SP500 Inverse Head & Shoulders Pattern - ????

There has been a lot of talk over the past 2/3 trading days regarding the Inverse Head & Shoulder pattern on S&P futures. Head & Shoulders patterns are one of the most familiar patterns to traders, I also know from personal experience, that they can be one of the most frustrating. Many a time I've found myself jumping on a neckline break, only to be frustrated (I've also found myself committing the cardinal sin of trying to anticipate the break). Breakout failures however can often be more instructive than successful breakouts, not only do they have a tendency to rapidly wipe out the gains(losses) of that pattern, they often move well beyond the extremes of the pattern.

I've posted 3 charts below. - The top chart is the current SPM0 intraday, showing the current Inverse Head & Shoulders pattern. Below that is two examples from the SP500 of prior Head & Shoulders patterns. The first of these two shows the recent top on the S&P500, this was a successful Head & Shoulders. The lower chart shows the S&P500 from last May/June, this appeared at first to be a classic Head & Shoulders top, however the breakdown failed wiping out any losses during the formation of the pattern and the breakout, before making further substantive gains. I believe there is a strong possibility that this recent inverse Head & Shoulders pattern may fall into the category of a failed break, which could lead to significant further losses for the SP500 and US Stocks.Further to the above it is worth noting that the recent episode of Risk aversion across a wide range of markets, which began in late April/Early May, could be about to reassert itself following the pause/correction of the past week. A number of markets have returned to test key levels. Both the Dow Industrials and the S&P500 broke through the 200 day sma the week before last, since then they have both corrected back towards the 200 day ma. The AUDUSD (See below) appears to have completed a large 'Double-Top' pattern, breaking though the neckline of the double-top, however last week's price action saw a return to the breakout of this level. Also Sep10 Eurodollar Futures (See Below) broke down from a rising support line on the 20th May, dropping sharply to 98.865. Since then the future has rebounded to test the breakout of the rising trendline at 99.25, however the future now stands at 99.125.
There have been a number other markets returning to key break levels, including the CAC and the AUDJPY cross. Certain other risky assets have barely made a correction - EURUSD and IBEX to name but two, which really does not bode well for these two. EURUSD is back to the twin lows of mid 1.21s, and may well be breaking out of an Inverted 'Cup & Handle' pattern, I fear a sustained break through 1.2100 here could see rapid losses to 1.15/1.16 area.
I think an interesting week lies in store.

EURUSD - Corrective

The Top chart is EURUSD (Day ÷ 3) Apr – May 2010, the lower chart is EURUSD (Weekly) through 2008 – early 2010.

There seems to be a close match between price action in the lower chart from Summer 2008 through to Spring 2009 and the recent period in the upper chart from late April to the current period. It is also noteworthy that both these period coincides strongly with sharp corrections lower in stocks and the move away from risk.

If this similarity were to continue, it could suggest that after some consolidation beneath the declining white trendline (with pullbacks probably limited to 1.2200), a breakout may occur towards the 1.2600 – 1.2700 region, though it is possible that a breakout may occur without consolidation should the EURUSD make a sustained break of the downtrend line. - The 1.26/1.27 area contains the 1.2672 20^th May retracement high. , it also has several key Fibonacci retracement levels. From there I would expect a period of consolidation. This would tally quite well with a return to the neckline of a multi-month Head & Shoulder pattern. Beyond that I have highlighted some other possibilities, including after some further corrective activity a move higher towards 1.2900 – 1.3000 (which have highlighted in blue). I have also highlighted a couple of other possibilities which given the nature of the bearish move recently, definitely can not be excluded…

- Note – Since this analysis, the pair has broken over the downtrend line posting an intraday high so far around 1.2450. However it has to sustain this break over the next few hours in order to provide some validation to it.

Bulls & bears slug it out.

