Market breaks out ahead of FOMC

Another light day in dataflow today ahead of tomorrow’s busy schedule, which includes the FOMC meeting, housing starts, ABC consumer confidence, and Canadian CPI. Homebuilder Lennar beat EPS estimates, coming in at 16c vs 3c expected. Meanwhile, the ESFS was awarded a AAA rating by Fitch and is now deployable if necessary. Though news flow was light, risk was bid significantly right from US open and equity saw key resistance levels get taken out. It is interesting to note that Tsys also rallied today, with 10yr yields down 4bps.

SPY today broke out of its 113 resistance that I’ve been pointing out in recent pieces. Volume was so-so, but price action appears bullish here. Risk breaking out ahead of FOMC suggests QE expectations are driving the push higher, but with recent economic data flow showing slightly upside surprises, I don’t think the Fed will announce further asset purchases tomorrow. Midterms are coming up and the GOP (particularly the ones on the margin—the Tea Partiers) will be pushing debt/deficit/spending critiques of the Obama administration. Dems probably will not want further asset purchases unless & until fresh economic data warrants it, and I think the dovish Fed realizes this. Dems need to characterize the recovery as sustainable and well-on-its-way and fault the Republican opposition to stimulus & easing measures as the obstacle to that recovery. Still, the market seems to think that the FOMC will go ahead with further asset purchases and the charts show that bulls are winning. Watch S&P 1150 as a potential profit-taking level and look for a 200d breakdown and potentially sizable selloff on a move back below 1130.


A more granular look at the dynamics behind current market optimism signals caution, however. Back near recent cycle lows, I was mentioning that the sub-0.60 AAII Bull/Bear ratio suggested extreme bearishness. This was back when the AAII survey was >45% bears. We currently are at 24.3% bearish and 50.9% bullish, as of September 15. This signals another extreme, this time on the buy side, as the Bull/Bear ratio is over 2.00. Bulls are likely positioning based on expectations of further asset purchases being announced tomorrow, so perhaps we will get a news-driven catalyst for some vindication/humiliation of the bulls/bears. The extremely bullish skew, at levels seen only once before since the crash and only four times in the last five years, could be setting the market up for a correction. The last time the Bull/Bear ratio went from below 0.50 to above 2.00 in a sharp spike like this month was in May 2008, near the cycle high around S&P 1430, preceding a 16% decline from interim peak to interim trough (and of course, a 53% decline from interim peak to generational trough). Not calling for a repeat scenario here, but I do think that rallies can be justifiably faded when sentiment is so extremely bullish. Below is a chart of AAII Bullish % on top of the S&P 500, courtesy of Be aware that the AAII Bullish % (the proportion of the AAII survey takers reporting bullishness) is not the same as the Bull/Bear ratio (Bullish %/Bearish %).


Because of this, I stayed out of entering risk today, although some of my favorite cloud computing issues broke out higher today on strong volume, including N surging 7.8%, CRM rallying 5.5%, and VMW & FFIV both jumping over 3.5%. Alas, I missed their moves, as I was away from the screen during most of market hours today and am averse to chasing beta ahead of FOMC.

Besides these stocks, there are a handful of nice charts I’m seeing in US equity, including MMR, an energy play breaking out today on strong volume. BIDU, the familiar Chinese ADR, broke out of a six-week base today on 1.78x average volume. Its American counterpart in search engine space, GOOG, rallied as well, following through on Friday’s move on good volume. Its US analogue in tech equity space, AAPL, broke out of its own five-month base today, with solid volume.

The IWM/SPY ratio is breaking out of its channel that I have presented in recent pieces, and if this finds some follow through then we could have further bullish price action to come. If it corrects then we should be headed down but further gains from here would imply that the correction in beta hot flows since May is over.


Portuguese & Irish spread widening sent the euro lower premarket. Record periphery spreads (Ireland & Portugal are both sitting around 400bps spread to Bunds) the same day the EFSF gets AAA support isn’t exactly bullish. Risk appetite during the day sent USD lower and helped EURUSD stabilize ahead of US equity cash close. In a Bloomberg piece today, a money manager was quoted as saying “better news out of the U.S. has offset bad news out of Europe.” I would recharacterize the better news out of the U.S. as higher expectations of further QE. Although U.S. dataflow has improved, the divergence in recent news flow between Europe & the U.S. at the margin is negligible, if not skewed toward Europe’s bearishness. It appears to me that the European situation is heating up again and this has been thus far masked by a declining USD keeping EURUSD afloat. But USD is being sold off of QE expectations more than anything else. EURUSD is still sitting near the top of its triangle, right under its 200d. A rally of about 100 pips or less would not invalidate these technical, while the triangle implies a move down to around June lows. A break below 1.291 should trigger significant selling. I am (prematurely?) calling for this to be an interim top in EURUSD.


