Sunday, September 20, 2015

Market Analysis for Week of 9/21/15

I was willing to grant the Fed a small window to attempt a token, symbolic rate rise for a few non-economic reasons, but mostly so they could say when we're looking back in a few years, after it all blows up, that they weren't the most irresponsible organization on Earth and they tried to raise rates but the market wouldn't allow it, so the fact that we hit another recession with their back against the wall and no choice but to go negative is not their fault.  They tried.   What so many people seem to be in denial about is there is never going to be the economic conditions for hiking rates, especially not a full cycle toward normalization.  Those dot plots are delusional.  That will never happen.  A possible rate hike was only about whether they could pull off a one-and-done, or whether the market would let them do two, meaning how far could they get before they're forced to retreat.  We can squabble over whether they actually had any intention all along to raise rates or not but the big game changer was the China devaluation in early August.

The broad trade-weighted dollar index actually broke its March $117 highs right before China announced their devaluation and it's currently $3 higher at roughly $120.  The difference in this index is that it weighs the Euro at only 16% and the Yuan at 21%.  Whereas the narrower currency-driven dollar index with a futures contract doesn't include China and the Euro weighting is 58%, which explains why it's still consolidating well off the highs as the trade-weighted dollar breaks out.

China's exports fell in July by over 8% and in August by over 6%, so if this trend continues I would expect the China devaluations to continue (overall), which will drive the trade-weighted dollar index higher even without the Fed raising rates.  Not only are the Fed's hands tied because there is not an actual economic recovery taking place (can we please stop pretending the 5.1% unemployment rate means anything - seriously, put down the Koolaid), but with China entering the currency wars and putting upward pressure on the dollar, the Fed simply can not add fuel to the fire by tightening.  And now that they openly admit this is a problem, even worse news for the Fed would be if the ECB expands its QE program.  I'll get to the charts in a moment but this is one reason I can't give up on the idea of the dollar just yet.  I thought the Fed would be the big catalyst one way or the other but it might end up being the ECB in Oct.

The other major bombshell from Yellen was the admission that they would even consider doing negative interest rates.  The main reason I switched from being an inflationist in my end game outlook to a deflationist at the end of 2012 was the realization that the central banks would eventually run out of assets to buy so their ability to inflate the currency away had limits.  So I thought the most likely outcome after they reached those limits would be a massive global deflation and the introduction of a new reserve currency like the SDR so all the countries of the world could devalue their debts overnight against it.  And now that I write it, I still think that's the only inevitable option, but the path of how we get there might be drastically altered if the Fed goes down the road of negative interest rates.  But that's getting too far ahead.

The "appropriate" response to the negative interest rate question should have been like that beer commercial with Colts coach Jim Mora when he said: Playoffs?!  Playoffs?!   Yellen should have stood right up and got that same twisted look on her face as she said: Negative?!  Negative?!  How crazy do you think we are?   But she didn't.  And that's very revealing.

So here's the thing about the dollar.  Yes, it could be in big trouble.  However, if the ECB expands in Oct, and the Fed hasn't admitted it can't raise rates, we could see a self-propelling loop where the Euro tanks, forcing the dollar up, forcing China to devalue more, forcing the dollar up...until the Fed finally has to return to the devaluation game.  So the timing is the key.  And this is where technicals will help.  There's a very clear pattern in the EUR/USD and the dollar index.  Most likely the resolution of these patterns will run quite a bit.  But there's been a few false starts as the market tries to figure these fools out.

Dollar daily bounced off its 200 EMA and closed Friday strong.  It now sits beneath the rest of its moving averages with a lot of room before any kind of action is forced.

The EUR/USD weekly chart closed back inside the range after breaking out and getting rejected twice now.  The next ECB meeting isn't until Oct 22nd, so technically there is room to hold this pattern until then but the daily ranges would have to shrink and it's rare to go all the way to the end of a triangle.  I've seen it before and it would be a dream scenario if it happened because a triangle this well-defined breaking out on fundamental news would be the most confidence you could possibly have taking a trade.   One can hope.

The gold market acted how you would think with a dovish Fed, but it is approaching a well defined trend line of its own.  A breakout through there opens the door to the monthly horizontal resistance at $1180, or the bigger downtrend line that runs through $1230-ish.   I'm still thinking the long side of gold is counter-trend and short-lived but I consider these spots playable.  You just have to be careful of the fake-out.

