The Bank Index and Housing Index, worrying signals. + 'Sub-Prime 2' ?? + Quick EURUSD comment.

My posting on Friday and my posting today will be totally contradictory. Friday's posting showed a reason to be bullish on the back of a comparison of the SP500 in the mid 1970s versus the past year. This has been a part of the backdrop for the year and has been one reason (amongst other technical reasons, holding me back from getting my bearish hat on since we based in the summer). However, there have been a number of reasons I have failed to join the bull trade, despite reference to various bullish scenarios I have made, which is that I just see too many conflicting signals and this keeps me wary of the the bull run.

My post today will focus on what is going on with financials and housing. In recent weeks I have made various references to how the financial sector continues to lag this market. Using the Phili Bank Index as a proxy for the financial sector, at times the financial sector has threatened to move up, but every times it tries it gets shunted back down again. This week the SP500 once again moved higher, however the Bank Index yet again failed to follow suit and ended the week having endured a torrid time. On Wednesday morning the Bank Index made a small break up through resistance on the open only to completely reverse and by Friday's close had lost around 7% from Wednesday's high. This can be seen on the chart below showing the SPDR Bank Index ETF. 

What worries me is that the financial crisis of the 2007/2008 saw a big divergence between the broader indices and the Bank Index through 2007 prior to the collapse in 2008.  The top chart shows this below, the second chart shows how we are once again seeing a strong divergence.

 

 
The next pair of charts show the Phili Housing Index (an index of 27 stocks representative of the housing sector) and the SP500 over the past 5 years. Note how strongly these diverged through 2006 and 2007, then eventually in 2008 the housing index and the broader market started to move in unison, during 2009 both markets recovered then fell away in summer 2010, however rather like banking stocks the direction of the housing index and the broader market has diverged over the summer and fall.

Finally and linked in to the above I want to draw attention to this weekend's John Mauldin letter. I have been reading his letters for a few years now, he makes these available on free subscription basis (click here to open his home page where you can subscribe). Mauldin has been a brilliant commentator of the financial markets, and I believe a read of his weekly letters is a must for anyone who wants to understand the fundamental backdrop to the big issues facing markets. - This week's letter is titled 'The Sub-Prime Debacle: Act 2', the title says it all, I don't need to elaborate any further, however I do suggest reading it in its entirety (it can be seen clicking here). Mauldin first really started focusing on the Housing Market as a major potential worry in the second half of 2006 and became more focused on Sub-Prime through 2007. I am posting a link here to one exceptional article he wrote in August 2006, which not only highlighted concerns about the housing market, but talked about about how a series of small shocks can weaken the underlying structure of a market leading to the sort of instability which makes a 'Crash' possible. In light of events through 2008, I really think this article was somewhat prophetic in nature.

There have been many analogies with regard to events throughout the 2007 - 2008 financial crisis, personally I prefer the analogy of a Tsunami, a substantial earthquake takes place thousands of miles away in the ocean (Sub-Prime) a wave races out in all directions, as it gets closer to the coast it grows larger, still those close to the coast have no idea it is approaching, then seemingly from nowhere utter devastation, often out of all proportion to the original trigger event. The thing with Tsunamis is they usually consist of many waves, not just one wave, this is often referred to as the tsunami wave train. The amount of time between successive waves, known as the wave period, is sometimes only a few minutes, in other instances waves are over an hour apart. Many people have lost their lives after returning home in between the waves of a tsunami, thinking that the waves had stopped coming. - I can not help thinking the waves of the Sub-Prime Tsunami have yet to have fully passed by, perhaps if Mauldin is correct, then Sub-Prime Act 2 is the next wave.

Perhaps the early indications are starting to show in the behaviour of the divergence between financials and the broader indexes. I am not sure the market is yet ready to succumb to the next wave, however the fingers of instability remain, and new ones appear to be emerging. It is possible the SP500 has one final spurt, helped by the impending arrival of QE2 and a stated change to the Feds Inflation target, which could see a move back to the highs of April 2010 or perhaps a touch higher (the 2007 divergence of financials and the broader index happened as the SP500 made a slight new all-time high) or perhaps it could succumb sooner. -  One technical analysts I follow is 'Humble Student', he believes we are very close to the next tsunami wave. I have come to respect his calls after following him for a while, he provides lots of alternative technical analysis methodologies and nailed almost to the minute the 'Flash Crash', and the low and rally in late August/early Sept (thus in my opinion enabling him to avoid the moniker easily attached to so many Tech-Analysts of 'Perma-bear'). His timing has not been perfect thus far on this call, however if something so big and significant is about to hit either soon or after a small delay, then exactness on timing is probably not the most critical issue here.

EURUSD

Friday saw a sharp turnaround in the EURUSD in the wake of the Bernanke Speech after hitting its highest level since January. The 1.4000 area appears to be large psychological resistance area for now. I feel we may see more corrective activity this week. The past two days have produced some potential reversal candle signals. The two charts below reflect this, the first one is the daily Spot FX chart, the second chart is the CME EURUSD future.

Finally the 4-Hour chart (below) appears to reflect the above, showing strong bearish divergence on both RSI and MACD, and also a failure at the rising trendline of the past months rally. Short-term, I think we may see an attempt at 1.3860-80, where a shallow trendline of the 2 weeks intersects, below it is quite possible we see a deeper move to 1.3580 (38.2% retrace).