SP500 quiet,,,,+ 10 Year note comment.

The SP500 continues to churn within the consolidation zone of the last 2 weeks. A sustained break of either side of the approx 1130/1150 range is needed for this to start gaining some momentum in either direction. My bias is neutral at the moment, with the more bullish technical arguments offset by some concerns that highlight a potential bearish resolution. I covered these extensively in Friday's post, they can be seen by clicking here.

G7 10 Year yields are once again pushing the recent lows. JGB 10 year yields, which had rebounded sharply from 0.90% to 1.2% little over a month ago are once again threatening the 0.90% lows, currently they reside at 0.93%. German 10 Year Bund yields are at 2.24% having only recently rebounded to 2.50% from around 2.10%, and US 10 year yiel , which had rebounded in late August from 2.40% to 2.85% are back to below 2.50%. All three yields charts can be seen below. -

  

With regard to the US 10 year yields, I still favour these to push towards 2.20% and probably lower. There is a chance that the recent rebound may be a precursor to a deeper correction, with this move a re-test of the low and perhaps the early stages of a trend change, however I feel this is the less likely scenario. The next chart shows the US 10 Year Note continuation future weekly, the correction in yields shows up on this chart as a Bull Flag, with a strong Bullish breakout over the past couple of weeks. I have highlighted a strong similarity between the Bull move in 10 Year notes over the past few months and the late 2007 rally into early 2008. I have also added extra emphasis on the current Bull Flag and breakout and a similar pattern in Dec 2007,  whilst a repeat is not guaranteed the similarities are quite striking, and I believe this supports the idea of higher 10 year note prices/lower yields in coming weeks.  

Rates Update + SP500 may be getting ready for break higher.

Global Rates

The past couple of weeks have seen some very sharp corrective activity on Rates markets. This corrective phase has occurred in the face of very sharp drops in Government Bond yields over the past few weeks and indeed months. There have been a number of events which have helped contribute to the large drop in yields over the summer, chief amongst these have been 'Flight to Safety' fears regarding the Euro Periphery (PIIGS), Double Dip fears as US economic data disappointed over recent months, poor economic data in other G7 countries, and the increasing belief that Central Banks were going to increase Quantitative Easing in response to fears of further economic pain.  - Is this the beginning of a real turn in the rate environment or a mere correction? - Personally I think this is too early to come to any firm conclusion, however it is something I am going to try and focus on over the next few days and weeks as this is likely to be a barometer of the level of fear and/or confidence running through the global economic environment.

My initial feeling is that this is a correction in rates for now, which probably still has further room to run. - Regarding the issues above, the PIIGS issue has not gone away, Credit Default Swap (CDS) levels remain elevated, though price levels have eased a touch over the past few days. Double Dip fears have eased slightly in the face of marginally better data over the past couple of weeks, (but still remain elevated), stock markets have recovered there poise and QE2 has not yet materialised, though it remains a very strong possibility. - The charts below show US 2 year and 10 year yields, German, Japanese and Australian 10 year yields. --- I have highlighted the Japanese 10 year yield level of 1.20%, this has been a pivotal level for the past few years, the recent collapse in yields across the G7 really accelerated upon the confirmed breakdown through 1.20% in June, and the rebound of the past couple of weeks in JGB yields moved from 0.90% to 1.20% before easing back to current levels around 1.6%

SP500 Index

Last Thursday's 'Shooting Star' candle failed to turn the markets down, with futures levels currently suggesting cash trading around 1118/19, it would appear that this signal is a fail. Unless today's likely stronger opening turns round to produce a weak losing close, then the focus is likely to switch back towards the 1130/32 key resistance area from June and early August.

The chart below shows the patterns which I think are likely to have the greatest influence on the market going forward. I believe the market may be preparing for a breakout higher, I have listed below my reasons for this below. However, as long as the 1130/32 continues to offer strong resistance, and until we see a clear and sustained break over this level, the risk of further consolidation or a move lower remains a possibility.   

Clues as to why a breakout higher may be due soon :

1) The large 'Falling-Wedge' pattern (highlighted above): I covered this many times over the past couple of months, including this posting from the 2nd August (Click here). I am re-posting some work I have done on 'Falling Wedge' patterns below.

