Global economic surprises remain flat to down. Leading indicators for Euro-land fell to minus 0.8. Globally, some countries have slipped negative, others remain positive. ECRI US leading indicators came in at 0.1. Draw it all together and the picture is one of weakening but mixed leading indicators and current data disappointment. Add to this fear over Greece, with impending elections in June, and Euro CDSs still on the rise, and it is perhaps not surprising that we sold off and moved down to oversold and overbearish in pro-risk in a variety of indicators. However, now that we have hit those levels, a snapback rally should occur. Regardless of outlook, a period of mean reversion should come to pass.
I consider two possibilities for how this will arise. The first is that we bottomed with the Capitulation point I wrote about a week ago and that the tentative pull-up from there that took place is cemented as the low. The second is that we need to make a lower low, with a positive Nymo divergence, before we rally. In doing so we would perhaps hit oversold/overbearish extremes in those indicators that haven’t yet delivered, such as Investors Intelligence sentiment and Rydex market timers. The full moon occurs a week today and we normally see downward pressure into it, which would support the lower low option. Supporting the rally-from-here option, we are particularly stretched in the Euro-Dollar, with its pro/anti-risk implications. MACD positive divergence, excessive Euro shorts, extreme Dollar bullishness. Here is the USD index chart:
The US dollar is trying to break out on those extreme contrary readings, which suggests it could reverse here and make that little break to the upside a fake out. If it is to do so though, it needs to occur right away, which would support the rally-from-here option. Clearly, newsflow has the power to trigger here. Since capitulation a week ago, stocks rallied without any real positive developments on the macro front. For this reason I suggest the rally was thus far fairly weak. But should some positive news come to light, then the mean reversion should accelerate.
So let’s see how this week pans out. No position changes for now. If we make a lower low with positive divergence into June, I will attack on the long side again. If we rise up from here I will alternatively be looking for negative divergences and weak internals if I am to take profits on longs. I believe the macro picture make it likely the ECB will cut rates in June and China will ease/stimulate in some way. The FOMC is just 3 weeks away and Twist expires then. I suggest the Fed will also deliver ‘something’, as nothing would amount to tightening (given Twist will expire). The President may also be keen on something to juice the markets, as the chart below makes clear:
Source: Big Picture / Bianco Research
Several technical indicators that I have previously referred to (such as nominal Nymo, insider buying) point to this being an important bottom, suggesting we can rally into mid-year. By solar cycles, we should see a natural turn up in growth and inflation and speculation. I expect that to occur, but boosted by central banks intervention in this soft period. The secular position that I wrote about supports upside too. So, I remain a bull, with longs. But the acid test will come as we make the mean-reversion rally ahead. If this is supported by central bank actions and improving leading indicators and economic surprises, then I expect to be proven correct. If however the picture remains weak and negative divergences abound, then I would alter stance and sell into the rally.