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S&P 500 Jumps as Market Participants Remain Absent

S&P 500 Jumps as Market Participants Remain Absent

2011-08-29 20:41:00
Christopher Vecchio, CFA, Sr. Currency Strategist
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I’m republishing this article once more as a reminder that it’s not advisable to chase profits amid the run-up of risk today, especially given volume on equity markets. To recapitulate a previous observation made, on August 16:

A tenet of technical analysis is that a move by an asset (commodities, currencies, equities, etc) is considered to be ‘technically strong’ if there is strong volume supporting the move. Such has not been the case. Volume has been lacking behind the recent gains in equity markets in recent days, especially compared to recent averages.”

With minimal price action the past few days, relative to the first few weeks of August, and volume substantially lower, the trend appears to be resuming, with today’s data augmenting my argument favorably.

SP_500_Jumps_as_Market_Participants_Remain_Absent_body_x0000_i1026.png, S&P 500 Jumps as Market Participants Remain Absent

Prepared by John Kicklighter

As indicated by the chart above, there was a notable run-up in the S&P 500 today, as noted by the blue line. On the other hand, volume was lower. At the time this article written, volume on the S&P 500 was 686.40 million shares – roughly 230 million less than Friday’s volume. Similarly, the Australian Dollar and the Canadian Dollar are two of the best performing currencies on the day, up 0.72 percent and 0.35 percent against their American counterpart, respectively. This is expected given their correlation with U.S. equity markets.

I would point out that, like the DJIA, the S&P 500 shares a near-identical correlation with the AUD/USD, while also sharing an equally significant negative correlation (positive with the Loonie) with the USD/CAD.

What is ultimately suggested here, that if volume picks up, the S&P 500 will likely fall (or vice-versa: if volume drops, the S&P 500 will likely gain), and given their correlations with the S&P 500, the Aussie and the Lonnie will move against their American counterpart in step with the stock index; this occurred on Monday, as expected.

Background

During the second round of quantitative easing, from November 3, 2010 to June 30, 2011, the S&P 500 traded mostly higher, rising from 1221.06 to 1320.64, as noted in the chart above. Volume was both dense and thin, and the correlation between the S&P 500 and volume was an insignificant -0.14 over the life of the Federal Reserve’s liquidity injections vis-à-vis quantitative easing.

SP_500_Jumps_as_Market_Participants_Remain_Absent_body_Picture_1.png, S&P 500 Jumps as Market Participants Remain Absent

Prepared by Christopher Vecchio

Since July 1, the day after quantitative easing round two ended, a quite different story has unfolded. The S&P 500 has dropped from near 1350 to as far as 1100 in the first two weeks of August. Volume, on the other hand, has been steadily increasing, as noted in the chart above during the first two weeks of August. The correlation here, albeit, on a smaller pool of data, is significantly stronger: a -0.72 correlation since the second round of easing ended.

Conclusions

Recent price action is a cause for concern over the short- and medium-term. A brief glance over correlations between currencies, equity market performance and volume necessarily suggests that currency traders maintain cautious optimism towards the riskier assets, especially the long-components of the FX Carry Trade Index (AUD, CAD and NZD).

David Rodriguez, Quantitative Strategist recently noted thatThe Australian Dollar’s link to the Dow Jones Industrial Average likewise trades near record-strength, and the AUD/USD remains a speculator’s favorite as a proxy to stocks and commodity prices…Thus if you believe that the DJIA is headed higher, the AUD/USD represents an attractive and more liquid alternative to straight bets on the Dow itself."

We have seen this play out in recent days, and this should continued to be monitored in the coming days and weeks. If the current trend continues to hold, we will look to sell into rallies by the riskier assets, rather than buy the dips.

Written by Christopher Vecchio, Currency Analyst

To contact the author of this report, please send inquiries to: cvecchio@dailyfx.com

Follow Christopher Vecchio on Twitter: @CVecchioFX

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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