 

I have long favoured that we have a Type 2 pattern (as per the above), though I have had doubts, which have led me to question that we may actually have a Type 3.  However the re-test of the breakout, which has held well, does lead me to once again think that this is a Type 2 pattern, which has bullish connotations whereas a Type 3 has a very bearish connotation. - Note: Type 2 patterns usually morph from failed Head + Shoulder pattern, which in its own right is a Bullish pattern.

2) The Higher Low (highlighted in above chart) is another supportive factor.

3) The internal 'Inverted Head + Shoulders' pattern. - I am loathe to actually call this a true 'Inverted Head & Shoulder pattern' as these would normally occur at the end of a sustained trend, however when combined with other signals, these can act as continuation patterns.

4) My own Long-Term trend following system remains in Bullish posture, it failed to produce a sell signal on the May/June sell-off. I posted a blog on this a couple of months ago (can be seen here). This system is not a forward looking system, hence I do not consider it as a trading signal, however it should not be ignored either.

5) 1970's redux. I posted about this in July, the price action since then has actually re-enforced this even further.  Below is an updated chart of the near-term comparisons, note history does not repeat itself, but it does rhyme.  (Click on the Highlighted link at start of this paragraph to see full item for bigger picture).

6) AUDJPY -- This has been one of my main risk barometers over recent months. I have previously highlighted the Symmetrical Triangle on this FX cross. The price appears to be breaking out of the top of the pattern (see chart below), if this is maintained, this would be bullish for the AUDJPY, who's moves have been well correlated with moves with the SP500 over the past couple of years.

Of course, all this will be 'by the by' if the SP500 fails to clear 1130/32, or makes a short-false break. In the meantime, I would not be surprised if selling pressure was to emerge ahead to this key area. 

Fear and Risk-off v Risk-on.

         Last week I wrote a blog about whether fear was abating (can be seen here), I used an Investors Intelligence piece highlighting how Newsletter writers were at a level of bearishness which had previously seen the market rally strongly, I also pointed to the correction occurring in Japanese Government Bond yields, after their huge summer rally. - However, as I look at the bigger picture, this does not yet to me reflect a climate in which fear is abating, last week's stock market bounce, strong though it was, is just one of many sharp moves in recent months as equities have continued to gyrate in a wide range. Also the jump in Japanese Government Bond yields from 0.90% to 1.20% last week was a large move in a very short term, however it had dropped from 1.40% over the past 5 months. At the moment, a move such as this appears to me to be corrective (See chart below), though how it unfolds from here going forward will determine whether this is merely a short-term correction or the start of something more meaningful in a positive direction.

 

However when I look at various other indicators of fear I start to question whether fear is abating, or whether it is getting ready to re-assert itself.  The initial fear has certainly abated, in this case the fear that led to a sharp increase in volatility (as measured by the VIX index) through May and June, however US equity markets have not recovered, they have remained range-bound (though now nearer the top of the range) since initially rebounding in early July. 

Elsewhere, other measures of fear remain high. By this I mean the measure of fear as gauged by where investors are willing to park their capital. Over the summer, we have seen investors favouring a number of very low yielding products and markets, this surely would only occur if fear was high and people seeked certainty over return: Looking at 10 Year Government Bond Yields for most major western economies, these have seen yields drop sharply over the course of the summer; 

Japan      1.40% to 1.14%  (Low 0.90%) 

US          4.00% to 2.60%  (Low 2.41%)

Germany 3.20% to 2.23%  (Low 2.11%) 

UK         4.08% to 2.91%. (Low 2.79%)

Amongst FX markets, Japanese Yen and Swiss Franc (The traditional safe haven, and lowest yielding currencies) have been 2 of the strongest currencies over the summer. The charts below show the performance of the USD, AUD and EUR versus the JPY and CHF fx crosses.

 

Gold, Silver and Copper have remained strong over the course of the summer, and are currently pushing up against recent highs. But most strikingly the European PIIGS issue has failed to go away, in fact it has continued to trend higher, though it remains shy of the May and June spikes higher. See charts below; top chart is Greek 5 Year Credit Default Swaps (CDS), middle chart is Spain 5 year CDS over the past few months, lower chart is Spain 5 year CDS over past 3 years. (Note; I have highlighted a possible bullish Symmetrical Triangle on the Spain 5 Year CDS chart, which may be a precursor to this breaking out to a new higher level)..

