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Global Stocks Move Towards Fresh Lows, Will Yellen Save the Day?

Global Stocks Move Towards Fresh Lows, Will Yellen Save the Day?

Talking Points:

- Global stock markets are off to a rough start to the week; the Synchronous Bear Flags that we discussed last week have all been broken as most equity markets are making lower-lows and lower-highs.

- We discussed the negative feedback loop currently being seen in markets to end last week, driven by US Dollar strength as the Fed continues to talk up higher rates. We hear from Ms. Yellen during her twice-annual congressional testimony later this week, and this can certainly hasten or reverse recent trends given her stance on upcoming rate hike expectations.

- Potential for volatility for the remainder of this week is extremely elevated. Make sure your risk management has been addressed, and if you’re looking for ways to generate trade ideas based on crowd positioning and sentiment, check out our Real-Time SSI. It’s free.

- We looked at the short stock play well ahead of this most recent bout of mayhem began, and some of those targets still remain active. Click here to access our Q1 forecasts.

Stocks are taking a hit to start the week: With much of Asia on holiday and China closed for the entire week in observance of Lunar New Year, this appeared like a prime opportunity for a quiet start to a potentially heavy week. But that was not to be; selling in Europe started on the open and hasn’t really calmed down yet. Given that we’re in a fresh start to the week and there’s been essentially no data to feed into these declines, this would indicate that we’re seeing either a) technical selling or b) a broader, ‘bigger picture’ theme take place. From most available signs, the latter would appear to be the operative case.

We discussed such a theme last week in relevance to the S&P 500, and how market turns often take time as investor sentiment flips. After the initial scare (such as we had in August and September of last year), many investors will often still remain bullish. This is when that buy the dip mentality comes back, and we had outlined that back in October of last year as Chinese stocks were enjoying a rip-roaring run back to the up-side. But, do all investors come back? After a fright of that nature, some investors are rightfully scared and stay on the sidelines. Some may even open short positions; whatever the case, this often leads to lower-highs as bullishness begins to wane.

This means that, unless something fundamentally changes, there are fewer buyers to push prices to new highs. This also means that there are likely fewer buyers on the sidelines waiting to ‘buy the dip.’ On the other side of this coin, the motivation to sell increases as a market is unable to make a new high. This leads to even fewer bulls and even more bears, and then this leads to lower-lows to go along with those lower-highs. This is the cycle that markets are constantly repeating. As the lower-lows get even lower and as lower-highs become even less frequent, the market moves on from a bullish to a bearish state and that old prior bias no longer ‘works.’ This is why price action is such a key tool for those that trade, it strips out the noise and focuses on what matters (executable prices and people actually backing their opinions with capital by taking on risk). We discussed this gyration as it had begun to happen in US Stocks a month ago.

These lower-highs are precisely why we looked at short global equity setups in our Q1 forecasts on indices. We’ve already had a few targets hit, but many of these setups remain active. The most pressing one for this morning is in the DAX as political risk continues to increase in Germany. For right now, it appears as though we’re getting near-term support on the psychological 9,000 level; and it’s already put in a big move to start the week. Be very careful of chasing here. Wait for resistance, and don’t look to trigger short until you’re confident that you can properly manage your risk. When a market makes a significant new low early in the week, it has a tendency to snap back.

Created with Marketscope/Trading Station II; prepared by James Stanley

Data this week is centered around one item on the calendar (Wednesday and Thursday): It’s a fairly quiet week on the data front and with China closed in observance of Lunar New Year, this would normally be the type of week in which retracements in trend-side moves would be expected. This goes back to the sentiment that we mentioned earlier; as new lows come in on an increase in bearish sentiment, a void of data will often allow for that bearish sentiment to wane a little bit.

But this week will likely not be quiet. There is one major piece of news that takes up two days that can significantly heat up trend-side movements or retracements of those moves, and that’s Ms. Janet Yellen’s twice-annual testimony to Congress. This will take place on Wednesday and Thursday, and the wide-spread expectation is that she’s going to do what the Fed has been doing of recent, which is to stick to the idea of more rate hikes throughout this year while also alluding to keeping a watchful eye on global developments.

The big question is what she says about the March Fed meeting and whether or not she’ll back off of that rate hike, and given the pandemonium that’s developed of recent that’s extremely unlikely, as she probably won’t want to look inconsistent in front of Congress. But that’s likely going to be the show of interest as we’re in an election year and much of the voting populace has qualms around the economy. Ms. Yellen, unfortunately, takes a lot of heat for that even though it’s those very same congressman that are actually responsible for fiscal policy. But this does mean that we’ll likely see some element of political grand-standing which could bring this issue of rate hikes, QE and continued tampering with monetary policy to the headlines.

But – with a Fed chief unlikely to back down in front of Congress, this does bring up the prospect of continuation plays on the short-side of stocks. The big point of divergence in markets right now are US rate expectations, and as we had written to end last year, this is likely the driving factor in the increasing pain threshold being felt by the economic world right now. Asia has been slowing down for over a year now, and commodity prices began selling off well over a year ago; the one big thing that’s changed of recent is the Fed.

If Ms. Yellen doesn’t back down from rate hikes during her Congressional testimony this week, or if she doesn’t exude caution over global developments, expect global stocks to continue to trade in a risk-averse manner.

Created with Marketscope/Trading Station II; prepared by James Stanley

--- Written by James Stanley, Analyst for DailyFX.com

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

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