Markets Roared, Central Banks Offer a Jostled Response
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As we entered the New Year, it became obvious that the lack of further Central Bank support in December threatened the fragile recoveries that have been seen around the globe in the post-Financial Collapse environment. The European Central Bank had talked up more QE leading into their December meeting, and that fell flat on December 3rd when the bank failed to increase their QE program, and instead merely cut the deposit rate into deeper negative territory. The Bank of Japan avoided any additional stimulus actions in December, and we even saw an actual rate hike out of the Federal Reserve. So in one sense, it appeared as though we were nearing the end of the ZIRP-fueled environment that reigned across global markets for the past seven years. But that feeling of strength did not last for long.
The reverberations were felt near-immediately on the open of the New Year. The concurrent pain factors of an Asian slowdown while full-fledged carnage was taking place in commodity prices was too much for the world to bear in a tighter (or less loose, even) monetary environment. It only took six weeks of pain before we saw Central Banks begin to bend to the pressure. The lows across many markets were set on February 11th, which was the second day of Ms. Janet Yellen’s Congressional Testimony. And while she didn’t say anything directly assertive regarding interest rate policy or QE, she did provide enough confidence to financial markets that the Fed would remain supportive while global risk factors were flaring.
Created with TradingView; prepared by James Stanley
This brought a night-and-day type of impact to risk tolerance, and this supportive stance was further iterated in March when the European Central Bank made a massive increase to their QE program, followed by the Fed lowering their forecasts for rate hikes in 2016. This puts Central Banks back in the driver seat for risk trends as we move into Q2, and their delivery on these expectations for continued support will need to be met for risk trends and indices to continue to rally. Should they falter, or should Central Banks begin to lose confidence from markets, the entire post-Yellen rally could come undone very quickly and we could be right back into ‘bear market territory.’
Of particular interest for risk tonality in Q2 will be the Bank of Japan, Fed meetings in April and June, and perhaps even the prospect of a Brexit when the UK goes to the polls to vote on the matter on June 23rd. From the chart above, you can notice that the Nikkei has been the laggard of the five followed indices. The Bank of Japan made a movement to negative interest rates in late January in a move that was widely panned throughout financial markets. This move was designed to deflect capital flows, but in reality only increased risk aversion as the Nikkei took a heavy hit. The next Bank of Japan meeting is on April 27th and 28th, and this could be a big meeting not only for the Nikkei, but for risk tolerance around-the-world; if the BoJ continues to flag inventive new ‘emergency-like’ policies, fully expect risk aversion to return. As we saw in late January from the BoJ (when risk aversion heated up) and again in mid-February from Ms. Yellen (when risk aversion turned around), Central Bank meetings in one economy can most definitely bring impact in others. Fed meetings are on the calendar for April 27th and again on June 15th, and as has been the case of recent, this will likely be the ultimate determinant as to whether risk will continue to rally.
When beginning an analysis for indices, it’s wise to have a handle on the long term picture. This monthly chart of the Dow Jones Industrials is close to as long term as it gets! Basically, the ‘angle of influence’ on a long term basis is the line that connects the 1932 and 1982 lows. A parallel extended from the 1966 top creates a channel. That upper channel line has come into play as support and resistance over the last 16 years. In fact, the line was precise support in September 2001, and then support throughout 2004 and 2006 as global equities ascended into their 2007 tops. The financial crisis low registered at the center line (also known as median line) of this channel. The aforementioned upper channel line was touched again in November 2014. The index traded around this line until June 2015. In other words, former support (in 2001 and 2004 to 2006) has become resistance (2014-2015). The dynamic is long term bearish but the index can still rally to a new high. The same line will be of interest for resistance again. So, we view the indices over the next quarter and longer with the understanding that the long term reward/risk situation is generally unfavorable.
The S&P 500 rally from the 2009 low is viewed in the same fashion as the Dow rally from the 1932 low; as a channel. An important change in behavior took place last November, when the upper channel line (in red) provided resistance. In the event of a new high, this same line is resistance again. The line is barely above the May high, so a new high would be viewed as a last gasp and the new high would probably be marginal. Internal channel lines (at 25%, 50%, and 75%) have proved worthy as pivots at times. As I type (on 3/23), the 75% line, which was support in October 2014, is providing resistance. The 50% line (median) was support last August and October. That line could provide support in the 2nd quarter near 1965 (December 2014 low and a high volume level from the August 2015 drop). Finally, seasonal tendencies call for a top at the end of April and June is historically the worst month of the year for the stock market. So, the 2nd quarter could see a grind of sorts (within a range of 1965 to 2160) into the next market top (watch the red line!) before sharp weakness towards the end of the quarter.
The DAX held its 200 week average in February. Other than that, the index looks terrible. Trend from the 2009 low was defined by an Andrew’s structure. The support from that structure broke in January and is now viewed as probable resistance near 10200 on its way to a test of the 2000 and 2007 highs at 8136 and/or a test of the 2009-2011 trendline, which is lower. The DAX may hold up as the S&P 500 squeaks out another high but focus on this index is selling resistance.
UK100 Weekly | Yearly
The FTSE doesn’t look good either. The failed breakout to a record high in April 2015 remains the most important feature on this chart and is longer term bearish. Estimated support for the 2nd quarter is 5731 (close of the low week). Resistance is better defined as a zone defined by the 50% and 61.8% retracements of the April 2015-February 2016 decline at 6311-6503. More emphasis is placed on the upper end of the zone given the October 2015 high at 6487 and 200 week average (currently 6420). Also, the 2015 yearly candle is of the outside bearish variety.
Nikkei 225 Weekly
The Nikkei 225 rally into July 2015 was probably a 3rd wave advance within a 5 wave cycle from the 2009 low. The implication is that weakness since July 2015 is a corrective phase that will eventually give way to leg higher that exceeds the 2015 high. The February low is at the 200 week average and more importantly at the top side of the 1996-2007 trendline (former resistance provided support) so it’s not impossible that the 4th wave low is already in place. However, a ‘better’ place for the low is the 14300s. This level has proved big as support on a number of occasions since 1992, most recently in October 2014 when the BoJ went ‘all in’ on Abenomics. Do we get to this level in the second quarter? No idea, but it’s wise to mark the level on your chart. A grind higher into the seasonal top (late April) wouldn’t be a shock. The February high at 17898 and 61.8% retracement of the December 2015-February 2016 decline at 18019 combine to form a well-defined resistance zone.
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