Markets are incredibly whippy as the Bulls and the Bears battle this out. Who will win ?? Tough question.... a couple of times in the past week or two, the Bears have suffered some hefty blows, yet despite hitting the canvas a couple of times, they have bounced back surprisingly fast. The Bulls have expended an awful lot of energy trying to floor the Bears, and though (in my humble opinion) they still have the strongest punch (and will probably win this battle over the long-term), unless they land the fatal blow pretty damn soon, they will have to stand back and recharge themselves. This will give the Bulls, who seem to have incredible stamina and reserves of energy but a lighter punch, the chance to pull themselves back into this one, for now......

Interesting price action on the CAC Index. - The CAC has been one of the leaders on the decline in risk and stocks over the past 4/5 weeks. Over the past few days, the CAC appears to have completed a rare 'Bullish Island Reversal' (See chart below). This is a strong hint that this index may be due for a more meaningful correction. Also note the reversal higher in Sep Eurodollar futures, following the large hammer candle which I alluded to a couple of days ago, has continued. - Additionally, it is worth noting that there has been a strong correlation between the EURUSD and the CAC in recent weeks, however the recent low on the CAC was not confirmed by a new low on the EURUSD, and this non-confirmation may also be significant.

With regard to the S&P index. The past 4 trading days have seen 'extreme indecision'. This can be seen on the following 2 day candle chart. If this is going to reverse/correct higher, it is going to be essential for the S&P to make a 'Sustained break' above the high of the past 4 days around 1091.

SEP10 Eurodollars bounced sharply intraday.

The Sep 10 Eurodollars have posted a large rebound this afternoon having sold off sharply this morning. Liquidity fears have been one of the drivers of the recent sell-off in stocks. - Below are charts of Daily Sep Eurodollars and the Daily Dow Industrials.

Wall St - Movies & Crashes !!!

It was recently brought to my attention that the sequel to the 1987 movie 'Wall Street' is due to be released in September this year. Originally titled 'Wall Street 2' the movies name was changed to 'Wall Street: Money Never Sleeps'. It was also pointed out to me that a movie also called 'Wall Street' was released in December 1929. Now I'm not one the superstitious type, however I am a sucker for coincidences: 1929, 1987, now 2010. --- I have posted charts of the market set-ups in the 12-18 month period leading up to the release of the movies. Some may say that the graphs bear a spooky similarity, others may argue that this is merely a 'Random walk down Wall Street'!!!!

Meltdown Postponed

A nervous stock market managed to hold some crucial levels on Friday as the US session rallied after gapping down on the open. This morning, thus far equities markets have failed to follow through on Friday's turnaround in a relatively quiet (European holiday affected) session. I believe the on-going negative environment in global markets is likely to keep markets on the defensive over the near-term. The recent turmoil in financial markets continues to pressure Libors as interbank lending tightens up. Libor spreads remain on the radar for traders and investors, the charts below highlight the recent tick-up in Libor relative to the OIS market. They also show the link between this funding spread and the stock market moves of the past few years. -- It is worth noting that the move has so far been relatively small compared to the 2007/2008 period. However I believe a) The stock market is far probably more sensitive to tightening liquidity than it was at the start of the credit crisis. b) It is unlikely (though not impossible) that we will repeat the highs of 2007 and 2008 in the Libor/OIS spread, since bank balance sheets are probably less exposed than they were during those periods, and much of their risk has been assumed by sovereigns.

Mad as a Box of Frogs.

'Mad as a Box of Frogs' describes these markets of the past few days. Currencies, Stocks, Commodities have been all over shop this past 24/48 hours. Overnight, the currency markets saw some huge swings. - Of note the AUDUSD moved sharply lower, hitting 80.72, tagging the 38.2% fib retrace of the entire 18 month rally into 2010, it then posted a 3 big figure rally in a few hours before settling down (relatively speaking). EURCHF has possibly been the most significant mover however. The SNB spent virtually all last week defending the 1.4000 area, their 'line in the sand', then in the past 2 days they squeezed the EURCHF massively higher. Overnight it almost hit 1.4600, since then it has retreated back below 1.4400. It will be interesting to see if what the do today, particularly following comments yesterday from the SNB's Danthine, stating that there were 'no limits to FX intervention'. There are reasons why I believe the EURCHF rebound significant in the immediate environment, which I will elaborate on below.

