View: Near-term equity upside doesn’t change longer-term bear picture
The returns from the summer’s front running exercise have been very healthy across many equity markets but now central banks have actually delivered, directly in the case of the BoE, the Fed and as of this morning the BoJ and via promised intervention by the rather more standoffish ECB, the question comes back to whether this move is actually sustainable. As ever there is the sales pitch that valuations are compelling which appears particularly relevant for the beleaguered Eurozone periphery and the more dubious view that higher equity markets themselves are a precursor to better economic times. Of course the central bull driver really is positive expectations as to how this further quantitative easing will impact asset prices, reflecting on the lift risk assets saw following QE1 and more relevantly QE2.
Looking at the technical picture the overall move higher continues to look rather suspect though, not that that means it can’t necessarily extend in the shorter-term, with numerous divergences present on the longer-term charts and volumes still shocking. Indeed S&P volumes for August were the lowest since June 1998 having been trending lower ever since the market touched that 666 low back in March 2009. We also continue to note the differing trajectories of the DJI and Transports index, another one of those parameters required for a Dow Theory sell signal. While momentum has picked up a little over the past few weeks the general direction still has a bias to weakening while there are persistent RSI divergences on both the monthly and weekly charts which usually come right in the end.
For the moment though the immediate trend is clearly upward with higher highs and higher lows the order of the day. Indeed for the bears to shift back into the driving seat the market needs to break down through the 1,266 level which is some 15% away. We think while there is a corrective bias after the strong gains of the past 16 weeks it’ll take a significant event to get the market back through here (low volatility means long dated puts might be a good strategy if you want to hedge something like an Israeli strike on Iran which might facilitate such a crash), particularly with all the supportive flow from QE which should continue to drive cash alongside the specs into riskier assets. With this in mind the S&P500 should be able to hold 1,422 and certainly the more important 1,360 level (approx. 76.4% Fib of the big ’07-’09 sell off) ahead of making a more important top which should fall shy of the 2007 record highs at 1,576 which bulls are now focused on, leaving the long-term bear trend in place in the process.
This fits with our fundamental concerns over the global economy – be it from headwinds of recession in Europe, Chinese economic and political problems or slower domestic activity in the US further dampening growth potential – which should reassert themselves as the QE3 lift is worked through, not to mention those other political and geopolitical dangers. Some of these are partial derivatives of the adjustment process following the financial crisis, still toxic bank balance sheets and the ensuing drag on growth that higher levels of government debt also has though distortions that central bank stimulus has had on asset levels and investors holdings (particularly if volatility spikes in any meaningful way) is also relevant. With all this in mind it’s always worth a glance at the Nikkei chart above as to what can happen.