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Wednesday, 15 September 2010

Opex chop

It was a very strange day yesterday with big moves on rumors that the Fed is likely to start large scale quantitative easing again. The effect was a big fall on USD and a rise on equities that hasn't been sustained so far. We did get the exact hit on the neckline of the big SPX IHS that I've been waiting for:

I was expecting a bit of a retracement yesterday and it looks as though we may well get it today instead. Dow and SPX have now broken their support trendlines and we appear to be in a topping phase that will probably last until opex. I'm expecting us to chop around in the 1100 - 1130 SPX area until the end of the week at least.

There were a number of bullish developments yesterday on a number of markets. One that caught my eye was emerging markets, where the April high was exceeded slightly. I've posted the EEM chart before to show how it tends to bottom before SPX as a lead indicator. Here's the daily futures chart to show where we are now, with a rising wedge top trendline hit as well as April resistance, and a retracement towards the lower trendline that has already started:

That illustrates one of the numerous reasons why yesterday's high is such a strong resistance area for equities. We are likely to see a significant retracement from this area regardless of what happens afterwards and my view is that we most likely chop around in a topping area for the rest of opex week and then retrace next week. What happens after that is harder to say but I'm leaning more bullish after yesterday.

On EURUSD the IHS neckline was convincingly broken yesterday and EURUSD made it all the way up to the next major resistance level at 1.303. It is retracing now and I'm watching carefully to see whether the 1.292 neckline is tested or rebroken. If it is rebroken then the IHS is less likely to play out to the 1.325 target. If the next major break is up through 1.303 though, then that target will most likely be made. The EURUSD IHS isn't as high quality as the SPX IHS as one shoulder is very much smaller than the other, and that does tend to affect reliability:

I had a query yesterday after I posted the 74% probability of meeting target for the SPX IHS if the neckline is broken. That stat is from Bulkowski based on many past patterns on many stocks and indices, but I had a look at the three year SPX chart to see how these patterns have performed on SPX over recent years.

The two previous large IHS patterns that have formed were from the March 2009 and Feb 2010 lows and both played out to target. The only two large bearish patterns I found were the one from last July that failed, and this year's pattern that has failed so far and looks unlikely to play out to target now. That is encouraging for bulls at least if the current IHS neckline is broken:

30 year treasuries hit my support level earlier in the week, and have since bounced strongly back to the top trendline of the short term declining channel, which was good resistance yesterday. I was reading some speculation yesterday that large scale Fed purchases of treasuries would support the bond market and drive down yields but I have to say that there's little evidence to suggest that is true. Bonds are negatively correlated with equities and the large scale Fed purchases of bonds last year had a very positive effect on equities, but bonds were flat at best. Bonds only really took off when large scale Fed purchases of treasuries ended in March this year.

I've illustrated this with the chart showing 30yr treasury yields with SPX as the background. Yields move up when bond prices move down of course, so the correlation with equities becomes a positive one:

If equities do break up on Feb purchases on bonds therefore, then the strong rally in treasuries that we've seen in recent months is most likely over, and bonds should trend flat to down while USD gets trashed again. That is also common sense as equities rising strongly is in anticipation of a stronger economy, and a stronger economy would strongly imply higher interest rates.

Gold and Silver had massive days yesterday as the rumor that the Fed was going to resume large scale efforts to debase USD once again underlined the value of a store of value that can't be printed. The two year rising channel on gold that I posted last month at 1170 has the next upside target at over 1400, though I'm expecting some retracement when silver hits the February 2008 high at 21.33. Here's the channel on gold:

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