The PIIGS and Risk aversion - The sequal.

Concerns over European Sov Debt continue to rattle these markets. Irish 10 year yields are pushing close to 9%, to put some perspective on that just two weeks ago they were below 7%. The Irish contagion has spilled over to other PIIGS as CDS prices have risen strongly for Portugese, Spanish and Italian govt bonds. Meanwhile traditional safe-haven currencies USD, Yen and Swissy are outperforming the Euro and the risk orientated currencies such as the AUD. - Stocks have been wavering through the week, however overnight futures markets have seen heavy losses, and the risks are growing of a much deeper setback. The chart below is the SP500 e-mini futures over the past year. I have highlighted strong similarities between the period Dec 2009 to May 2010, and the period over past few months, the likeness is almost uncanny. - If history were to repeat itself here, (or more to the point rhyme), then things could start to get very ugly. The runaway train which was the SP500 last week may now be getting ready to come of the rails.

Something for the weekend:
Here in Britain, these rain-swept islands perched off of the North-West coast of Europe, we have generally been deemed largely irrelevant in the great race into space. The first country to send anything successfully into space were Germany, unfortunately for us in the UK, we were the intended target, with most of Germany's V2 rockets falling back from space and on to London. Since then the US, Russia and China have all managed to send people into space, plus the odd dog and monkey. We did try sending a probe to Mars a few years back, but we don't think it ever actually got there. -  Finally however, I am very proud to report that Britain finally has a space first, something which has been achieved at a mere fraction of the cost of the many Billion Dollar programmes achieved by other nations. Britain has become the first nation to put a paper plane into space. The story can be seen by hitting this link.  -- So lets hear it for British genius, ingenuity and inventiveness, and from now on, whenever you think of nations pertinent to space exploration, please remember to include Britain very firmly on that list. 

Have a great weekend .........

SPAIN IRELAND V SP500

I will keep this short and sweet today... Spain Credit Default Swaps are soaring, as have Irish CDSs been. In recent weeks Greece and Portuguese CDS have soared. The SP500 has shaken these off so far bolstered by QE, it may continue to do that, but I can't help thinking that a lot of good news is now priced in, whilst new global concerns may start to weigh, particularly as Spain is a much bigger fish than either of the other three. The charts below shows Spain and Irish CDS versus the SP500 over the past year, I have highlighted previous periods where CDS prices started to soar and how the SP500 reacted at the time.

The JPY crosses and the SP500

On Friday I mentioned that my bias on the SP500 is to the upside based on the weight of Technical Arguments, however I also said that I have not been participating in this rally as I had a number of concerns.  I did not think Friday's payroll produced a set of data worthy of the reaction, though the market seems to favour poor data almost more favourably than better data as it suggests more likelihood of QE2.

One other concern I have, which I did not mention last week, is the most recent performance of the EURJPY and the AUDJPY FX crosses. I consider these two crosses as key barometers of risk-on v risk-off. They fell sharply with the stock market in 2008 and rallied well in early 2009 as the stock market turned, though the EURJPY rally fizzled out through the remainder of 2009. Through this year their moves have been quite well correlated in direction (if not magnitude) with moves in the SP500, however as the SP500 has rallied recently, these two crosses have started to stall out again. This can be seen on the next couple of charts, the first charts show the SP500 v EURJPY, note how the price has fallen out of the recent rising channel on the EURJPY, the second charts show the SP500 v AUDJPY, the AUDJPY has been in a big sideways consolidation for three weeks now.

I make these points as observations at this stage rather than suggesting we are about to go into full scale reverse on the SP500. The AUDJPY though is interesting in particular, and I think any sustained breakout of this consolidation may offer some clue as to which way the SP500 may head, and should therefore be watched closely.

Just to reflect my confusion as to the bigger picture, I am posting the some charts of 5 year Credit Default Swaps form Italy,Spain, Ireland and Greece. These seem to be suggesting that fears with regard to these may be easing, given the recent Euro strength this is probably not surprising, still if this continues it should suggest less risk aversion. It is however possible that fears surrounding the PIIGS issue could be a red herring, as in general this has not had a high correlation with the fortunes of the SP500 other than during the period of May-June this year.

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.

Some thoughts on the SP500, EURJPY and Risk-on. Plus RBS trade idea.

US equities took a breather yesterday, and though I believe daily charts continue to support the recent bullish breakout, the failure to make a meaningful assault on 1130, shorter term momentum divergence patterns, plus rather poor volume, all hint that we may see some further consolidation and possibly warrants a little caution.

