Looking at the equity market and some of the background dynamics Citi’s FX Technical group cannot help but be reminded of 2011. They also warn, despite the constant hope-driven rallies this week, there are also some aspects of what we saw in 1998 and similarities with 2000 that are worth noting. The bottom line, we have had the view for some time that we would see a much deeper correction in the equity market (in excess of 20%). Recent price action and developments might (just might) be suggesting that it is time to revisit that theme.
Via Citi FX Technicals,
DJIA pattern today looks very similar to that seen in 2011. (Daily)
After a 2010-2011 surge helped by QE2 in November 2010 (A move that was guided since August that year) the DJIA peaked with a head and shoulders formation completing in early August 2011(02 August break) at the same time as a break below the 200 day moving average.
The end of QE2 in June 2011, uncertainty about the US debt limit negotiations and (icing on the cake) a downgrade of the US by S&P on August 5, 2011 (Friday) created the backdrop for a sharp fall.
The target of the head and shoulders top was about 10,800 and the actual low hit in Oct 2011 (04 Oct) was 10,404. This gave us a high to low fall of 19% in the DJIA while the S&P fell 22%.
The present pattern could be viewed as another potential head and shoulders top with a neckline at 14,862 OR as a double top with a neckline at 14,760. The target on a break of this range would be 13,800-13,900 or about 12% high to low. (Compared to a 16% target in 2011 that was overshot). The rising 200 day moving average now at 14,686 also needs to be watched.
DJIA today compared to 2011 (Weekly chart)
The 55-200 week moving average set up is (not surprisingly) also similar, albeit more stretched this time than 2011.
In 2011 the DJIA eventually overshot the 200 week moving average by about 2%. A repeat of that would see the DJIA as low as around 12,200 or 22% off the peak set post the FOMC meeting.
While in 2011 we had some momentum divergence, this time around we have clear “triple momentum divergence” taking place at the peak.
VIX today compared to 2011 (Weekly chart)
The present set up on the VIX looks very similar to that seen in 2011.
In that instance we saw a smaller double bottom “morph” into a larger one that eventually sent the VIX towards 48% in August.
Right now we have a potential double bottom on a close above the 18% area that would suggest at least 24%
In that instance we would complete the larger double bottom at around 22% that would suggest a move to at least 32%
Such a development would be consistent with an acceleration below the support levels mentioned above on the DJIA
In addition the DJIA posted a bearish monthly reversal off the trend peak in August this year at 15,658. While we did get a daily close above that level on 18 Sept. (Fed debacle day) it was not sustained on either a weekly or monthly basis suggesting that this reversal is still valid.
What else was going on around this time in 2011? Actually the dynamics in Europe were on the threshold of deterioration also.
So, looking at the charts above the road map seems to be:
The Equity market is in danger of seeing a much lower level over the weeks/months ahead. High to low this move could end up being in excess of 20%.Given the fact that the Fed has been “setting it’s store” on a move to tapering it would be very difficult for them to quickly flip from tapering to no tapering and even further to expanded QE (This is pretty much what did happen in prior instances of equity market “stress”). In our view that takes away the short term potential for a “Yellen put” absent significant financial market/economic stress and makes it easier for that deeper correction to materialize.
Fixed income yields (US) will likely head lower and drag other long term yields with them.
EURUSD will likely move a bit higher in the near term but as the analogy of “When the US catches a cold the rest of the World catches a fever” kicks in, the USD is likely to go bid again. This may well be across the board as the USD once again sees itself benefit in a “risk off” environment.
We would expect that this backdrop could once again create stresses in peripheral Europe (With Italy looking a prime candidate at the moment) with an elevated EURUSD rate also not helping. This may manifest itself in
– Bunds going bid while peripheral bonds go offered.
– The European bank index turning lower off its present period of strength/outperformance as peripheral equity markets get hit again
– The ECB moving into “super dovish” mode culminating in
– A sharp fall in EURUSD from slightly higher levels (1.37-1.41) than we see today.(In 2011 that fall was 14 big figures between end August and early October)
It is also worth noting that we see some similarities in today’s markets to some other periods. Namely:
The S&P surged to a trend high in August 1998 in a rally that began 4 years earlier in 1994
This was followed by a sharp reversal into October 1998 that saw a high to low fall of 22%
This period followed an attempt by the Fed to “tinker” with monetary policy in the summer of 1997 (they raised rates 25 basis points) that derailed emerging markets (Asia in particular) and culminated with a Russian debt default in August of 1998 and the collapse of LTCM (Long term capital management) in September 1998.