From a trading stance, I have maintained a short position on the June SP futures this past week, which has helped get my year back on track, following a spate of small disasters through April. Whilst I am of the opinion that we are in the early stages of the next leg of a significant bear market in stocks, I believe we are at risk of a short sharp correction from around current levels. I have posted 2 sets of charts below, the first chart shows the SP500 index over the past 18 months. This shows a line of support connecting a series of lows since Oct last year. It is my belief that this line is critical, and whilst I expect it to succumb I do feel that it may hold a first attempt, which would favour a short sharp correction higher

The second set of chart shows the EURCHF and the SP 500 over the past couple of years. I have highlighted the 2 previous sharp bounces higher in the EURCHF in Oct 2008 and March 2009. It is noteworthy that in both cases the SP corrected sharply higher, whilst I appreciate that 2 data points do not prove anything, I think it is an observation worth noting.

With regard to my trading yesterday; whilst satisfied with my action on the SP500, I am somewhat disappointed with my trading performance on the Bund. Having bought on the break up yesterday through 127.60, I felt we could see a move up into the mid 128s. However, I decided prematurely to get out at 127.80 anticipating a return towards the break-out, which would then be followed by a move sharply higher into the 128s. Well the return to break never occurred and the Bund rallied sharply higher into the 128s, without me on board. Finessing can sometimes be expensive.

My First Post – Time to pay the piper.

I write this first blog in interesting times. -- Financial markets have been incredibly volatile in recent weeks. The EUR has dropped like a stone in recent weeks, European stock markets are dropping fast, which has spilled over to US indices, and the risk trades of the past year, such as the AUDJPY carry trade have recently gone into sharp reverse (See chart below).

At times like this I believe it is essential to understand the big picture. It is in my opinion that we are on the cusp of a major deflationary cycle. I do not profess to be an expert economist, however let me explain anecdotally why I think this is occurring. To me it is clear that Debt - Sovereign, Municipal, Corporate (though perhaps less so) & Private - in the mature economies, have reached the limit of their excesses. In recent years the economies of Europe, the US and other modern economies years have seen their debts spiral. -- There comes a point where we become saturated with debt, every individual knows that there comes a time when you either repay that debt (Pay the Piper), or you declare bankruptcy and no longer have access to further debt. The upshot; - no more nice holidays or fast cars (not in the immediate future anyway). It does not matter how cheap the price of debt, you ‘ain’t gonna get it’, unless you want pay a visit to the local loan-shark and pay crazy rates, with the added risk of losing your kneecaps. – This is the situation facing the global economy (BTW the IMF would be the loan-shark). The Greek crisis has merely served as a siren to other nations and to investors with regard to what is likely to happen if debt is not brought under control. Austerity measures abound in the PIIGS countries, and whether forced or pre-empted, this is going to be a major theme within the global economy for many years. Governments will have to enact hefty spending cuts or higher taxes, or most probably a mixture of both. This will heavily impact the overstretched consumers, and will likely lead to either higher levels or more prolonged elevated levels of unemployment.

This backdrop is not going to be favourable for stocks. I do not know what the correct valuation for stocks indices are; however I bet they are not discounting a major deflationary cycle. Furthermore, with governments trying to reduce their debt obligations I do not think they will be rushing to the bailout station as rapidly as in the past 2 years. It sounds doom & gloom; I wish it was not, I have never considered myself a permabear (nor a permabull for that matter). As a trader I like to merely try and capture the moves, however it helps to be a realist, and this is the ugly background to the financial markets – in my humble opinion.