The Eurostoxx 50 has broken above the upper line of the symmetrical triangle which I referred to in Monday's post (see here), though thus far it is balking at resistance at the Mid-May and Mid- June highs at 2793.5 and 2787.5, these levels may prove pivotal, and until they are broken, a period of consolidation may ensue below these pivots.

With regard to the risk-on trade possibly coming back into favour, I first referred to this in a piece a couple of weeks ago (this can be seen here). Since then the aversion to the PIIGS countries has strongly receded, the large July funding issues have been overcome, CDS prices have dropped significantly, and the spread of PIIGS bond yields over German Bond yields has eased for all countries but Greece, though even the Greek spread has settled down into a range. The charts below show the 10 year v Germany yield spreads for the PIIGS since the start of 2010. (CLICK ON CHARTS TO ENLARGE).

Another measure of risk aversion has been the EURJPY fx cross. The EURJPY dropped sharply earlier this year as the flight from the Euro and risk took hold. Over the past couple of months this appear to have been forming a base, and in the past 24 hours it has attempted a push above the upper boundary of this basing pattern (Rounded Bottom Pattern). The top chart below show the bigger picture of EURJPY over the past 3 years, highlighting the 2 periods of  'Risk Aversion'. The lower chart is a close-in look at the past year.

One note of caution: I keep alive the possibility that this apparent bottoming process, with regard to risk, could morph into a new bearish phase. - Though I do not favour this outcome, as of yet none of the major risk-on trades have cleared or significantly cleared key pivotal or psychological levels. For example 1.3000 on the Euro is clearly a key psychological level for the market, more significantly the sharp drop following the announcement of the Greek bailout occurred from around 1.3100, I also have some key levels around 1.3100/1.3150 which I consider pivotal. The above mentioned Eurostoxx levels are pivotal as is 1130 on the SP500, many other risk-on trades remain close to key pivotal levels but have yet to have made a clear break. 

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Finally a quick look at an individual Stock trade idea. RBS has been a bit of bellwether for the Financial Crisis over this side of the pond. The top chart below shows the Weekly performance since 2006. I have highlighted a possible Ascending Triangle pattern formed over the past couple of years, though this is not yet complete. The chart below that shows BT (British Telecom) for the years 1999 through to 2007, this was a bellwether stock for the Telecoms and IT crash of the early 2000s. I am trying to show how RBS is evolving in a similar way to how the BT price evolved as a base in the years following the Telecom's crash.  
(CLICK ON CHARTS TO ENLARGE).

Looking closer at the basing phase on BT (See chart below); when the price broke above the triangle top, after a lengthy period of consolidation, the stock eventually climbed towards the triangle target and then the base of a significant consolidation zone, - before eventually falling away.

The next chart (see below) shows a closer look at RBS. The price behaviour is similar, and may portend a similar evolution to the BT chart. However there are two significant differences: Firstly the RBS 'Ascending Triangle' pattern is potentially a more bullish pattern than BT's 'Symmetrical Triangle', since resistance at the top of the 'Symmetrical Triangle' pattern is pushing lower, whereas this does not occur with an 'Ascending Triangle' pattern. - Hence any RBS breakout may be more bullish than the tortured breakout which occurred on the BT chart: Secondly, there is a large 'vacuum' of resistance above the RBS triangle which occurred as a result of the price downdraft in Oct 2008. - If the RBS price can clear £0.72 then £0.85 it could see the opposite effect of the downdraft, whereby the price rises rapidly (though not as rapidly as the decline).

Of course the above is all largely academic at this stage, and will remain so until the top of the triangle pattern at £0.60 has yet to be broken. The current price is around £0.50 and still £0.10 points shy of this key level, so it has some work to do to get there. However, I like this trade as it provides a potential nice Risk/Reward. The downside is £0.11 (stop below the recent low). The upside target, if it breaks £0.60 (where one could also add), would be £1.07 for the Triangle target, making a gain of £0.57 (Risk/Reward 5.7/1). Potentially though it could move much higher to the highlighted resistance lows around £1.40/1.50, or even to around £2.00 where the downdraft in October 2008 began, offering a much greater potential Risk/Reward.





