The theme of the week, month and year is the ongoing broken record that is the Euro equity bear. Last week Draghi told Euro traders and anyone else who might be listening the ECB would do whatever was necessary to make Europe right. We’ve seen some version of this script before but the importance is most markets went parabolic and crazy over the news. I’d like to tell you equity bears learned their lesson last year when Greece didn’t create the next Lehman moment but I can’t because they are certain to short it again at some point. The problem with the market is bulls aren’t committed beyond the near term either. So when did you ever see a market disliked by longer term bulls with a VIX so low?
We've known each other a long time. Can we be frank? In 13 years I’ve never seen market conditions like this. The VIX is low but there’s no euphoria and when there’s been this much lack of interest the VIX is usually much higher. There’s a decent amount of fear out there as represented by the headlines. The latest Presidential poll has Romney and Obama in a flat footed tie 100 days out from the election. The very fact the incumbent could be this close to losing his job suggests the dissatisfaction with the economy. The GDP number came in at 1.5% which has sapped the confidence from the public as well as real buying interest in this market. At the end of the day we can’t rule out any of the scenarios we’ve discussed over the past 3 weeks. The nightmare scenario is a VIX which continues to melt down into the October time window which could create a new long term top and descent into a brand new bear market. On the recent downturn it appeared we sidestepped away from that scenario but not yet.
So we had the big test of the low in the EUR-USD which was expected if you had the patience of a saint. The US Dollar dropped again which allowed all inverse instruments to rise with one exception. The Chinese SSE hit a new low. That’s the big divergence because while Europe spiked China did not. It’s not a new bear market low but it is a new 3rd year low off the secondary top. If this move down since last year has accomplished one thing, no longer is anyone in China talking about a soft landing. So their market is starting to get the job done. Now the main theme we get out of China is how could such a gigantic economy only grow at a rate near 7.5%? The latest headlines from this month suggest the economy has cooled and shows the need for policy action. The Reuters story reports the Chinese growth rate has slowed for 6 successive quarters to its slowest pace in more than 3 years. What does this market speak mean when we translate it into English?
In the past year to 15 months we’ve gone from complacency of the expectation of a soft landing to the alarm that economic activity has slowed more than was anticipated. This reminds me of the sentiment in early 2008 when US policymakers realized we weren’t coming in for a soft landing and the subprime mess might not be contained. However there is one key difference. The Chinese economy is not sitting on the brink of a crash or a panic. They are more than likely working their way through economic times like we had in the 1970’s. This is a 4 year old bear market and if we can identify where we are in terms of sentiment, chances are they are close to mid-point of the whole pattern. That means we could still be several years away from the end of the correction and if we look to the 70’s the lesson is that while the true bottom came in 1975, the Dow didn’t really take off again until 1982. I can’t tell you that we’ll take out the SSE bottom again but this is a market that can go through alternating trading legs like we’ve had for another 3 years. The only way this correction ends sooner is if Europe really goes in the tank and China has a similar reaction. I don’t think we’ve seen the end of the European debt crisis either because I’m not satisfied the way it ended this week. To be sure, the 2010 low was tested and it held. But the traditional end to a crisis of this nature is a market that goes down to the point it doesn’t feel like it’s ever going up and in terms of the news, we do get to the point where someone does leave the Euro. To be fair, the kind of low we had this week could be a test of the bottom of a trading range that continues on for several more years. The Euro could perfectly well have a nice trading rally from here but odds are that at some point in the future it will be back. At the end of the day I still suspect the Dollar is going to get to 86 and the Euro is going to break below the 2010 bottom. But it may take the patience of a saint to see it. Didn’t I say that already?
Where am I going with all this? First of all I don’t like the fact the SSE is not confirming the excitement we see in the rest of world markets. I think that unless Shanghai responds really soon it will drag the rest of the world down. I also don’t think jawboning by the ECB is anything to hang your hat on in the long term but it’s a step in the right direction. Finally someone in Europe figured out that it’s all a confidence game and while words haven’t been put the test in a real crisis, economies do start healing when they have a reason to feel confident. But all we’ve really achieved is another twist in a very long winding road. Then you have the Olympics where Europe can ill afford for the event to be anything less than a spectacular showcase. Thank Mr. Draghi for getting that right because they are off to an excellent start. If I have one problem with Europe right now, it’s the fact they didn’t trot out Jimmy Page in the Opening Ceremony after having him accept the torch at the Closing Ceremony 4 years ago in Beijing. I’ve waited 4 years for this and I can only hope we see Mr. Page in the Closing Ceremony 2 weeks hence. See, I already put a smile on your face!
So here’s the situation with the US Dollar. It’s about to hit the Andrews channel on the downside which could cause it to bounce violently. The fact it had a parabolic drop last week suggests it’s already oversold and is way overdue to snap back. It could put a chilling effect on equity markets this week. Certainly if that does happen we get another test of the Euro low and under those conditions would make it mighty hard to see a reversal in the SSE. We also see a larger slightly up trending set of brown lines which means it could get to about 82.30 before turning back up. If Friday’s low does hold the brown lines get tweaked and we look to the possibility of an ending diagonal triangle which could still take weeks to play out. For now we should look for an oversold bounce in the very least and quite possibly a trading leg to the upper end of the range.