There have been a plethora of reports in the technical analysis sphere focusing on a continuation “triangle” formation in the major stock indices. Many are looking at the triangle as an asymmetrical one in which the lows rise and the highs fall as the triangle approaches its apex. However, there are two other kinds of triangles: ascending and descending. The shape doesn’t matter so much. What matters is where the market breaks out, below or above. Currently, the triangle has shifted from an asymmetrical pattern to a descending triangle. The fact that the market was able to close above 1215 at 1216 puts it only 2 points shy of the November 1st closing low. The triangle in the S&P 500 continues to exist and it’s a bullish pattern considering the market rallied nearly 20% before the consolidation.
Fitch Ratings reported yesterday that “though U.S. banks have manageable direct exposures to the stressed European markets, further contagion poses a serious risk.” Additionally, today, a Wall Street Journal article discussed funding stresses at Eurozone banks. Some are starting to run out of eligible collateral for ECB repos. The ECB has been asked to broaden its pool of acceptable collateral.
“They also are a sign that struggling banks across Europe are preparing for a period of prolonged reliance on financial lifelines from the ECB. The Continent's intensifying financial crisis has made it difficult for many banks to obtain funding from customary market sources.” Banks Face Funding Stress, WSJ.
The market seemed to ignore the article for most of the morning, but selling kicked into gear once the 1226 level on the S&P 500 was broken (more on that later).
Oversold
On a short-term basis, the market is oversold. Today, only 6% of stocks in the S&P 500 index are trading above a short-term moving average (the 10-day moving average). If we continue to remain in a trading zone, then the market is expected to bounce from here.
Another short-term trading indicator many follow is the Arms Index or TRIN which is a ratio of bullish and bearish participation in a decline or advance (a measure of breadth) in the market as well as a ratio of supply versus demand in volume. What you need to know, is that a reading above 3 is considered oversold. Tracking this indicator this year, I’ve seen it get oversold at the beginning of a decline and at the end. It hit a high of 3.75 today and it hit a high of 6.40 in Wednesday’s selloff last week. This indicator is telling us we’re either at the end of a correction, or one is just beginning (new trend). So we’ll need to look at a few more indicators for advice.
Looking at price levels, many chartists have had their critical eye on 1226, 1220, and 1215. We passed through 1226 and 1220 today like a knife through butter, but the battle ground at 1215 held at the end of the day when the market rallied from the lows of 1209 to 1216 at the close in the last 10 minutes. 1215 was the intraday low on November 1st, the day after Papandreou announced a referendum on the October 27th Brussels agreement. It (1216) was also a previous closing high on September 16th and 1218 was a closing high previously on August 31st. The August and September closing highs around 1216 and 1218 are significant since we’ve been trading above them for some time now. These levels should support this rally. If they do not, then the bear market will have reasserted itself in the stock market.
Additionally, we have the 50-day moving average, which is 1205.55 today. We came less than 4 points away from touching that level. For all intents and purposes, we essentially have tested that zone and rallied from it. The caveat technically, is that if we break that level, all bets are off and an intermediate top will be set in the market.
Triangle Continues
As I stated earlier, the triangle in the S&P 500 still exists, only its form has changed from a pretty asymmetrical triangle to a descending triangle (flat bottom). That flat bottom, on a closing basis, resides between 1216 and 1218 (recall those as the previous closing highs in August and September). Resistance becomes support – the staple of technical analysis as investors who sold at resistance previously have a second chance to “get back in”. The market rallied 20% and we have given some of that back in the past month. Looking at a fibonacci retracement of the October advance, we’ve only given back 38% of the advance. THAT’S BULLISH. As I’ve stated on the radio show, the fact that the market has digested so much negativity in the headlines is an indication of strength in the markets. I believe a lot of that strength is attributed to solid economic improvement in the U.S., underperformance and under exposure for fund managers, and accommodative moves by central banks around the world.
Source: NAAIM
The ECB’s role
Reports on Monday showed the ECB had cut their purchases last week in half as Draghi made it clear in the first week of November, that the SMP bond purchasing facility was temporary; as such, yields were able to rise on sovereign bonds for the past two weeks. Twice now, Italian yields have been brought back down below 7% as the ECB probably has had to step in, yet yields on Spanish bonds and others continue to rise. Foreign banks have repeatedly announced during their earnings season they were cutting back on sovereign debt to raise capital for their capital requirements. Economic reports continue to look abysmal for Europe with Germany as the only country showing any growth at all. Europe needs a lender of last resort.
Draghi is expected to talk early tomorrow morning. The markets will be tuning in to his press release while Americans sleep. Pressure continues to rise regarding their purchases and role as a lender of last resorts. Germany continues to dissent with the president of Bundesbank and an ECB governing council member, Jens Weidmann, stating, “fixing an interest rate for a country is certainly not compatible with our mandate.” Whereas Peter Bofinger, an advisor to the German government, said targeting rates paid by governments is a logical extension of the control central banks have over interest rates. He states, “you have to do everything needed to keep this core (market) stable.” It’s all just one giant game of chicken. Captain Bart Mancuso of the U.S.S. Dallas in the movie Red October said it best, “The hard part about playing chicken is knowing when to flinch".
Sarkozy has joined the side to step up the ECB’s role but that was rejected by Merkel today.
“I’m convinced that none of these approaches, if applied right now, would bring about a solution of this crisis,” Merkel said in a speech in Berlin today.“If politicians believe the ECB can solve the problem of the euro’s weakness, then they’re trying to convince themselves of something that won’t happen”… While President Barack Obama renewed calls for Europe to act, Merkel said “political action” to tighten budget rules is needed to stem the turmoil.” (Merkel rejects French Calls to Deploy ECB as Crisis Backstop on Euro Debt, Bloomberg)
Tomorrow will be an important release to get clarity on the ECB’s role and intention to keep sovereign debt yields down before they get out of control and block access for bond issuance at the capital market level. The markets may watch what they say tomorrow, but that might not necessarily be what they’re doing. Recall comments from our own Treasury Secretaries over the past ten years concerning a “Strong dollar” and the 30% drop in its value? Monday is when we’ll get the next report on SMP purchases. It’s pretty obvious they were in the markets helping Italian bonds this week. It will be important to see if they stepped up purchases compared to last week or cut them.
