This week has been on average the most bearish of the year historically. We also have downward pressure into this coming weekend’s full moon. To add to that we had reached levels of overbought and overbullishness in a range of pro-risk markets (plus support/resistance levels in Euro and Dollar). And following previous QE announcements, the markets corrected for a couple of weeks after the initial euphoria of the announcement, example here:
Source: Chris Ciovacco
So, I expect the markets to continue to consolidate into next week, and then resume bullishly. It is important that those markets that broke out over their previous March/April 2012 highs, stay above those breakouts, or succesfully backtest. I have shown that level on the chart below which overlays the Sp500 on the Dax – I would like to see the Dax hold above 7200 and the SP500 above 1420.
On the macro front, the environment has improved for pro-risk. Economic Surprises remain positive and in an up trend:
Source: Ed Yardeni
European debt accuteness has retreated:
Source: Acting Man
ECRI US leading indicators continue their uptrend:
The missing piece of late had been global leading indicators which persisted in the negative, however we now see positive development here, and evidence that reflation is coming:
Conference Board Leading Indicators 26 Sept 2012:
Conference Board Leading Indicators 24 Aug 2012:
The snapshot of the CB leading indicators above today and one month ago show a much healthier picture. With China particularly strong looking forward, that aids the commodities bull case. However, we now need to cross reference this with surveys and data coming out of China and the rest of world to ensure the improvement is valid.
One other key macro consideration is earnings, particularly US earnings, and US earnings season begins again 9th October with Alcoa. If pro-risk does consolidate into next week, then the following week I would be looking for pro-risk to be back in bull resumption, but it would be against the backdrop of earnings announcements beginning. In other words, it is important that earnings do not disappoint. As well as the earnings factor, Euroland is back in the news, so developments need to be monitored, but broadly speaking the macro evironment is currently supportive for pro-risk.
Dow Transports continue to be a concern. That index completely reversed its positive reversal, as shown:
Source: TSP Talk
The divergence with the Dow Industrials has been in place now for 6 months (DJIA made a new high but Transports did not). At some previous important tops in equities, the Transports topped out 1-8 months before the Industrials. That makes it a warning flag – unless of course it recovers and makes a new high.
If I am wrong about stocks pushing higher into the end of 2012, and this is indeed a top, correctly flagged by the Transports, then recall that topping is a process, and should take some time and messy price action, as highlighted for the last two cyclical bull peaks:
We should see more flags appear, and negative divergences appear in breadth and market internals. Also, we only just reached overbullish levels in indicators such as stocks over 50MA and bullish percent / call put, and these too have historically needed some time flirting with the extreme zone before the market keeled over.
If we consider for a moment that the topping process actually began in March/April and this is a little overthrow of the previous highs but essentially a double top in a multi-month topping process, then know that we don’t share the usual features of a cyclical bull top: leading indicators are trending up, economic surprises are trending up, there has been no inflation accleration or rate tightening, US yield curve is normal, rotation only recently began out of defensives, and so on. So I believe that scenario, that topping has been occurring since March, is unlikely, but a breakdown back beneath the March/April highs s/r level in the stock indices would give that more merit.
In short, I see us at a reflationary point, which should enable further upside for pro-risk. But too much frothiness first needs working off to some degree.