By Pinchas Cohen
Yesterday, in our Opening Bell post we discussed the confusion among investors regarding risk. While Asian shares declined on renewed tensions between the US and North Korea, European shares advanced and European bonds fell, even while US equity futures were declining and US Treasuries were rising, all at the same time. Later, after the US market open, US shares resumed the decline that began with futures – the Dow fell 234 points and the S&P 500 fell the most since August 17, ending a six day rally, and Treasuries extended their earlier declines.
In short, the global market openers and closers (Asia and the US, respectively) traded risk-off, while the middle market (Europe) traded risk-on.
Why The Global Market Divergence?
There are four possible explanations:
- Europe displayed classic Middle Child Syndrome and bucked the trend.
- While Asian and US risk-off sentiment were influenced by tensions with North Korea (due to geographic proximity in Asia's case and being North Korea's enemy in the US's case), Europe may have felt like a neutral zone.
- Global traders started the day yesterday with the recent escalation fresh in their minds and traded risk-off, but by the time European trade opened investor fears subsided. When US markets opened, traders got news of Hurricane Irma’s follow-up to Harvey, and returned to risk-off.
- Global traders couldn’t make up their minds – they started the day with risk-off, sheltering in safe havens, then shifted to risk-on and came out of hiding, only to get scared and return to risk-off and sheltering havens again.
So, which is it? Risk-on or risk-off? While no one can know for sure, we can extrapolate.
While point #1 was written with some humor, a comprehensive study of trading during European hours yesterday compared to the Asian and US sessions may reveal something on Middle Child Syndrome.
The second reason, namely exposure to the North Korean threat, is plausible, but shouldn’t that be moot in a global market? If Asian and/or US shares fall they will inevitably drag European shares down with them.
How about the third reason, a second hurricane? It makes sense, but market reaction—namely rising oil and declining gasoline—was the opposite of what occurred during Harvey when oil declined due to offline refineries and shifting energy demands sent gasoline soaring 27 percent.
The current rise in oil and decline in gasoline seems to be a correction of the previous moves rather than a shift in the trend as the major fundamentals remain the same. Fundamentally, oil is rising to three-week highs as refineries restart after Harvey, while Irma spells trouble for gas as it heads toward Florida. There are no obvious signs of market reactions specifically to the hurricane. Rather, the narrative focuses mostly on North Korea and a bit on the looming U.S. debt ceiling.
Could it possibly be the fourth reason, traders’ inability to make up their minds due to a lack of leadership? If that’s the real reason, it is a telltale sign of a market top. Let’s look at the balance of supply and demand, as represented on the chart.
The first obvious sign of trouble for the integrity of the current uptrend was the failure to find support on August 18, on the recent uptrend line since December 30. The second obvious sign of trouble was when the late August rally failed to climb above the former late-July/early-August rally.
Official Bear Market?
However, an unnoticed sign of trouble sent an alert even before the obvious one when the price crossed below the uptrend line that has held since December 30. Market breadth was not supporting the S&P 500 benchmark’s latest record highs of July-August. A second unnoticed sign of trouble beat the additional obvious one, failure to maintain the succession of rising peaks, when market breadth again failed to support the latest peak, providing the lowest participation across the market for a peak since August 2016.
However, it should be noted that the current trend – with all its uncertainty – is still considered an uptrend. Only upon the breaking of the neckline, or reversal-line, would the trend be considered reversed, as two peaks and troughs in a declining pattern would have emerged. As well, the longer uptrend line since February 2016 should be violated by then.
The implication of the successful breaking of the neckline would imply a price target as measured by the height of the pattern from its top to the breakout point. If the breakout point would be 2430.00, the height would be 2490.87 (August 8 peak) subtracted by 2430.00, which equals a movement of 60.87 points. The breakout price of 2430.00 subtracted by 60.87 points suggests the 2369.13 target price, roughly 2.5 percent. However, should that target be achieved, the uptrend line since February 2016 will have been violated, suggesting a potential retest of the primary uptrend line since February 2009, at the current angle of 2000, which is 19 percent lower. That is already flirting with an official bear market.
Trading Strategies
Conservative traders would wait for a decisive close beneath the neckline, as well as employ a filter to avoid a bear trap, 1-3 percent deep depending on risk aversion. They would also wait for a likely (but not necessary) return move to retest the now-resistance of the neckline, before entering a short, to avoid the whipsaw. The stop-loss should be placed well above the neckline, as it slopes upward, which means the return-move may very well reach higher than the price at which it broke it.
Moderate traders would wait for a decisive break on a close of the neckline, while employing the filters mentioned above, placing a stop–loss as mentioned.
Aggressive traders may short now on the probability of continued North Korean rhetoric until its “foundation day” holiday on Saturday, during which time the North Korean sabre rattling is likely to continue, as well as the approach of the second hurricane and the looming US debt ceiling.
Very aggressive traders may go long after the price reaches the neckline, now at 2425.00, for an expected bounce before it might break it.