It is going to be an interesting week in the US equity markets, one that may provide direction for the rest of this quarter, and perhaps for the year. By Friday we should have a better idea of what to expect.
The S&P500 cash index (SPX), closed the week at 2051.82 on Friday (Jan. 23), a nice 32-point boost. Given the sharp correction that earlier in the month had threatened to take the market down, down, down, the Bulls were breathing a little easier by the end of the week.
But there is still cause for concern among the pessimists. Almost all of last week’s lift came on Thursday, and it was almost exclusively driven by the European Central Bank’s announcement that it will follow the direction of the US Federal Reserve and initiate a massive quantitative easing program.
More Easy Money! Hooray!
But there are three factors giving investors the creeps. One is the continuing strength of the US dollar, or stated differently, the continuing weakness of virtually all other currencies. For many years, investors around the world have made good profits by borrowing cheap money in US dollars and putting it into investments denominated in other currencies, which typically pay much higher rates of interest.
Investors can borrow in US dollars at less than one percent; invest in Brazilian reales and earn 11 percent. What’s not to like?
But the US dollar has broken decisively out of a long-term falling wedge pattern, and shows no signs of stopping. Investments denominated in foreign currencies are not only not profitable now; they are becoming impossible to manage.
So massive positions are being liquidated quickly, and nobody is sure what effect hundreds of billions of losing trades will have on the global economy. But everyone knows it will not be good news.
Related to the strengthening dollar is the increasing rush to invest in gold. Gold has had a very nice run in the past few weeks when quoted in US dollars. It is up about $200 an ounce in the past few weeks.
But denominated in other currencies – in euros, for example, or in Canadian dollars – the rise has been much sharper.
Gold is where money goes when it gets nervous. The increased price for gold – a moderate increase in US dollars, but a monster for most other currencies – is a measure of just how nervous investors are becoming.
In this environment of increased nervousness, the market becomes extremely vulnerable to bad news. And there is bad news on the horizon. Apart from all of the places where people are actually shooting each other, this week the election in Greece resulted in a government that wants to get out of the Eurozone, or at the least wants better terms for staying in.
The result will be more instability in Europe. Predictions about how this will play out are guesswork. It might not damage US equities, which are increasing seen as a refuge from uncertainty in Europe, but it introduces an unpleasant sense of unease in big money investors.
Technical Analysis
From a technical perspective the failure of the SPX to follow through after Thursday’s sharp rally is disquieting. But even with Friday’s lackluster performance, the SPX held above the 20/40 day moving averages. The medium-term uptrend is intact.
Now the market is reaching an inflection point. There is a long-term inverted head-and-shoulders pattern on the daily chart, followed by a skewed double bottom. Both are bullish patterns. However the market is being held down by an active resistance area (the neckline of the double bottom) that represents the last attempt by the Bears to rekindle the earlier decline.
For example, the overhead resistance could easily be broken by a change in the language in the FOMC announcement due on Wednesday, or by the Fed hinting at a delay in raising interest rates.
Our call is that the resistance will be broken, and the SPX will continue toward the 2100 level and higher. However, it would not take much to reverse the sentiment and drive this shaky market back down toward 2000. Lots of things could catalyze a downward movement this week.
We’re long but nervous, trading this market with one eye on the price and the other on the exit. We expect the uptrend to continue, but we aren’t betting the farm on it. By Friday we should have a clearer notion of what comes next. But by Friday it may be too late to trade it.
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