We are going to start things off today by returning- albeit briefly- to the chart of the U.S. stock market back in 1987. At top right we show the S&P 500 Index from the autumn of 1986 into the spring of 1988.
We have argued on occasion that there is something rather specific that we look for with regard to the moving average lines for a security or market. On virtually all of our charts we show the 200-day e.m.a. line (in red) and the 50-day e.m.a. line (in blue-green). If we include a different moving average line other than these two it will be shown in some other color.
Market bottoms or counter-trend corrections often begin around the time that the 50-day e.m.a. line ‘crosses’ through the 200-day e.m.a. line. This means that when the moving average lines cross prices tend to reverse.
The idea is that a simple correction involves a break through the moving average lines sufficient to make them ‘cross’ followed by a recovery back towards the moving average lines. A trend change, on the other hand, involves exactly the same thing with one important difference- prices then go on to new highs or lows.
To explain… in 1987 the stock market ‘crashed’, the 50-day e.m.a. line ‘crossed’ down through the 200-day e.m.a. line, and then the market rallied. Since the SPX never went on to break below the lows set in October and December of 1987 this was nothing more than a violent correction in a rising trend. In other words it is a significant correction of the moving average lines ‘cross’ but it only becomes a trend change if prices subsequently move to new extremes.
The point that we are circling has to do with last weeks’ argument regarding the sum of the Canadian and Australian dollar futures. Since the trend for these two currencies is very similar to that of the euro we have included a chart of the euro futures at right.
Notice that the euro corrected substantially enough last year for the moving average lines to ‘cross’ and this led (eventually) into a rally that pushed this currency back to the moving average lines. For as violent as the forex markets have been the chart-based argument would be that the euro would have to break below 1.25 this year to make this a trend change instead of a mere trend correction.
Below we have included a chart of the U.S. Dollar Index (DXY) futures and the ratio between the share price of Coca Cola (KO) and the S&P 500 Index (SPX).
We have developed an entire intermarket thesis based on the KO/SPX rastio but the purpose today is to show that both the DXY futures and the KO/SPX ratio have risen far enough to ‘cross’ the moving average lines to the upside and are now working through a correction back towards the moving average lines. To really lock this in we would still like to see new highs for both the dollar and the ratio.
As a quick aside… one of the KO/SPX ‘thesis’ arguments was that the dollar tends to turn lower around the time that the KO/SPX weakens to the point where its moving average lines ‘cross’ back to the down side.
Below is a comparative view of the stock price of Canada’s Bank of Montreal (BMO) and the ratio between Johnson and Johnson (JNJ) and the SPX.
There are certain similarities between the current market and that of the spring of 1982. The detail that we are fixating on at present is the trend for BMO because if it moves to new lows then we would expect to see continued strength in the long end of the Treasury market and and extention of the relative outperformance by JNJ. In simpler terms… if the commodity markets-sensitive Canadian banks continue to make new lows expect lower long-term Treasury yields and better relative action in the non-commodity equity markets sectors.
Quickly- the equity markets have tended to swing back towards some sort of energy theme during the month of January in recent years. If crude oil prices remain weaker this could help widen the spread between refined products and crude oil which would, in turn, help improve the profitability of the refiners. We show Valero (VLO) along with the ratio of crude oil to gasoline futures below.
