East to West: Caution

Markets settled after the sharp fall of the previous week but a hint of caution was evident, with buyers wary of being caught by an after-shock. It should take several weeks for sentiment to settle back into a semblance of normal routine.

Short candles were common, as on South Korea’s Seoul Composite Index, with buyers displaying a lack of enthusiasm.

Seoul Composite Index

The long tail on Japan’s Nikkei 225 Index reflects buyer support but the large overlap with the previous candle suggests hesitancy.

Nikkei 225 Index

China’s Shanghai Composite Index likewise displays a short candle below the new resistance level at 3250.

Shanghai Composite Index

After a strong bull run India’s NSE Nifty Index is surprisingly hesitant. A close below the rising trendline would signal a test of primary support at 10000.

Nifty Index

DJ Euro Stoxx 600 shows a stronger blue candle but is still testing resistance at 380.

DJ Euro Stoxx 600

The Footsie shows a similar pattern, with resistance at 7300.

FTSE 100

In the US, bellwether transport stock Fedex respected support at 230. Follow-through above 250 is likely and would signal resumption of the up-trend, a bullish sign for the economy.

S&P 500

Canada’s TSX 60 respected primary support at 880. Recovery above 920 is likely and would indicate a test of 940.

TSX 60

Patience is required to weather the uncertainty of the next few weeks without making knee-jerk decisions.

The intelligent investor is a realist who sells to optimists and buys from pessimists.

Benjamin Graham: The intelligent investor…..

Why Aussie banks are weakening

Australian banks are breaking primary support levels. There are two major reasons for this. One is the precarious level of household debt as a result of the housing bubble. The first graph below shows how housing prices have more than doubled compared to disposable incomes (after tax but before interest payments) over the past 30 years. And how household debt has risen, not as a result of, but as the underlying cause of, the housing bubble. Without rising debt there would be no bubble.

Australian House Prices and Household Debt to Disposable Income

Growth in Australian housing prices is now slowing, prompting fears of a correction.

Australian House Price Growth

The second reason is falling returns on equity. Banking regulators have increased pressure on major banks to improve lending standards and increase capital backing for their lending exposure. For decades banks were given free rein to increase lending without commensurate increases in capital, to the extent that the majors hold only $4 to $5 of common equity for every $100 of lending exposure. Low interest rates, increases in capital and slowing credit growth have all contributed to the decline in bank equity returns to the low teens.

Australian Banks Return on Equity

ASX 200: Banks break support

The ASX 300 Banks index broke primary support at 8100, signaling a fresh decline. Follow-through below 8000 would strengthen the signal. Another Trend Index trough at zero warns of long-term selling pressure. The next major support level is the 2016 low at 7200 but expect retracement to first test new resistance at 8100.

ASX 300 Banks

Miners rallied, softening the blow.

ASX 300 Metals & Mining

But decline in its biggest sector would weigh heavily on the ASX 200. Retracement is likely to test 6000 but respect would warn of a test of primary support at 5650. Bearish divergence on Twiggs Trend Index warns of long-term selling pressure.

ASX 200

Dollar falls, Gold rises

The Dollar weakened, with the Dollar Index testing support at 88.50. Respect of new resistance at 91 — the last primary support level — confirms the strong down-trend. Completion of another Trend Index peak below zero would further strengthen the signal.

Dollar Index

* Target calculation: 91 – (95 – 91) =87

The extent of the Dollar’s fall is best illustrated against major trading partner China’s Yuan: a 9.5% fall in just over two years. And that is despite rising US interest rates and a $120 billion increase in China’s foreign reserves over the last year.

USDCNY

Gold is again testing resistance at $1350. Breakout would signal another primary advance, with a target of $1450*. Follow-through above $1375 would confirm.

Spot Gold

* Target calculation: 1350 + (1350 – 1250) = 1450

The All Ordinaries Gold Index has been undermined by the strong Aussie Dollar. But recovery above 5000 would signal another advance.

All Ords Gold Index

East to West: Sweeping conflagration

The tinder was dry and all it took was a spark from the US to set off a sweeping conflagration across global stock markets.

South Korea’s Seoul Composite Index broke support at 2450. Technically, Dow Theory requires a lower high followed by a new low to signal a reversal. What we have is a new low, without a preceding lower high. Often described as large correction, there has been debate over the years as to whether this constitutes a valid reversal. I prefer to sit on the fence: follow-through below 2300 would confirm reversal to a primary down-trend, while recovery above 2450 would signal a false alarm.

