Home > Uncategorized > 2011/09/23: Fellini Financials: It Could All Be Deemed Surreal If It Wasn’t So Rational

2011/09/23: Fellini Financials: It Could All Be Deemed Surreal If It Wasn’t So Rational

It seems like “Fellini Marketyricon”* for the past month-and-a-half. We do not know whether it’s program trading or the sustained shifts in the sentiment due to the Greece-on/Greece-off risk model: Moody’s debt rating agency just knocked another 2 notches off eight Greek banks today due to their exposure to Greek government debt and the abysmal Greek economic outlook this year into next.

Whatever the case may be, we sympathize with those who are disturbed by the manic $100+ swings between the top and bottom of the range the S&P 500 has established (and over 1,000 points in the DJIA) since the early August debacle low. Yet, the markets tend to discount fluctuations between very good and very bad news with commensurate swings. And as part of that tendency, they also tend to move between the most important technical levels when they are that volatile, and not spend much time (for the most part) respecting the interim technical levels.

The questions become why is this happening, and how to read it as a dealer or investor?

(*a metaphorical reference to 1960’s movie maestro Federico Fellini’s somewhat confusing and fragmented surrealistic magnum opus Satyricon, which uses Roman Empire decadence as its setting. In fact, the original story was written by Petronius; as one of Nero’s courtiers, he ought to know.)

The answers are actually fairly straightforward. The markets are trading in these large shifts of value due to the fundamental sentiment shifts on whether the European powers-that-be or the Federal Reserve has a solution to a combined problem: the fear of European government debt defaults (especially Greece in the near term) and attendant bank failures, and the global economy generally weakening to an across-the-board degree that was not imagined previous. Of course, the latter amplifies the problems associated with the major fiscal rebalancing; look for more for that soon on the next round of the US Debt Ceiling debate.

The way to handle it as a dealer or investor is also fairly straightforward: investors should have been raising cash and can still benefit from hedging their portfolios. This was not a mystery, and certainly no secret. The US and Europe remain the major economies that decide the fate of the global economy. In spite of the greater contribution and influence of the larger rapidly developing economies (RDE’s) like India and especially China, they are relatively small by comparison. All of those who predicted their delinking from the major developed economies over the past few years (especially since the 2008 economic and market crash) have been at least partially right; for all good reasons of demographics and macro-economic development stage.

And yet, anyone who expected the RDE’s alone to pull the major developed economies out of their slump were looking for a ship-of-the-line destroyer to successfully tow an aircraft carrier. And beside that, the mercantilist policies of the RDE’s were not geared to drive the developed economies by importing huge amounts of goods and services; in fact, quite the opposite.

The reality is that the developed economies have sustained financial market recoveries by a combination of central bank largesse and overt banking system rescues. Now that the US Fed has demonstrated that pure liquidity expansion (QE2) has not grown the economy, and the European Central Bank has only held the Euro-zone experiment together by outright purchases of tainted government bonds (also contributing nothing to economic growth), it has become apparent that the solution can NOT be strictly monetary.

Only a fiscal fix that includes more near term spending within a broad plan to lower debt across the intermediate term will restore confidence. That is not likely in the US due to the current political dynamic. It is also not likely to be the case in Europe due to similar factors such as the concerns over spending in the successful northern economies. It is also burdened by the political structure whereby 17 nations’ parliaments (or at least their budget committees) must approve any move. And in general the degree to which investors and many mainstream portfolio managers and advisors have maintained that it would all be ‘just fine’ in spite of the macro-economic deterioration has been a classical major triumph of hope over reason.

So the word to investors is to hedge their exposure because it is not likely that the factors which have plagued equity markets since May are going to be addressed anytime soon. And it is the case that the forecasts from the OECD (as far back as July and sustained into September), and all the signs from IMF and the central banks as well (with the ECB finally allowing that growth was waning at its last press conference) point to the degree to which the global economy is slowing to a degree that will not likely support current equities valuations.

How much lower might they go? That’s more of a technical than economic question, and we can only site the lower supports from the trading on the way up. However, each of those should be taken with some degree of caution. The fact is that the clear top which the S&P 500 lead contract future formed since the top of this year until the August Breakdown below the mid-1,200 area had a downside Objective of 1,147. However, those technical Objectives are always minimum targets. And if they are overrun there is a tendency for the trend to perform according to the classic observation, “Trends tend to last longer and go further than anyone expects when they begin.” (The same was true on the way up. In December the lead contract S&P 500 future overran the 1,246 UP Objective of last summer’s bottom; presaging a major extension of its rally.)

The fact that the downdraft in early August was based on the somewhat intractable factors noted above, and it immediately overran the 1,147 DOWN Objective on the way to more major 1,100-1,090 support, speaks of the likelihood this downward phase is going to be with us for awhile. And based on that, it is problematic whether it will hold the next lower major supports (from last summer) in the 1,040-1,000 range. We shall see.

Dealers should allow for full tests of the more major technical areas, and try to avoid positioning in between. In fact, this perception on  the part of the more savvy short term market participants is a contributing factor in the volatility. On recent form, it seems the well-informed dealers understood that as bad as the S&P 500 looked in the low 1,100 area (like after the initial release of Mr. Bernanke’s Jackson Hole Speech text on July 26th), any recovery back above the mid-1,100 area was likely to lead to a retest of the low 1,200 area. And vice versa.

At least that’s how we were seeing it, and advising accordingly. And that makes the current December S&P 500 future retest of the low 1,100 area critical once again.

