Waiting to digest FOMC

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Bull run

The S&P500, Dow Jones and NASDAQ had a nice bull run on good volume (they all formed two bullish scallops) on the back of earnings such as Amazon, Alphabet and Microsoft. The ECB’s hint at further QE and China’s interest rate cut (the sixth this year) on October 22nd lead to a nice pop on the NASDAQ, S&P500 Thursday and Friday. On both the NASDAQ and S&P500 a gap formed and closed above their MA200 ending in both indices closing above their September high and moving averages, with VIX below 16 (bad for bears) – nice and bullish.

Bull flag. Or is it?

On first glance it looks like a small bull flag has formed on both the S&P500 and NASDAQ. However I am suspicious Friday’s gap is actually an exhaustion gap with an island forming. We still have two weeks of earnings to go, but there already some clear weakness in this bull run and we have some headwinds blowing.

Small and Mid caps not bringing up the bull run rear

Despite the strong run of the S&P500 and NASDAQ, the small and mid caps (S&P400, S&P 600, Russell 2000) have continued to be weak – S&P600 was down more than 1% yesterday. Not one of them broke their September high and not one broke their daily MA200. Moreover, they are looking like they want to make a move down now. Momentum peaked around October 12th and since then has been fading (down sloping MACD histogram) with the MACD now in bearish alignment on all three indices. Without their support bringing up the rear the bull rally is not sustainable.

Europe headwinds

DAX Friday’s gap was an exhaustion gap, it subsequently turned back from heavy resistance and has now formed a bearish evening star DOJI. Moreover:

  • stocks are overbought
  • momentum is slowing
  • little nearby support underneath
  • the ECB’s QE hint is now fading (central bank inspired rallied are short lived)
  • On the weekly chart it’s currently at the top of a descending broadening formation

It’s likely the DAX is heading down, possibly to 10,200-10,400. This will obviously blow some headwinds on US stocks.

Treasury yields puts a bearish look on this rally

The treasury market can give clues to the direction of a the economy. Looking at yields it looks bearish. I would expect on the back of a strong rally to see the selling of treasuries as money rotates from bonds to stocks. However, this doesn’t seem to be the case, which throws another question market over this bull party. Treasuries (10 year yield) did not rally. They are still hovering around breakdown territory near 2% and on the weekly chart (not shown) it looks like a head and shoulders is forming. You can see on the daily chart we are about to get a death cross on the MA50 and MA200. It seems the bond market is anticipating a very different outcome to the stock market (perhaps the market, is too doped up on QE to even care anymore).

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Taking a break, waiting on the FOMC

With the S&P500 It’s clear the markets are now waiting to digest FOMC when it concludes on October 28th before making their next move to new highs or back down. Unless the FED says or does something to rev up the bulls I think the latter is more likely – we’ll probably see some retracement to 2030-2040 in the short term. Long term, the outlook is pretty cloudy. We are seeing a global weakness that is having a knock on effect. China has been a particular red flag that has been sending shock waves, rippling out across Asia, Europe and the US. To name a few: a stock market that collapsed (still  overvalued) and resulted in the government heavily throwing money at it, going after anyone shorting the market and destroying its futures market. Record monthly capital outflow (which resulted in the shock August currency devaluation, clearly they couldn’t cope with the outflow), the manufacturing sector is awful. Even the official growth rate, if you trust it, is half what it was in 2007 despite continued massive stimulus. Government and corporate debt has taken off like a rocket to Mars and after the stock market collapsed the corporate bond market has blown up into a ripe bubble that is getting dangerous. The only, supposed, bright sector is services, however, this is still not large enough to support the economy.

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