 

Austerity measures the Vogue in Europe + Japan 10 Year Yield Analysis

Today's main event in the UK, is the new government's first budget, and one that they hope will re-assure markets with regard to the credibility of the UK's finances. However, I think its significance may be that it will be further confirmation of the reversal of the expansionary Fiscal policies of Western governments of recent years, particularly in the wake of the financial crisis and recession of 2007/8. European Governments have started already, in the case of the PIIGS they have been or are being forced into tough austerity measures, whilst the core Euro governments argued strongly at the recent G20 that deficit reduction is now priority Number 1, and Germany just recently announced a budget aimed at drastically reducing its own deficits. Across to the Far-East and just over a week ago the new Japanese prime-minister Kan Naoto spoke of a new 'Third-way' in Japanese economic policy, whereby deficit reduction measures will become a key leg of government policy. Elsewhere, in emerging markets economies, fear of inflation may be leading to stronger anti-inflationary measures, some commentators cite this as one of the reasons for the weekend's Chinese move of allowing its currency to strengthen against the US dollar. - The US continues to stand by its more expansionary fiscal policy of recent years, however the drive for tighter fiscal policies from Europe and Japan, alongside continued deleveraging efforts by consumers, increases the risk that deflationary forces may continue to exert pressure on asset valuations.

I will post one chart today, it follows yesterday's analysis on the US 10 year yield, whereby I stated that I believe the balance of risks favour lower yields, although as usual things are not that straight forward and we remain close to key pivotal levels which could lead to a reversal in yields. Today I am posting a chart showing weekly 10 year Japan government yields over the past decade (See below). Like the US 10 year yield, this sits very close to a major pivotal line, and today it has moved to within a whisker of this level (The close last night was 1.195%, the lowest close since 1.17% in Jan 2009). Also like the US yield chart, significant price patterns are exerting downward pressure on yields, price action over the past couple of years has led to the formation of a Bearish 'Descending Triangle', additionally price action since 2003 has evolved possibly as a multi-year Head & Shoulders type formation. - Since 2003, the support zone of 1.17-1.20 (my line in the sand), has held as support on numerous occasions, and is likely to be a difficult hurdle to overcome, furthermore rating agencies are watching Japan closely which may provide further support. - However, should this line suffer a clear and sustained breach, I believe that it would suggest stronger deflationary pressures ahead for Japan, though this time, it might not be Japan alone facing the threat of deflation.One final set of charts, unrelated to the above. It is the SP index in 3 charts. Top Chart is 1980s through to present day on a Log Scale. Middle chart is SP Index Mar 2009 daily. Lower chart is 5 minutes for past couple of weeks. Are there similar patterns forming across the 3 different time scales?? ,,,or perhaps I am just curve-fitting (Always a danger)? If the S&P bounces to around 1120ish, then falls through support around 1105/06, it may suggest something in this, though the likelihood is strong that I have curve-fitted...........

PIIGS, Ratings and the World Cup

I don't know if anyone else has noticed, but there seems to be somewhat bizarre correlation occurring with the World Cup and the real world, particularly with regard to a countries performance compared to their investment ratings. - This follows the disastrous spill by the English goalie 'Green' against the US, which echoed the disastrous spill by a British company with a 'green' logo against the US. -- Looking at the PIIGS countries' world cup so far brings home my point. Portugal, one of the pre-tournament favourites, struggled in a 0 -0 draw with Ivory Coast. Current World Champs Italy scraped a draw against mighty Paraguay. Ireland did not make the finals thanks to some handy work by the French, but former European champions Greece looked totally abject losing 2 -0 to South Korea. However, the big shocker was the defeat yesterday of hotly fancied current European champions Spain to Switzerland, a country with barely enough flatland for more than a couple of football pitches. Yet as Spanish government bonds spreads were once again sold heavily and spreads widened sharply, no doubt prompting fears of further downgrades, their football team was losing to the country with possibly the highest rated government bonds in the world. -- Meanwhile the top performers of the opening round of matches pretty well match the recent top performing countries bonds, Germany had the best result of the opening round, whilst the US and Japan, both countries where football (or soccer) rarely gets much attention, easily exceeded their expectations. And finally on a day when Chile looked very impressive in winning their first match, Moody's actually upgraded Chile to Aa3 from A1, 'you could not have made it up'.

Which brings me nicely onto the subject of Spain and Bond yields. Once again the spread of 10 year Spain has widened versus the German benchmark. already as I write this morning, they have widened 10bps on the day, and are now +42bps on the week. However, at the moment markets seem unphased with regard to this, and thus far equities and the Euro are onto holding strong gains made this week. I personally feel that this is like watching a Hurricane forming deep out to sea, which has the potential to be a full strength category 5 with heavy destructive capability should it touch land, however the way markets are behaving it seems they feel that it will probably never reach land. This suggests to me that either this hurricane will blow itself out, or there is too much confidence that its path will not veer onto a more dangerous course.

The chart below shows the widening of Spain v Germany and the divergence with the EURUSD fx rate over the past week.