US Federal Reserve chairman Ben Bernanke fronted up to Congress for his testimony to the House Financial Services Committee last night our time. After his comments last week sent stocks skyrocketing, everyone was waiting to see if he would continue with his dovish tone.
He didn’t disappoint when he said ‘I emphasize that, because our asset purchases depend on economic and financial developments, they are by no means on a pre-set course.‘
Financial markets began to rally on these words, but it was a muted rally. As Goldman Sachs said in their round up as reported on ZeroHedge: ‘despite having ample opportunity, the Chairman did not significantly push back on expectations that tapering would begin in the next few FOMC meetings.‘
So it looks like tapering is still well and truly on the table later in the year, but the goal posts could be shifted if worse data than expected starts coming in…
Thus begins the twilight zone of good is bad and bad is good. If data continues to improve at a faster pace than expected then tapering may be brought forward and increased and stocks and bonds could suffer. If data falls off a cliff then tapering will be delayed and stocks and bonds may rally.
Forget spending years at university studying macroeconomics and fundamental analysis of stocks. The US Fed is the only game in town and that’s all you need to know about.
I will be interested to see how markets react over the next few days to the slightly less dovish tone of Bernanke’s testimony. After a very sharp rally over the last month the S&P 500 is retesting all-time highs. I would expect to see a pullback from overbought levels if the market is disappointed by Bernanke’s comments.
ASX 200 Diverging From AUD/Yen
There have been some interesting developments in the relationship between the ASX 200 and the Aussie/Yen in the past month. I’ve mentioned how closely the two have tracked each other over the past few years on many occasions.
ASX 200 vs Aussie/Yen
I’m still amazed when I look at the above chart and see how strong the relationship is between the two.
There is little doubt that the relationship has broken down on this most recent rally in the ASX 200. When you look at the rally in the ASX 200 within the ellipse it is quite clear that the Aussie/Yen isn’t coming along for the ride.
What could this mean?
Investors have borrowed in Yen and invested money in Australia which has caused the Aussie/Yen to rise along with the stock market as those investors bought stocks and bonds.
As a result it may not be so far-fetched to say that the current rally isn’t being caused by carry traders loading up on risk again. If it was, then you would expect to see the currency rising alongside the stock market.
If this rally isn’t being caused by the thing that has been so instrumental in our stock market rally of the past year then what is causing it? Perhaps the rally is just a bout of short covering and soon enough the buying will peter out and the ASX 200 will turn down and reconnect with the Aussie/Yen.
Of course the Aussie dollar may be nearing the end of its current downtrend and we may see the Aussie/Yen jump to meet the ASX 200, in which case we could become more confident of the staying power of the rally. But at the moment I think the large divergence that has opened up between the two brings the current rally into doubt.
Another thing that I have my eye on is my ATR indicator.
The ATR indicator shows the average true range (including overnight gaps) of a stock/index over a certain period of time. It’s a quick gauge of price volatility. I like to tweak the indicator by taking the ATR value and then dividing it by the price of whatever I’m studying so that you end up with a percentage of the price as the average true range number. I use the 10 period ATR.
I then overlay the indicator and invert the scale so that you can see the relationship between changes in price and volatility.
ASX 200 and ATR Per Cent Indicator
This indicator is most useful when looking for divergence between prices and volatility. You can see from the above chart that there have been a few instances over the past few years where the indicator gave a great warning sign about an impending decline.
In early 2011 (inside the first circle) you can see where prices and volatility diverged. The stock market shot to new highs but the ATR indicator didn’t go along for the ride.
In other words volatility was still high even though you would expect volatility to fall during market rallies that are sustainable. (Remember the scale for the ATR indicator is inverted so when the indicator rises in the chart it is saying that volatility is falling).
Sure enough, the stock market made a new high but then promptly fell over and began what was a 1300 point dive over the next five months.
Fast forward to May this year and you can see that the same thing happened again. Prices rallied from the end of April to the middle of May but the ATR indicator didn’t go along for the ride. Yet again, prices topped out and then fell in a straight line to 4700. That set-up was one of the reasons why I predicted the fall in the ASX 200 at the time.
The current rally is not being confirmed by the ATR indicator, so I’m sticking to my guns and saying that this rally is a bull trap and will soon enough run out of puff and turn back down.
Murray Dawes+
Editor, Slipstream Trader
From the Port Phillip Publishing Library
Special Report: The Sixth Revolution
Daily Reckoning: A Structurally Sick Economy
Money Morning: With Gold, Don’t Miss the Top
Pursuit of Happiness: The Dark Side of Technology
