their relationship garners lots of interest and speculations. But like a celebrity couple, they like to keep everyone guessing - will they stay together, or not? When trying to answer this question, we must first note the fact that we are in year-end/holiday trading mode which means thin volume across the board and a general reluctance on the side of big money managers to take on sizable positions. Having said that, we must also note that it is perfectly normal for currencies and equities of the same country to march in tandem - commonly a sign of a strong economy heading toward, or in the process of, interest rate hikes.

It may be a stretch to describe the US economy as "strong" but I think most people agree that things are getting better and interest rates can only go up from their current levels. It is quite possible then for forward-looking markets to anticipate another step toward normalization which may explain the dollar's and equities' newly found friendship. Will the new relationship hold? Only time will tell.