Graham Summers’ Weekly Market Forecast (Currency Pairs Edition)

It’s all
thanks to the Fed’s funny money and computers.

Thanks to
the world central banks’, particularly the US Federal Reserve’s, constant
liquidity injections combined with the automation of almost ALL trading courtesy
of the massive rise in high frequency trading programs (HFTPs) and other
computerized trading systems, the world financial markets have entered a period
of incredible correlations between asset classes.

In plain
terms, everything is now moving in near perfect direct correlation or near
perfect inverse correlation to everything else on an almost tick-for-tick
basis.

The most
obvious examples of this were presented in last week’s forecast, namely that
the S&P 500 now moves in direct correlation to the Euro/ US Dollar and
Aussie/ US Dollar currency pairs.

However, as
the below chart reveals, the other critical correlation traders need to note is
that of the S&P 500 vs. the US Dollar. As you can see, these two asset
classes are now moving in near perfect inverse correlation to one another (one
rising when the other falls and vice-versa):

As state
before, these are the most critical correlations for traders today. However, we
are seeing record or near record correlations between ALL asset classes across
the board, including between individual stocks themselves (according to BNY’s
Nicolas Cola, the LOWEST correlation between an individual stock sector and the
S&P 500 is around 83%).

We’ve seen
periods of this kind of intense correlation before, namely from March-November
2009 during the most intense period of the Fed’s QE 1 program. The fact that
we’re back to this stage again largely because investors expect a massive QE 2
program to hit in November (and the ongoing weekly POMO cash injections from the
Fed) tells us in plain terms that the investment world is completely detached
from economic fundamentals and that the most critical items to focus on from a
trading perspective are the aforementioned correlations and the days of the
Fed’s POMOs actions.

On that
note, we have POMOs on Monday, Wednesday and Friday this week. So while the
market appears to be showing clear signs of topping (more on this in a moment),
we can expect massive intraday ramp jobs to occur on these days between 10AM
and 11:30AM.

To show you
what I mean, I’ve included a chart illustrating the impact of these POMO
actions on the S&P 500 in late September. You’ll note that on four of the
five POMOs occasions we saw sharp intraday spikes occur, including reversals
that stopped collapses dead in their tracks.

Bearing all
of this in mind, from a technical perspective stocks appear to be topping right
now, having formed a bearish rising wedge pattern. This is a classic topping
pattern which, when broken, usually sees a reversal to its base (in this case
1,040 on the S&P 500).

Indeed, we
saw the exact same pattern form during the July stock rally. The collapse that
followed its completion was true to form, bringing stocks almost to the base of the pattern (I’ve drawn both wedges on the
chart below).

As you can
see, we’re right at the breaking point for this current pattern, which means we
should see a sharp sell-off begin in the S&P 500 soon. We gain further
support for this forecast from the fact that financials and semiconductors
(historically, market leading sectors) have been breaking down and failing to
confirm this recent rally.

Having said that…  the trillion-dollar question is: can the Fed’s POMOs and
rampant investor bullishness overcome the significance of this pattern?  The answer is: we’ll soon find out (the
pattern is SO close to ending). But with stock participation dwindling (fewer
and fewer stocks are accounting for the indexes’ gains similar to the action in
2000 and 2007) I wouldn’t want to bet much on it.

Good Trading!

Graham Summers

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Comments

[Dadoomsayer]

The bottom line is Bernanke is dropping his helicopters full of money, but they are landing only on the banks.  The banks are in turn buying nearly all asset classes across the board.

What happens if and when assets start coming in?  Do banks implode?  Do we save them again?  When does the boom bust cycle end?  Dec 2012 when the Mayan calander ends?

Seems to me this is a dangerous game, but Bernanke doesn't care, his goal is to send all assets into the hands of the banks.  So far it is working like a charm. All the while Obama is cheering him on. 

Broken system.

[Rasna]

I'm amazed that analysts try to apply the "old" tried and true analysis techniques to this market... The key term here, that is the game changer, is POMO...

We've seen this for over a year-and-a-half... Rallies out of nowhere, narrow range algo trading, HFT crashes and decreasing volume... I've been short for a very long time (In my investment portfolio) based on "conventional" market, economic and monetary analysis, and it's been a long, frustrating time... Based on what I know now, I'm about to tap out and look for a better area to short.

Overbought/Sold, Stoch, MACD, RSI, have little to no meaning given the Fed's interference and manipulation... Who can forget the Hindenberg Omen that had everyone running for higher ground, to await the crash...

Now, one can trade this market based on the pattern recognition analysis that is presented... At this point thinking that a "rising wedge" which normally would be a bearish signal, portends anything other than a breakout to the upside, should take a step back and turn off their monitors... If we've seen these POMO ramp jobs on a consistent basis, then that should be tradeable.  Shouldn't it?  It may be the case that a lot of the people on ZH are not traders, but are looking for a longer term play, so I can see the frustration.  I share that too, but I also trade.

My maxim is to "trade what you see" excluding just about anything else.  We now have additional information, verifiable facts... The Fed is going to conduct the POMO's as long as the want or until an exogenous event - Black Swan - comes along to change the market dynamics in a way that they can't control.

I pity the dumb money that buys into the Ponzi and jumps aboard because this is not an investing environment, but it can be traded, in the short time horizon... That's what I do.