Seoul Composite Index

Japan’s Nikkei 225 Index remains in a primary up-trend, though retreat below the rising trendline at 21000 would warn of a loss of momentum.

Nikkei 225 Index

China’s Shanghai Composite Index was also hit hard. Primary support at 3250 has been breached but again by a large correction. Follow-through below 3000 would confirm the reversal.

Shanghai Composite Index

India’s NSE Nifty Index remains bullish, with Trend Index troughs above zero signaling long-term buying pressure. Breach of primary support at 10000 is unlikely.

Nifty Index

Target 10500 + ( 10500 – 10000 ) = 11000

In Europe, the DJ Euro Stoxx 600 is testing primary support at 366. Bearish divergence on the Trend Index warns of long-term selling pressure.

DJ Euro Stoxx 600

The Footsie retreated below two primary support levels, at 7300 and 7200, confirming reversal to a primary don-trend. Bearish divergence on the Trend Index warns of long-term selling pressure.

FTSE 100

In the US, it is hard to identify primary support levels as there has not been a decent correction for some time. Breach of support at 6200 appears unlikely, with Trend Index troughs above zero signaling long-term buying pressure.

S&P 500

While Canada’s TSX 60 is testing its primary level at 880. Again this is a large correction, so we may need to look elsewhere for confirmation if support at 880 is breached.

TSX 60

The extent of the market reaction reflects high levels of fear from investors. Valuations are high, especially in the US, and the emphasis has quickly swung to protecting existing profits and away from further gains.

ASX 200 selling pressure, banks weaken

The ASX 300 Banks index fell sharply, testing primary support at 8100. Continuing Trend Index troughs below zero warn of long-term selling pressure. Breach of primary support would signal a decline to the 2016 low at 7200.

ASX 300 Banks

Miners also retreated, testing medium-term support at 3500, though primary support at 3300 is expected to hold.

ASX 300 Metals & Mining

The ASX 200 tested medium-term support at 5800. Bearish divergence on Twiggs Money Flow warns of long-term selling pressure. Test of primary support at 5650 is likely.

ASX 200

Dollar rallies, Gold retreats

On Friday President Donald Trump signed a $400 billion budget deal that sharply boosts spending and swells the federal deficit, ending a brief federal government shutdown. [CBS News]

The Dollar Index rallied as stock market volatility increased around the globe. Another test of resistance at 91 is likely. Respect would signal a decline to 87*.

Dollar Index

* Target calculation: 91 – (95 – 91) =87

Gold retreated as the Dollar rallied, confirming an earlier divergence on the Trend Index. Breach of primary support at $1250 remains unlikely.

Spot Gold

* Target calculation: 1350 + (1350 – 1250) = 1450

Long tails on the All Ordinaries Gold Index indicate buying support, fueled by a weakening Aussie Dollar. Recovery above 5000 would signal another advance.

All Ords Gold Index

Further (USD) Dollar weakness is likely to boost gold prices.

Next major target for the Dow and S&P 500

The next major target for the Dow Jones Industrial Average is 28000*.

Dow Jones Industrial Average

Target 14000 x 2 = 28000

And 3000* for the S&P 500.

S&P 500

Target 1500 x 2 = 3000

Reasoning: The Dow top of 14000 in 2007 was double its 2002 low of 7000 and roughly double its 2009 low of 6500, allowing for some GFC overshoot. The S&P high was similarly close to 1500 in 2007, compared to its 2002 low of 768 and a 2009 low of 666. Double the 2007 high of 14000 would give a target of 28000 and double 1500 for the S&P 500 gives a target of 3000.

Gold and Dollar hesitate

The Dollar Index found short-term support at 89, having respected new resistance at 91. Trend Index peaks below zero warn of strong selling pressure. Expect a further decline to 87*.

Dollar Index

* Target calculation: 91 – (95 – 91) =87

Gold respected resistance at $1350 as the Dollar found short-term support. Bearish divergence on the Trend Index warns of secondary selling pressure, warning of a correction.

Spot Gold

* Target calculation: 1350 + (1350 – 1250) = 1450

A strong Aussie Dollar is holding back the All Ordinaries Gold Index. Respect of the rising trendline would signal another advance.

