Glimmers of reflation?

Equities continue to defy gravity as central bank largess continues and global economic data remains neutral to negative.  An announcement Thursday evening by the PBoC (People's Bank of China) that they were lowering their benchmark interest rats sent the S&P E minis spiking overnight and provided another gap in he cash chart for the S&P 500 and all the major averages on Friday.  Although buying pressure waned throughout the day the S&P came back sufficiently in the last hour of trading and this type of price action can only be classified as bullish.  Here's a one minute chart of the S&P 500 ETF (SPY) that encompasses Thursday and Friday's price action:

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I had concerns that the market could not hold onto the gains at the outset of the day but in the last hour the "smart money" came in to position themselves for the coming week.

The bullish tenor of this market cannot be denied and there are even signs that small caps may be stirring with the Russell 2000, which has been flat all year, may be ready for a break out to the upside.  Here's a daily chart of the Russell 2000 since the beginning of 2014.  We had a double top in the early part of the year and it is self evident from the chart that small caps have experienced significant volatility this year:

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I've identified a possible inverse head and shoulders formation on the chart which could be predictive of a break out to the upside if the right shoulder comes to fruition.  Although I've identified this formation on the chart I personally don't have much confidence in "head and shoulders" formations after the past five years since the pattern has often signaled a false break out.  But I post it nonetheless because if we're going to move meaningfully higher in equities in 2015 then small caps are going to have to participate.  They have led this market higher in the last few years and they're characteristics as high beta (riskier) stocks and indications of a healthy economy necessitate their participation in any market up trends.

As I look at market internals I get the sense that although this market is tired we will continue to move higher into the New Year.  Net new highs on the S&P 500 don't impress me but at the same time there's no cause for concern:

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Yesterday's price action I outlined above was, for me, a significant indication that there's still enough buying pressure in this market to insure a rally well into 2015, possibly into February when we've experienced some weakness every year for the past few years.

I do think Treasuries are signaling that we're going to seeing some significant moves in the financial markets in the coming months.  Below is a 60 minute chart of the Ten Year Treasury yield for the past two months:

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The pink shaded area are Bollinger Bands which is a chart overlay that shows the upper and lower limits of 'normal' price movements based on the Standard Deviation of prices.  The fact that they have narrowed this much normally is predictive of a significant move in either direction.  Which way that direction is will have implications for stocks going forward.  However, inter market correlations seem to be changing and it's not readily predictable that a spike lower in interest rates would create a sell off in equities as it normally has in the past.  

In a world where central bank accommodation has the planet awash in liquidity, sovereign interest rates are anchored on the short end of the yield curve by fixed government rates and the long end continues to be suppressed by the same liquidity and buying pressure.  Significantly, the threat of deflation has been the main fundamental of this monetary phenomenon and will continue to be until we see signs of global growth, especially out of the Euro zone.

The US Dollar seems to be continuing its inexorable rise as it broke out to new multi year highs on Friday which is part of the reason why equities reacted in the cash session that day:

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A stronger dollar aggravates deflationary pressures in commodity prices as the world's reserve currency strengthens.  But the Dollar is also telling the story of a recovering US economy while Europe and Japan remain mired in flat deflationary economic conditions.  And so, the inverse correlation we have often experienced between a stronger US Dollar and US equities has now been significantly mitigated.

Surprisingly, we've been seeing some buying pressure in Gold over the past three weeks  which also has seemed to give the weakened commodity complex some juice:

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The chart above is a weekly chart and I like the weekly candlesticks with the long wicks on the bottom of each for the past three weeks (red arrow).  This may be signifying a bottom in the yellow metal but it's still too early to tell.  Sentiment has finally started to get ugly for gold which is a good contrarian indicator that the "blood bath" in the precious metal might finally be abating.  But the chart tells me it's still too early to be dogmatic of a turn higher.  

It's important to watch gold in the current global economic situation we find ourselves.  Higher gold prices will be predictive that the global economy is starting to win the battle with deflation.  It will mean Europe is turning around, and as stated in my last commentary, as Europe goes so will the global economy and financial markets in 2015.

As stated above, the jump in Gold has also seemed to drag along the commodities complex.  Below is a daily chart of the Reuters/Jefferies Commodity Research Bureau Index (CRB) and the index has broken out of a multi month downtrend on the daily chart:

(click on chart for larger image)

Are we starting to see glimmers of inflation?  It's still too early to tell but let's hope so!

Finally, I had some concerns on the divergence between the junk bond market and stocks that had developed in recent weeks.  Much of the problem stemmed from the fact that the market was starting to predict that smaller, highly leveraged players in the oil/natgas industry were going to start having problems meeting their financial obligations as oil descended under $80.00/barrel.  However, with some recent buy outs by some of the bigger names in the industry the market seems to have stabilized a bit as seen below on a daily chart of the SPDR Barclays High Yield Bond ETF (JNK):

(click on chart for larger image)

The chart displays a classic reversal pattern.  The high yield market is strongly and positively correlated to equities and the anticipated recovery in this market is bullish for equities.

Regular readers will notice I've stayed away from any fundamental analysis in this commentary.  The reason is that there's simply a lot of "noise" in the financial press on the direction of the global economy.  I outlined the challenges in my previous commentary two weeks ago and nothing has really changed.  Sometimes the best thing to do is let the market speak to you thru the charts and that's what I've done in this commentary.


Have a great week and Happy Thanksgiving!

The statements, opinions and projections made in this writing are for informational purposes and are my own.  They do not represent the views of my broker/dealer.  Additionally, this writing does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by me or my broker/dealer in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. 

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