General Market Observations

At least that’s how we were seeing it, and advising accordingly. And that means that the markets are back into some very critical decisions at present. That is both for the December S&P 500 future in the low 1,100 area, and even more critically for downside leader German DAX index sliding back below the recent and historically important 5,100 area this morning. The latter does not bode well for the equities in general. And any further slide that includes a violation of the low 4,800 area would represent a very nasty DOWN Break from an already intrinsically bearish pattern. (More on that in EXTENDED TREND IMPLICATIONS below.)

Of course, the major beneficiaries of all this equities weakness and attendant downbeat global economic expectations are the US dollar and the favored government bond markets (German, UK, incredibly the US, and others.) And in spite of how far each has risen of late, look for more of the same if the equities break down below the next critical supports. Of course, that would also mean more weakness for the energy markets, and even Gold that has finally fallen back to earth on those weak economic (i.e. no chance of inflation) expectations.

EXTENDED TREND IMPLICATIONS

 Equities: December S&P 500 future slipping below its next incremental 1,130 support on the gap lower opening yesterday leaves the mid-August trading low at 1,114 as a fairly critical Closing price level. Even though it snapped back up yesterday, should it Close the week below it an immediate attack on the more major 1,100-1,090 support is likely. And there is not much below that until the 1,040 and 1,000 areas. However, if it manages to hold, then as bad as it feels now there is a distinct possibility it can recover to upper 1,100 area; even if just as part of a broader pattern ultimately leading to a violation of 1,100-1,090 area.

Similar conditions prevail in the important near-term trend evolution of the DAX. It has dropped back below both 5,190-50 support from last week’s UP Closing Price Reversal (CPR) and its Tolerance at historic and recent 5,100 support. That probably means the low end of its near-term downward channel in the low 4,800 area will be tested. That is also very critical, as a violation of that support would indicate major DOWNward re-Acceleration; 4,500 would be the near-term target, yet with the distinct potential that any slippage below there would indicate an immediate swing to 4,000 area. That sounds pretty radical (surrealistic?), yet is just the way it has traded on all previous up and down swings in those areas!

Long Dated Government Bonds: Whatever else might be bullish for the favored government bonds, it all still raises the old question, “How high is high”? December T-note future had problems pushing back above the 130-20 resistance (previous December 2008 all-time high) prior to the FOMC statement, yet is now up near expired September contract’s 131-29 all-time high from two weeks ago. Of note, that is also the Tolerance factor on a major oscillator resistance, much above which a push to 134-00 is likely. The UK Gilt future is in a similar condition in the low-mid 131.00 area, while strong sister German Bund future would need to knock out the 140.00 area to also escape all resistance for another couple of points extension.

Foreign Exchange: It seems in the wake of the far more downbeat ECB forecasts for the European economy as well as other weak economic indications that the classical relationships have been reinstated to a goodly degree. At least that is the implication we must draw from the euro’s recent slippage below the low end of important EUR/USD 1.3900-1.3837 support that held back in July. US Dollar Index has also been out above the high end of its .7600-80 complementary resistance, and the weak global economic outlook means that is exacerbated by the weakness of commodity currencies. EUR/USD is back in an entire lower trading range, and even retesting next significant support in the 1.3400 area. As that is also the area of the broadest upward channel support from the major 1.1876 June 2010 low, any weekly Close below it points toward a retest of at least the 1.3000 area and possibly the 1.2859 January low.

However, on the failure of commodity markets (note the weakness in industrial and commercial activity bellwether Copper since it broke support at 400-390), those currencies are even weaker than the often beleaguered euro. As noted extensively of late in the Current Rohr Technical Projections – Key Levels & Select Comments, the Australian dollar support in the AUD/USD 1.0300-1.0200 area was a critical bellwether for whether its overall top and intermediate-term channel were going to Break DOWN. Since the AUD/USD failure below there Wednesday it has fallen below parity with the US dollar, hitting the mid- .9750 area. However, as it is also back in an entire lower range since violating the 1.0300-1.0200 area, next interim support is not until down in the .9600 area, with heavier extended support not until .9400 and even .9000.

Energy Markets and Gold: These are now both direct reflections of the trend in equities, with the significant shift of late being the yellow metal’s failure along with equities. Especially on the November Crude Oil stalling on its multiple tests of the 89.50-90.00 resistance over the past several weeks, weakness in equities was not good. Back below the important 83.85 February low, it is now in a test of the prominent interim support in the 80.00-79.50 area.

As noted repeatedly in recent analyses, it was most interesting that the lead contract Gold future had been only temporarily above its 1,886 major Runaway Gap Objective on two occasions over the past month, and immediately fallen back. It has now dropped below its 1,760-50 interim support (now resistance.) Of course, the more major lower support remains back in the early August 1,692-82 Runaway Gap that is now being tested this morning. Whether it holds is critical both in the near term, and to the intermediate-term trend. If there is a weekly Close below that area, the bears get the shiny genie back into the bottle for a significant top (Exhaustion Gap that forms when Runaway Gaps are not just filled, but outright overrun.) That would indicate the potential to immediately test the more major lower trend support in the mid-1,500 area; and possibly even slip back to the 1,400 area last major congestion prior to the massive rally extension that began in April.

Thanks for your interest.

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  1. September 30, 2011 at 3:11 AM

    Thank you. These are great fundamental observations for the near term.

    • September 30, 2011 at 6:45 AM

      You’re welcome. Glad you find them interesting.

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