All Ords Gold Index

Further (USD) Dollar weakness is likely to boost gold prices.

East to West: Global correction

There are clear signs that global stock markets are headed for a correction.

South Korea’s Seoul Composite Index followed a false break above its November high of 2560 with a sharp reversal. Bearish divergence on the Trend Index warns of selling pressure.

Seoul Composite Index

Japan’s Nikkei 225 Index remains bullish but shows strong resistance at 24000.

Nikkei 225 Index

A large engulfing candle on China’s Shanghai Composite Index warns of a correction. Breach of support at 3400 would test the primary level at 3250.

Shanghai Composite Index

India’s NSE Nifty Index also displays an engulfing candle at resistance of 11000*, warning of a correction. Trend Index troughs above zero, however, continue to signal long-term buying pressure.

Nifty Index

Target 10500 + ( 10500 – 10000 ) = 11000

In Europe, the DJ Euro Stoxx 600 penetrated its rising trendline at 390, warning of a loss of momentum. Strong bearish divergence on the Trend Index warns of a primary down-trend. Reversal below 380 would strengthen the signal.

DJ Euro Stoxx 600

The Footsie retreated below its new support level at 7600. Reversal below 7300 would signal a primary down-trend.

FTSE 100

In the US, the daily chart for the S&P 500 reveals market skittishness about higher inflation and interest rates.

S&P 500

While Canada’s TSX 60 ended its 4-month rally with an emphatic red candle breaking support at 940. Expect a test of the primary level at 880.

TSX 60

This looks like a global correction but it would be premature to call this a market top.

Wage rates spook the Dow

The Dow Jones Industrial Average fell 666 points on Friday as the market was spooked by an upsurge in wage rates.

Dow Jones Industrial Average

From the Wall St Journal:

Concerns about rising interest rates pounded financial markets Friday as investors started to take the threat of inflation more seriously, a sharp shift from the sentiment that has characterized most of the stock market’s nearly nine-year bull-market run.

Annual growth in average hourly earnings for the private sector jumped to 2.88%, close to the 3.0% expected to trigger a more hawkish stance from the Fed.

Hourly Wage Rates

The market is skittish about higher interest rates, with the VIX jumping to the highest level since November last year.

CBOE Volatility Index (VIX)

ASX rally faces strong resistance

The ASX 200 found strong support at 6000, rallying strongly to test resistance at the recent high of 6150.

ASX 200

The recovery was assisted by banks, with the ASX 300 Banks index rallying to test resistance at 8500. Shallow Trend Index troughs below zero reflect improved buyer sentiment (still bearish but only just).

ASX 300 Banks

Miners are correcting as iron ore continues to lose ground.

ASX 300 Metals & Mining

Sentiment has been buoyed in recent weeks by global bullishness towards equities. But Friday’s US reaction to rising wage rates warns that the market is growing increasingly anxious about high stock valuations. Expect strong resistance for the ASX 300 Banks Index at 8500 and the ASX 200 at 6150.

Black Monday, October 1987

What caused the Black Monday crash of 1987? Analysts are often unable to identify a single trigger or smoking gun that caused the crash.

Sniper points to a sharp run-up in short-term interest rates in the 3 months prior to the crash.

3 Month Treasury Bill Rates

Valuations were also at extreme readings, with PEmax (price-earnings based on the highest earnings to-date) near 20, close to its Black Friday high from the crash of 1929.

S&P 500 PEmax 1919 - 1989

Often overlooked is the fact that the S&P 500 was testing resistance at its previous highs between 700 and 750 from the 1960s and 70s (chart from macrotrends).

S&P 500 1960 - 1990

A combination of these three factors may have been sufficient to tip the market into a dramatic reversal.

Are we facing a similar threat today?

Short-term rates are rising but at 40 basis points over the last 4 months, compared to 170 bp in 1987, there is not much cause for concern.

13-week T-Bill rates

PEmax, however, is now at a precipitous 26.8, second only to the Dotcom bubble of 1999/2000.

S&P 500 PEmax 1980 - 2017

While the index is in blue sky territory, with no resistance in sight, there is an important psychological barrier ahead at 3000.

S&P 500

Conclusion: This does not look like a repetition of 1987. But investors who ignore the extreme valuation warning may be surprised at how fast the market can reverse (as in 1987) from such extremes.

