Saturday, January 19, 2013

Macro Analysis 1/18/2013

Equities took off this week, spurred by better US and global economic data as well as a flood of liquidity pouring into mutual funds and ETFs.  The S&P 500 penetrated resistance at the former high of 1474.51 set in September and there is only minor resistance in sight until we get to the all time high set in October 2007.  Here's a daily chart of the S&P and I've drawn some potential resistance lines:

(click on chart for larger image)
We have potential resistance at 1498.78 (red dashed line), 1523.97 (blue dashed line and corresponding to a Fibonacci price extension of 1528.71) and at 1551.68 (purple dashed line).  If I had to pick the stopping point on this leg higher it would be the 1523 - 1528 level.   Honestly folks, I believe we will be there within a month!
Treasuries surprisingly held their own this week but technical indicators suggest they are about to roll over.  The daily chart below is the Dow Jones CBOT Treasury Index which is composed of 30-Year T-Bond, 10-Year T-Note and 5-Year T-Note futures contracts:

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I apologize for the busyness of the chart but I need to illustrate a point.  While it's true Treasuries have bounced in the past two weeks there is still significant resistance at the 38.2% Fibonacci level and the index is forming a "Bear Flag" which is a continuation pattern of the ongoing downtrend.  We'd have to see the price action penetrate the 38.2% Fibonacci levels as well as the downtrend resistance line (burgundy dashed) for me to change my mind on the direction of Treasuries.
The price action in Treasuries is consistent with our inter market relationships.  As stocks continue to rally and the economy improves Treasuries should continue to weaken as the need for "safe haven" assets wane and investors take on more risk.
 Commodities are still trading flat with a slight bias to the upside which is consistent with a slow growth, incrementally improving economy.  Here's a weekly chart of "Dr. Copper" who has a PH.d in Economics:
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We're on the cusp of penetrating a downtrend resistance line (red dashed/black arrow) and have been in a steady uptrend for eleven weeks.

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This is a weekly chart of the Dow Jones UBS Industrial Metals Index and it has been trading flat for a number of weeks.

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Finally, here's a weekly chart of the Dow Jones World Basic Materials Index.  It's had a rather steep rally over the past three months but is presently encountering Fibonacci resistance.
All in all, the picture commodities are giving us point to a feeble global economic recovery and a struggle with still strong deflationary forces that are "going to and fro in the earth, and from walking up and down in it" (Job 1:7).
Gold was up 1.26% on the week and has been steadily rising for the past two weeks.  I'm posting an updated chart of the spot price for the yellow metal:

(click on chart for larger image)
Gold has run into some stiff resistance and until it breaks through that area all we can say is that it is repeating the rally it had in December (which was also turned away at the same level). 

I've expressed my view on where Gold is going in my January 4th commentary and I have not changed that position.  If I saw the metal pierce the downtrend line (green dashed) on the chart above it would force me to reconsider my bearish thesis.  Admittedly, with a crystal ball that always doesn't work the way I want, any number of factors can change the picture for Gold's prospects going forward.  However, when we consider all the liquidity that central banks have pumped into the global economy to stave off a virulent deflation, you would think that Gold's path of least resistance would be up.  But that's not what we're seeing.  Instead, the price action so far is reminiscent of putting in a long term top! 

We'll see where we go from here but if Gold's time is going to come I'm more and more of the persuasion that it will be in response to difficulties the Federal Reserve might have in unwinding the trillions in Treasuries and MBS that is on its balance sheet.  And that day is still a ways off.

The FOREX (Foreign Exchange) market is in turmoil due to Japan's new and finally sincere effort to stem the two decade long deflationary tide that has overtaken that economy.  The new government there has basically put a gun to the head of the BoJ (Bank of Japan) and is coercing it to do what our Fed has done which is to print reams of Yen in an effort to spark demand and inflation in that nation.  Whether they are successful or not is not the subject of this commentary.  But the Yen, being 13% of the Dollar Index, has been impacting the inter market relationships many traders and investors use to determine the direction of all financial and commodity markets.

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Here's a daily chart of the Dollar and what I want my readers to take way from this chart is the correlations that have started to change in the two lower panels. 
Historically, the market has been guided by inter market relationships or correlations which change very infrequently and can be relied upon to determine direction in global financial markets.  In my earliest commentaries I would post these inter market relationships at the beginning of each commentary:
                              Inflation              Deflation

If Stocks                     rally                    correct
Then Treasuries   will correct            will rally
Then Gold              will rally             will correct
Then Commodities will rally           will correct
Then US Dollar    will correct            will rally
  Some of these interrelationships have been with us for 12 years and, as I said above, change only rarely.  Since the beginning of the year, however, the Dollar has been positively correlated with stocks while the Dollar's correlation with the Euro has been negative (as it should be). 
What does this potentially mean?  If this skew in these relationships continue we could have a situation where the Dollar strengthens and stocks move higher.  In fact, this is the traditional inter market relationship where a country's strengthening economic fundamentals are reflected in higher stock prices and a stronger currency that reflects that strength.  Inevitably, it means that we're getting back to normal?  That the Keynesians won their battle with deflation?  That Bernanke's strategy is being vindicated? 
I'm not trying to provoke some folks who read this but whatever our political/philosophical biases might be, if the FOREX market continues to give us this signal rational men must consider this thesis.

Last week's commentary was brief and I meant to expand on this commentary and delve into a thesis on the possibility of future inflation but it will have to wait.  I've had a challenging two weeks and it has culminated in a miserable cold.  So this will be short as well.

Briefly, all systems are a "go" for higher stock prices.  The icing on the cake was the acquiescence of the Republican Party to offer a temporary extension of the debt ceiling on Thursday.  What was really encouraging was that the market responded to this news by just grinding higher; no "knee jerk" rally but a deliberate grind higher.  This is extremely bullish folks! 

In addition to this, volatility as measured by the CBOE Volatility Index is at levels not seen since early 2007:

(click on chart for larger image)
The chart above gives a brief financial history of events leading up to the GFC (Great Financial Crisis) of 2008 and subsequent events that roiled global markets.  The horizontal blue line delineates our present level from where markets were before the GFC.  Also notice that the VIX has traded at the 10 level.  An historical review shows it has gone as low as 9.31 in December, 1993. 

My purpose in posting this seemingly counter-intuitive esoteric chart is to show that the fear that has been part and parcel of these markets since 2008 is dissipating.  Now, anything can happen to upset global markets but when we look at the historic catalysts that have roiled these markets since 2008, whether they be in Europe, China or here, they are, one by one, fading from significance. 

Sure, we could have an exogenous shock from Iran or Al Queda.  But even these shocks, short of detonating a nuclear device in a European or US city (heaven forbid), could only have a temporary effect on our markets.

We're going higher.  Enjoy the ride!  The S&P should be at all time highs by mid spring barring some more "fiscal follies".  But even with these, we'll be at new highs by the end of the year.

Have a great week!