Sunday, April 29, 2012

Macro Analysis 4/27/2012

It would seem we had a turn around week in stocks.  All the indexes were up from 1.5 to 2.66% (Russell 2000) with the only laggard being the Dow Transports (up 0.63%).  The catalyst seemed to be Bernanke's comments after the FOMC meeting on Wednesday.  And it's not that he was saying anything that he hasn't said before but it seemed the market finally took his pledge of further monetary accommodation to heart.  Euro Zone worries seemed to fade away (although the problems are very much still there).  The other factor providing further impetus that ignited equities was the slew of earnings reports that beat street estimates.  As I've stated in a few recent blog posts, the street set expectations so low that we were bound to have a plethora of "beats".  Future guidance was not as rosy but the market largely ignored this as well.

If it sounds like I'm making excuses for the market's rise in lieu of recent posts that suggest weakness over the next few months I have to say in my defense that the same issues that roiled these markets last year are just plain being ignored in 2012.  Why?  Who knows!  But that's Mr. Market and why I'm a continually fascinated and passionate student.

Here's an updated chart of the Russell 2000 Small Cap Index which is an excellent indicator on the market's perception of the health of the U.S. economy.  This index is overwhelmingly comprised of companies that do their business exclusively in the United States:

(click for larger image)

The green arrow is where we ended on Friday.  The "RUT" has re -entered the trading channel it was stuck in for two months and has pierced a short term resistance line (red dashed).  Notice the momentum indicators are all turning up foretelling the probability of further upside action.  The bottom panel is the Russell price relative to the S&P500.  The Russell is showing relative strength to the S&P and this is also bullish for stocks.

So, with a seemingly slowing China and Euro zone debt woes looming again what's pushing stocks higher?  Here's where our inter market relationships serve to put the pieces of the puzzle together:

Here's a weekly chart of the Dollar and it is clearly breaking down out of a huge triangle pattern that has formed over the past few years.  One could hold out hope that the Dollar will bounce off the 61.8% Fibonacci retracement level it marginally pierced this week but the momentum indicators on the top and bottom panels speak to further weakness.  And remember, this is a weekly chart so the significance is much greater than on a daily chart.

Interestingly, Treasuries are defying the historical inter market relationship paradigm.  Throughout this week's positive price action in stocks Treasuries strengthened and yields dropped although the price action and momentum was tepid at best:

Here's a weekly chart of the iShares Barclays 20+ Year Treasury Bond ETF.  As you can see Treasuries have been manifesting some strength over the past few weeks but notice the momentum indicators in the top panels.  The ROC indicator (Rate of Change) has started to turn down.  RSI (Relative Strength Indicator) is overbought and flat.  As someone who watches these markets constantly I can attest that Treasuries don't have that crisp, vibrant price action that was indicative of their performance last fall when everyone thought the world, as we knew it, was ending.

It's almost as though there is some token buying pressure in Treasuries as a nominal hedge against any possible Euro zone eruptions.

Let's look at Gold:

My regular readers will recognize this as an updated chart of the Gold spot price.  I've been monitoring a potential head and shoulders formation with a potential target of about $2,100.00.  And we started to see some upside movement after Bernanke's comments on Wednesday.  We'll need to monitor Gold's price closely.  Investor attitudes toward the "yellow metal" have been frankly "flaky" as it seems everyone has a thesis on why Gold seems to be languishing and where it may be going next but none of the opinions seem plausible to me.  Maybe Gold is getting a whiff of inflation?

Now let's look at commodities whose price action has caused me great concern since the end of January.  And let's look at "Dr. Copper" with the PhD in economics:

This is a daily chart and I circled the past five days price action.  Copper had a powerful surge this week.  Momentum indicators have turned up as well.  And all the other commodity charts on a daily basis are showing the same pattern with the exception of steel.  Now, on the weekly charts all these commodities have a way to go before they penetrate resistance so all we can say for now is that we're in the beginning stages of a possible commodity rally.

And I thought I'd round out the commentary by posting a daily chart of the Shanghai Composite Index:

Chinese stocks staged an impressive rally in April but are currently snagged at the $61.8% Fibonacci retracement level.  Both momentum indicators (top and bottom panels) are showing hints that momentum is starting to falter.  And of course, the downtrend line (green dashed) has not been exceeded as of yet.

What to make of it all?  Clearly, we have to acknowledge that, in the short term, stocks are liable to be heading higher.  The key to understanding the direction of equities in the short to long run will be the direction of the U.S. Dollar.  As the Dollar weakens stocks will rally and as it strengthens, stocks will correct.

I believe the price action in commodities, while also effected by Dollar weakness/strength, will also be impacted by the direction of the Chinese economy.  So we'll need to monitor the Shanghai Composite as well in order to ascertain whether this week's upturn will be validated. 

Finally, watch Gold.  If we're truly in the infancy stage of a global economic recovery Gold will reflect that strength and its inflationary implications.  A failure of Gold to advance from these levels puts into question the present strength in stocks and commodities.

News that will move markets this week:

Monday - Personal Income & Outlays
Tuesday - ISM Manufacturing Index
Thursday - Weekly Jobless Claims
Friday - Monthly Employment Report

Germany has some important economic reports this week which may also move our markets and Spain and France auction off bonds on Thursday which, in the past, has been a potential catalyst for market volatility.  But in the present market environment we find ourselves, who knows!  And of course, French and Greek elections are next week starting next Sunday.  Watch the Greek election!  There will be no clear plurality in their parliament which will set the stage for the Greek goverment reneging on their austerity commitments to the European Union.

Have a great week!