This led to a capitulation by the Fed who then eased rates by 75 basis points between Sept and Nov 1998 creating a platform for the equity market to move higher again into 2000.
This is very similar to what we saw in 2011 where following the end of QE2 on June 30th we saw a complete “about face” by the Fed as they put in place Operation Twist by November that year. In both these instances we saw the S&P fall 22% into the October lows only to post a bullish monthly reversal (In both instances) as the Fed reacted to the deteriorating backdrop.
Overall, the equity market, USD and bond market dynamics of 1998, 2011 and 2013 all show some striking similarities.
Now on to our last period that the Equity market is trading in a similar fashion to….2000
This focus is the most “one dimensional” of the 3 periods and really just focuses on the equity market price action similarities.
Path of the Equity market 1998-2000 compared to 2011-2013.
The 1998-2000 rally was 68%. By contrast the 2011-2013 rally (So far) has been 61%
Then again, the broad market was not “dragged higher” this time by the huge NASDAQ bubble as in 1995-2000. Rather it has been dragged higher by the huge QE “bubble” encouraging misallocation of capital by putting the “Bernanke put” under risk. In addition we do not, at this point, anticipate a fall of the magnitude seen in 2000 and 2007.
In 2000 we had a massive NASDAQ bubble and in 2007 we had a housing bubble. These bubbles created a negative feedback loop into the broad economy and the core equity markets when they burst. This time some might argue that we have a “bond bubble”. There is an important difference though. When the NASDAQ bubble burst the Fed was not a “buyer of last resort” of NASDAQ stocks. When the housing bubble burst the Fed was not a “buyer of last resort of houses”. However in this cycle the Fed has been a buyer of last resort of Treasuries and mortgages. As we saw from the recent meeting, any disruption in the level of long term interest rates does affect the Fed pattern of buying. Having said that, what if we fall as we did in 1998 and 2011 (20%+) and the Fed once more backs away from normalizing monetary policy (As happened in 1998 and 2011)?
On the one hand that might create a platform for another “shot of 2 year adrenaline” for the equity market into 2015 and renewed bond market support. On the other hand, we would be concerned that we could once again get into the quandary we saw in 2000 and again in 2007 (Bubble) without the same degree of scope for a monetary response, leaving the Fed ineffective. (This more than anything is a good reason for them to look to end this “market interference/mispricing of risk/misallocation of capital that we call QE.
Let us just hope (we know that hope is not a good investment method) that if this fall in the equity market transpires as we expect (20%+) that the Fed adopts a more responsible approach for a change and does not respond with expanded stimulus.
Overall, we should point out that this 2000 dynamic is, in our view, a distant 4th from our preferred big picture view of the late 1970’s (Where the DJIA corrected 27% between late 1976 and early 1978) and the 2011 and 1998 pictures noted above.
In addition one of our favourite “Techamental” charts suggests a warning sign
Consumer confidence and the S&P500
Peaks in consumer confidence in 2000 and 2007 were followed by sharp falls beginning in the equity market within 3 to 4 months. In addition we did see sharp falls in consumer confidence into both October 1998 and October 2011.
If this June 2013 print is the peak in consumer confidence in another 4 year 4 month cycle then Equity market weakness in Sept-October this year is consistent with that picture
To sum up:
We retain our overall view that the big picture set up (2000-2016) continues to follow a similar path (with some material differences but a lot more similarities) to that seen in 1966-1982.
Within that the present period also has some similarities to:
– 2000 (Mainly Equity market)
– 1998 (Fed policy, EM, Equities, Fixed income and the USD but in particular…
– 2011: (Fed policy, EM, Equities, Fixed income, European periphery and the USD
For the weeks and months ahead we are now most focused on the July-October 2011 period as the road map for what the markets may hold in store for us.