Here's what a bullish scenario would look like to me.  First, the ECB has to not expand its QE, causing the Euro to breakout to the upside and the dollar to breakdown.  Second, gold needs to break and hold $1140, $1180, and then $1230 without the trade becoming so full of Spec longs that there is no one left to buy.  Next, the Fed has to officially announce they are no longer considering raising rates but instead of thinking about NIRP or more QE, which would likely require drastically worse data and/or a stock market melting down below last Oct's lows.  Until then all long side trades in gold should be surgically executed and short-term, meaning take profits at resistance and look to reenter or even get short.  Gold requires a shift in sentiment that creates incentive for the Commercials to believe they can hedge from higher prices because the Spec longs are returning with conviction so the depth of offers can lighten, which allows prices to rise on less contracts.   I'm still more concerned that the Fed won't concede for awhile and the ECB will expand, but we will see.  The dollar is requiring a super human level of patience but one way or the other it will pay off.

Oil weekly also has a well-defined downtrend line.  Eventually, it will break and make for a great long trade, but it too will likely depend on the dollar.  The correlations haven't been all that strong lately but that has a lot to do with the uncertainty of the dollar in this huge consolidation period.  It's not like the dollar correlations are tick-by-tick or even day-by-day, but when the dollar has a strong belief behind it, meaning its trending due to central bank actions, the correlated assets will not ignore it.  So in the short-term, until the dollar and euro make the next move known, oil's own fundamentals should be more important.  Until proven otherwise, you have to assume this downtrend line will be defended by the spec shorts and the commercial hedgers, pushing oil lower, unless the dollar breaks out of its range to the downside.  In terms of oil's fundamentals it sounds to me like the level of production needs more time to slow down before the demand will outstrip the supply and cause it to bottom.

Bonds made a strong post Fed move but this too will be influenced by both equities and the ECB.  Equities is obvious but if the ECB expands their QE and causes a dollar breakout to the upside it will cause China to devalue more which means selling bonds.  I don't know who wins between a flight to safety bid and possible China selling but when you look at the bond chart you have to notice that it put in a lower high and is now making its way back to the downtrend line.  It's also overbought on the short-term charts so this is one of those times when if it happens to pullback and setup a low risk intraday entry to the long side, I would take it and try for the test of the downtrend line just over 160.   At that point I would play a breakout of that downtrend line, or not be involved.  Only because I'm not into shorting a 30-year bull market in a time of potential sustained equity weakness.

ES daily did its usual nasty thang, breaking out of the flag on dovish news but reversing at the 50-day EMA to the tick and closing back into range at the bottom.  Even though it was a good 20 points away, I consider this the backtest of the 8-month range due to how it transpired as sellers capped dovish news, which makes perfect technical sense.  I did bet my life it would happen, although, 10 points short of where I thought it would go, which I already factored in 10 points short of the actual level, so maybe it's a stretch but it's not like it has to touch the level to the tick.  In fact, coming up short just shows weakness.  This market should not close above the top of the flag at 1992 anymore if the sellers mean bidness.

If you're a bull you have to be asking yourself why the reversal when the Fed, if anything, was surprisingly dovish and the flag broke out to the upside in options expiration week?  In a bull market, bad news gets bought up.  In a bear market, good news gets sold.  It's just about the positioning, the sentiment, and who's in control.  The actual prices are fairly meaningless.  

It pretty much went how you would think.  The weak shorts got flushed out into FOMC like they always do, you had the surprise dovish breakout, and then the big sellers showed up and made everyone their bitch.  So you have to assume the sellers will show up to cap rallies and keep the pressure downward from this point on.  We are a bit oversold on the short-term charts, so a rally, even almost back to the top of the flag shouldn't be a surprise if it happens.  But the sellers need to prevent a close above 1992 to stay firmly in control.  If you're a bull you also have to be asking yourself what could possibly happen now to cause the buyers to regain control if they couldn't do it on a no-rate-hike-until-the-world-is-a-utopia Fed?  I consider a breakdown close from this flag to be the official game on to the short side, potentially all the way to last Oct lows.  And any close above the flag at 1992 would be a caution flag making me question why the sellers couldn't hold it down.