AUDUSD pushes on higher, as the RBA’s Governor Glenn Stevens offered hawkish comments targeting inflation risk. Though the RBA left rates changed in their September minutes, as expected, the market is pricing in a rate hike in October or November. Trend is obviously up for now, as AUDUSD makes new left rates changed in their September minutes, as expected, the market is pricing in a rate hike in October or November. Trend is obviously up for now, as AUDUSD makes new year highs, but the effect of even tighter monetary policy, combined with falling new home sales and a (potentially) strengthening USD, could be disastrous for Aussie property prices, which would send AUDUSD much lower. Furthermore, AUDUSD is as played-out a derivative of China growth as it gets, and it is yet to be seen if the Chinese demand for Australian exports is sustainable and/or replaceable. Today’s Taiwan export orders showed a third consecutive sequential decline in orders from China, after strong growth in the first quarter. If these data are telling, then Aussie export demand from China may weaken without anyone to pick up the slack. From a technical standpoint, AUDUSD remains bullish in the near-term, as 0.94 is being held, but a break below could signal a strong correction. The resistance trendline for AUDUSD’s channel is also coming into play, which could also lead to selling. According to Bloomberg, AUDUSD is overvalued by 27% on a PPP basis.


GPBAUD is a classic example of a carry trade, especially as AUD has strong favorable backing and GBP’s fundamentals look bleak. After a sharp spike this summer during the return of volatility in risk assets, GBPAUD has sold off just as sharply as summer hawkishness from the BoE is giving way to renewed dovishness and RBA continues to posture hawkishly. We are approaching summer lows around 1.62 in this cross and if we sell off to there, GBPAUD could find a strong bid, which would be bearish risk. Whether GBPAUD finds buying at the support level is yet to be seen, but this is an important indicator to watch to provide context to other markets.


Another carry trade I’m watching is AUDCAD. Relative hawkishness from RBA has been driving the pair higher, especially as risk is bid and funded with lower-yielders. The cross is nearing November 2009 highs, which could offer some resistance and possibly cause a reversal. Same implications here as in GBPAUD.


Canadian CPI tomorrow should move USDCAD (no predictions here), but what I’m looking at is the triangle pattern developing on its chart. Underwhelming Canadian CPI and/or no further QE announced tomorrow could drive USDCAD higher, especially given that it sits around its triangle support line. This one is coiling for a big move, perhaps this fall.


QE expectations have been a strong driver of recent risk appetite and like I said, I don’t think it is the right move politically to go through with it this month. With that said, I’m not a political theorist and I could be reading it totally wrong. Either way, Irish & Portuguese bonds are yielding 400bps spread to Bunds, German data is weakening on a first derivative basis, and some anonymous Eurozone bank keeps accepting a sizable premium by funding via FX liquidity swaps rather than interbank. Whether these issues overshadow QE’s implications is anyone’s guess, but for now, I’m starting to get bullish USD again, especially vs EUR.


Short EUR/USD | 1.3120 | stop 1.3120 | +30 pips
Short GBP/USD | 1.5985 | stop 1.5810 | +405 pips
Long /ZW | 701.00 | stop 674.50 | +4.07%
Long EUR/GBP | 0.8305 | stop 0.8265 | +100 pips
Long BVN | 41.20 | stop 39.85 | +1.09%
Long USDCHF | 0.9975 | stop 0.9875 | +65 pips


Short /ES | 1113.00 | cover 1133.00 | -1.80%
Long /SI | 18.41 | sold 20.85 | +13.25%


Long USDCAD | 1.0285 | stop 1.0200

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DISCLAIMER: Nothing contained anywhere in this commentary, including analysis and trade ideas, constitutes or should be construed as investing or financial advice, suggestion, or recommendation. Please consult a financial professional and do due diligence before engaging in any purchase or sale of securities.

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