I think it is still fair to say that 'risk-off' remains very much in vogue when it comes to the major western economies. This is probably holding back stock markets, which despite a number of attempts to rally and try and retrace the May/June losses (DAX excepted), become dizzy every time they try to break higher above the top of the recent range. - I would guess that until the fear of risk starts to abate, stock market will continue to struggle to make gains and hold on them. -- I would also be slightly concerned that the PIIGS issue continues to stir in the background, and is showing some signs that it may be preparing to move to a new accelerated level. Another major flare up of the PIIGS issue, could lead to a new flight from risk going forward.

Fear Abating??

The past few days have seen a significant abatement in fear across global markets. - Fear had seemed pervasive across many markets over the past couple of weeks, which merely seemed a further installment of the various episodes of recent months. - The week before last week saw a capitulation in sentiment from the retail individual investor, last week it was the turn of newsletter writers to capitulate. The most recent survey by Investor's Intelligence saw a marked drop in those who see the market as a) bullish or b) within a correction, with those defecting moving to the bearish camp. Last week's reading was:

Bullish ................... 29.4 (-3.9%)
Within a Correction... 32.9 (-2.6%)

Bearish ..................37.7 (+6.5%)
   

This is the first time that the Bullish Camp has been below 30% since MARCH 2009. The chart below shows the SP500 versus the Investors Intelligence Newsletter survey since the early 1990s

Another indicator of recent fear has been the Japanese 10 Year Government Bonds, the yield on these bonds has dropped precipitously over the past few months, from an already low 1.4% to around 0.9%. (Yep, fear has been so strong that investors have been willing to accept yields below 1 per cent for the next 10 years on an instrument issued by a country with a Debt to GDP ratio of close to 200%.  - ( yep TWO HUNDRED PER CENT) - Just for the record the Greek debt to GDP ratio is around 130% (about 2/3rds of Japan's). -- [ I know that is not how markets look at this, but one day a very clever and articulate investor/trader with big bags of bucks, will look at it like that, and suddenly realise WTF,,, he (or she) will rush to get out of Japanese bonds, as well as US and all other bonds.... followed by one or two more, then before you know it everyone is rushing for the exits, and baaaammmm, up go Japanese Bond Yields, then US yields then Euro Yields, and suddenly we are staring a bond market crash right in the face. - Of course it may not happen,, but I believe at some point in the future it probably will happen ,,,,not immediately, but possibly in the next few years.. When that happens, I would not want to be invested in anything that is not at least shiny and hard.]    --  Anyway I digress, the past couple of days have seen a sharp correction higher in JGB yields, currently they stand at 1.12%, from last week's low of 0.90%, this may be reflective of the recent fear starting to abate. This can be seen in the chart below, which also highlights the under performance of US equities at the same time as Japanese yields declined.

The next chart shows fear in relation to the European Sovereign Debt crisis. The top window in this chart is the SP500 Index, the second window is the Spanish v German 10 year yield, I use this as a proxy for all the PIIGS, the third window is the VIX index, and the bottom window is the EURUSD FX. This shows how during late April though May, the PIIGS crisis really exploded, leading to a flight from the EURO and risk, and a sharp pick up in volatility. I have highlighted 3 episodes of Fear during the past 6 months, it is noticeable how each episode, has seen lower peaks in fear as measured by the Spain v German 10 year yield spread, and the VIX index, and the higher level of the EURUSD.

This easing of fear in relation to the above, if it were to continue, could add a favourable backdrop to US equity markets going forward, and this is something which is certainly worth keeping an eye on for now.

TIPPING POINTS ???????!

Overnight markets across the board saw significant moves. Chinese equities dropped sharply, the various indices posted declines of around 4-5%, this has seen follow through in other Asian indices, though not as steep as the Chinese decline. In Europe the move has seen declines of around 2 - 3% thus far, and S&P futures are currently down around 1.3%. Elsewhere global bond markets rallied, leading to a further declines in yields, with the US 10 year yield breaking below 3%. It now appears that Japan, Europe and the US 10 year government yields have all broken key levels... Meanwhile the USD has posted gains versus the Euro and the USDJPY has dropped and is moving close to the spike low posted on the night of the Flash Crash. -- Also worth noting that European spreads PIIGS v Germany have continued to back up following recent declines......
I have posted a selection of charts showing significant markets and the current move in a wider context... FWIW, I believe we are possibly approaching the end of this corrective phase on equity indices, though until the lows of late-May/Early June are clearly broken, this still has the ability to confound me and prove me completely wrong.