Signs of market stabilization… for now…
2016 has started off with severe volatility in the financial markets. The downturn in Chinese equities has led to global contagion as the Shanghai Composite had two trading days end closed 7% limit down and forced Chinese financial regulators to dispose of their circuit breaker policy. Additionally, the S&P has experienced the worst calendar year start ever. With so much uncertainty about future market direction, GFC would like to highlight some interesting market divergences that may point to signs of stabilization over the short term.
Last week saw a dramatic intraday reversal on Wednesday with Dow Jones Industiral Average losing 538 points intraday. During the midst of the selloff, the advance/decline ratio registered .0333 meaning that there were 30 stocks down for every 1 up. However, by the end of the day, the market recover to only lose about 250 points with an A/D ratio of .40 meaning there were only 2.5 stocks down for every 1 up. It was quite an intraday shift in momentum as many stocks experienced significant intraday reversals. The rest of a the week continued bullish with the market forming a fairly compelling reversal on the weekly candle. (see chart below)
The market reached very oversold levels last week and was due for a short term rebound. Whether or not this bounce has legs remains to be seen. GFC is of the belief that additional downside risk at this time is significant, and advise that speculators sell into strength should it manifest. The Daily Moving averages are confirming that a bear trend is in motion as the market is trading below the 50 DMA which is currently trending below the 200 DMA. Should the market rally to the 1925-1950 area GFC is prepared to enter into short positions.
Another interesting divergence that we noticed last week was that the VIX was not registering the type of volatility normally present during a panic. Despite rather severe selling pressure which carved out lower lows in the markets, the VIX was unable to eclipse the high it made during last summer’s selloff when it peaked on August 24th. This was a warning sign that the market was likely to stabilize in the short term which it did. (See chart below)
Another interesting and most unusual divergence that has been occurring lately is that of the performance of the U.S. Dollar in the Spot FX markets compared to the performance of U.S. treasury bonds. This divergence has been occurring since early December when the dollar shorts covered their positions on December 3rd. Since that time the EURUSD pair, the largest (47% weighting) component of the U.S. dollar Index, has generally been trading with a 150 pip range of the 1.09 level. GFC finds this interesting because while global equity markets have been selling off, the U.S. bond market has experienced a significant flight to safety bid. On December 3rd, the 10-year U.S. Treasury bond was trading with a yield of 2.33%. Over the past 2 months, yields have declined to 2% even where they are trading today. Normally when the bond market receives a safety bid like this, so does the US dollar in the FX markets. However this has not happened. The dollar has failed to rally against other major currencies. What makes this even more intriguing is that last week the ECB President Mario Draghi alluded to the possibility of additional QE measure for the Eurozone. GFC is surprised the US dollar didn’t have more of an FX rally than in did in the wake of this news which signaled a major diverging between U.S. and EU monetary policy.
Usually the bond market leads and other asset classes follow, so if the smart money is right, we should soon see the U.S. dollar begin to rally substantially in the FX markets. A closing above 100 on a weekly basis for the USDX will signal further dollar strength lies immediately ahead. Additionally, a closing below 1.0710 on a daily basis in EURUSD will signal additional weakness for the pair.