ASX 200 selling pressure

The ASX 200 found support at 6000 but the bears are not over yet. Thursday’s Hanging Man candle is bearish despite the long tail. Expect another test of support in the week ahead.

ASX 200

The monthly chart gives a long-term perspective. Respect of 6000 would confirm a primary advance. But bearish divergence on Twiggs Money Flow continues to warn of selling pressure.

ASX 200

East to West: Time to take the punch bowl away

Crude oil is retracing and a Nymex Light test of $60/barrel would take some of the heat out of the commodities market. A rising rig count in the US may help to increase supply and ease oil prices.

Nymex Light Crude

Political tensions remain high, with the Turks bombing Kurd-controlled territory in Syria, Iran proxies in Yemen firing missiles at Saudi Arabia, North Korea showing no signs of caving to sanctions pressure over its nuclear weapons program, and Russia fomenting tensions in the Balkans between Serbia and Kosovo.

Stock markets shrugged off the usual conga-line of autocrats behaving badly, instead focusing on signs of a reviving global economy. South Korea’s Seoul Composite Index is headed for a test of resistance at its November high of 2560. Respect of the rising trendline is bullish but the latest Trend Index rally is weak and a bearish divergence may be forming.

Seoul Composite Index

Japan’s Nikkei 225 Index remains bullish. A Trend Index trough high above zero indicates strong buying pressure.

Nikkei 225 Index

China’s Shanghai Composite Index broke resistance at its November high of 3450 to signal another primary advance.

Shanghai Composite Index

India’s NSE Nifty Index is advancing toward its target of 11000*. Trend Index troughs above zero signal long-term buying pressure.

Nifty Index

Target 10500 + ( 10500 – 10000 ) = 11000

In Europe, the DJ Euro Stoxx 600 broke resistance at 396. Trend Index recovery above the declining trendline indicates buyers are back in control.

DJ Euro Stoxx 600

The Footsie met short-term resistance at 7800 and is likely to retrace to test its new support level at 7600. Trend Index recovery above the declining trendline again indicates buyers have taken control.

FTSE 100

Moving to the US, the Dow chart says it all. Investors continue to shrug off concerns about high valuations as the up-trend accelerates. The few corrections over the last 12 months have been both mild and of short duration. A rising Trend Index, with troughs high above zero, indicates strong buying pressure. It is important to remain objective, focus on the long-term, and not to get caught up in the euphoria. Heady gains like this inevitably lead to a sharp blow-off. The question is: when?

Dow Jones Industrial Average

Right now it seems the rocket has plenty of fuel, with tax cuts expected to stimulate both buybacks and new capital investment, while a falling US Dollar should boost US manufacturer’s competitiveness both at home and abroad. A sharp reversal could be many months away.

It’s time that the Fed took the punch bowl away, to calm things down before the party really gets out of hand.

ASX retreats

The ASX 300 Metals & Mining index is undergoing a correction which is likely to test medium-term support at 3500.

ASX 300 Metals & Mining

Banks continue to weaken, with the ASX 300 Banks index testing medium-term support at 8300. Breach is likely and would signal a test of primary support at 8100. Trend Index peaks below zero continue to warn of selling pressure.

ASX 300 Banks

With both miners and banks in retreat, the ASX 200 is correcting for a second test of medium-term support at 5900. Respect would confirm the primary up-trend. But bearish divergence on the Trend Index warns of selling pressure and a test of 5800 is likely.

ASX 200

Target for the ASX 200 is the 2007 high of 6800 but a lot will depend on the relative strength of banks and miners.

Gold hesitates as Dollar retraces

The Dollar is retracing to test resistance. Dollar Index respect of the former primary support level at 91 would confirm a primary decline with a target of 87*. Trend Index peaks below zero warn of strong selling pressure.

Dollar Index

* Target calculation: 91 – (95 – 91) =87

Gold hesitated below resistance at $1350 as the Dollar retraced. Trend Index above zero indicates an up-trend. Breakout above $1350 is likely and would signal an advance with a target of $1450*.

Spot Gold

* Target calculation: 1350 + (1350 – 1250) = 1450

A strong Aussie Dollar is holding back the All Ordinaries Gold Index. Respect of the rising trendline is likely and recovery above 5000 would signal another advance.

All Ords Gold Index

Cessation of Chinese purchases of US Treasuries may not be permanent but will fuel Dollar weakness, improve the competitiveness of US exports in international markets, and boost dollar-denominated gold prices.