The weight of the evidence has been building in favor of the bears over the last week or two, making the US equity weakness this week anything but surprising. Throughout the duration of this post I'll outline the evidence that I've been noticing over the last two weeks and what it means for us as market participants moving forward.
Yen Strength - The Yen broke out structurally late last year and hasn't looked back since. Tactically my upside targets were hit this week, but structurally this market has a lot more room to run. Given the high negative correlation between the Yen and US equities, this should continue to be a headwind for equity markets going forward.
From late January until today, there have been tactical breakouts in currencies of countries with significant commodity exposure relative to the US Dollar. This has provided a tailwind to a number of emerging market equities that have subsequently followed through to the upside. Many of these equity markets are concentrated in Latin America, but areas like South Africa, Africa, Australia, and Turkey have benefited as well.
Whether or not these tactical moves will continue and develop into long-term trends is entirely unknown, but the risk/reward in the US Dollar/Brazilian Real looks particularly skewed in favor of the bears here.
One of the best ways to be positioned over the past 2 months has been to be in Emerging Markets, not in U.S. Stocks. I've been pounding the table on this trade since January and it has really worked out in our favor. The big question today is: Now What? Does this thing keep going, or does the longer-term trend of the U.S. outperforming Emerging Markets resume in the second quarter?
Intermarket Day is one of my favorite days. Yes I'm a huge nerd. Deal with it!
This is when I go through many markets relative to each other. These markets include individual U.S. Sectors compared with the overall U.S. Stock market. We also look at other assets against each other like Bonds, Commodities and Currencies. We price Gold in other currencies, and change around denominators for both trade idea generation and also for informational purposes.
Here are some of the things that stood out from this week's homework:
Last week a structural breakout in AUD/USD was confirmed. Whether you trade currencies or not, it's worth paying attention to because of its implications from an inter-market perspective.
From a structural point of view, the Australian Dollar has been in a downtrend since 2012, with the selling really accelerating in late 2014. Recently this pair met its downside target at support near 0.68-0.69 and began consolidating as momentum diverged positively. Last week, prices broke above the downtrend line from the November 2014 highs to confirm the bullish divergence and breakout. This development suggests that as long as prices remain above the downtrend line, this market is likely headed toward prior support near 0.8075-0.81.
Crude Oil confirmed a failed breakdown below the 2009 lows last week. This development is extremely important from a risk management standpoint and has big implications from an inter-market perspective.
This market has been in a structural downtrend since late 2014 when prices broke down out of a five year long symmetrical triangle. The resolution out of this pattern was explosive, with prices declining roughly 75% off of the 2014 highs in less than two years. During this decline there has been no reason to be long this market for anything more than a tactical bounce, but with last week's close above the 2009 lows it is finally feasible for those with a longer-term time horizon to approach this market from the long side.
On Monday afternoon I was over at the Bloomberg headquarters in New York City to discuss markets with Joe Weisenthal, Alix Steel and Scarlet Fu. Every time I've been on a guest on this show I've had pretty much nothing but bad news to share as far as the stock market is concerned. In January, all of our downside objectives were achieved and I've really changed my tune. I think this strength we've seen in stocks over the past month continues, particularly the relative strength in emerging markets.
With the Yen rallying nearly 10% from intraday low to high in as many days, this breakout is not one to be ignored. Since the Yen has a strong negative correlation with US equities, this inter-market relationship is an important one to keep track of regardless of whether you trade currencies or not.
Structurally the Yen has been trading in a seven point range at and below the 2006-2007 lows for the last 15 months. Late last year prices confirmed a failed breakdown by breaking back above the 2005 & 2007 lows, as well as the downtrend line from the 2012 highs.
Over the past two weeks prices have accelerated to the upside, providing additional confirmation that this market is headed higher. As long as prices can hold above support outlined in gray (.0082), then the weight of evidence suggests the first upside target is near the 161.8% extension of the late 2014-2016 range and prior support near .0098-.0099.
