Submitted by Nic Lenoir of ICAP
Yesterday I thought that for no particular fundamental reason the market was possibly going to temporarily base as technically it seemed we had a few important supports and exhaustion signals. That call looked good overnight until 6.30AM when S&P futures turned South and broke the 200-dma support, followed by AUDJPY which is a key risk barometer dropping through the key support at 76. At least from a day trading standpoint the game plan was clear: sell the break! Levels as clearly established as these tend not to turn out to be headfakes and today was no exception with AUDJPY trading down to a 72 handle.
The medium term trend, and I want to clear about this, remains down. I have argued for this for a while now, and risk appreciated so much from March 2009 until April in the case of US equities that the correction will run for a lot longer than this. I ultimately think we will see new lows in equities and I stand by my target of 380 for the S&P (I came up with that one in 2007, I looked stupid then, I still look stupid now, just a little less).
Short term, we have a monster support at 9,830/9,880 in the DJIA. If we break through this we trigger a big H&S in a very unstable environment and this time it won't prove a false break like it did in June 2009 when the market was still quite oversold. This level can be put in parallel with the USDCLP inverted H&S. I would also like to draw attention on the Trade Weighted Euro.
We are back at the levels seen at the bottom of the financial crisis 1.0 (we are experiencing 2.0: debt deflation takes over government support, 3.0 will be the final insult with hyperinflation once the markets have cleared at absurd lows but that's a few years down the line). Anyways, back to our observation on the EUR and USDCLP or the approaching Dow support, we are at key levels here. EUR for all intents and purposes held today, and USDCLP rejected the break out. Part of it was helped by intervention from the SNB and the BIS in the market (look up EURCHF if you need proof) which basically held the FX market. EURUSD is quite oversold (though we are still above the lows in momentum/RSI observed in 2008) here so as long as we stay above the 1.2440/1.2300 congestion (see EURUSD 10 minute chart) the risk could be that we bounce further, whether it is driven by intervention or short covering. On the upside there is no real resistance until 1.2760 and more importantly 1.3170/1.3200 which would be a big resistance if we bounce there. It seems audacious but in September 2008 we bounced from 1.38 to 1.48 in a matter of a few days before dropping 25 figures.
Equities are a bit more ambiguous than FX here. We have long said that Washington is completely bipolar/schizophrenic. The US economy works as long as the upticks in financial assets allow the wealthy to create service jobs for the not so wealthy and not so educated. So we need stocks going up at all costs under that model. However overhauling the financial industry and putting constraints on leverage is drastically bearish stock. Let's pause for a second: we are in the middle of debt deflation with horrible difficulties in the USD funding market. Putting limits on bank leverage will kill lending, and that is only going to make matters worse. Therefore we are fighting fire with fire, and I don't think there is a way to resolve this problem other than more debt deflation and asset devaluation. Stocks responded exactly along those lines to today's votes into the close and after hours with renewed selling pressure. It seems central banks are not only fighting a liquidity drought, they also have to fight the consequences of the political witch hunt against the financial system. Yes there are a lot of reforms needed, but I am just saying that you need to pick your poison. Here Washington has placed a higher priority on its vendetta against Wall Street as it has to the path our economy is on: buyers beware.
Since the financial industry overhaul is long term a big negative for the US, I feel we could see a bit of a correction for the USD, which won't be sustained because of the debt deflationary forces at work. But that could be were stocks keep underperforming while the FX market does not validate this weakness for a few days. Fixed Income markets also indicate Treasuries are on resistance levels and exhibit some exhaustion but are waiting for a catalyst to correct.
If there is a bottom line tonight it is that politicians have been setting up the very system they are fighting right now, not realizing that our workforce is not educated to compete, burried in debt, our costs are too high, and that for demographic and structural reasons our economy is in terrible shape. With the decision made to pin the housing excesses and the excessive leverage in the system on Wall Street, the government has set up the stage for deflationary forces to work their way eating up the value of financial assets in a way that people are greatly underestimating. Wall Street needed a cop, but it got a dictator.
Good luck trading,