Europe is heading north while the US heads south. The divergence between the German DAX and US stock indexes continues to widen into a yawning chasm. The always trend-following momentum players – the hedge funds and banks – continue to drive the DAX into the stratosphere high on the elixir of ECB QE ‘stimulus’.
At the same time, they are rotating out of US shares because of one main theme – European shares are ‘cheaper’ than US shares. Isn’t it wonderful that the smart guys who ‘earn’ mega-bucks in the big trading rooms can focus on this simple-minded idea. Of course, they do it because everyone else is doing it.
Not following the herd is a job-threatening strategy, so let’s join the party and damn the torpedoes. I am sure most traders believe it will end up in a big bust, but they don’t get paid for predicting that scenario (at least publicly).
Here is an interesting chart showing the relative performance of EZ indexes cf US:
If anything, this is demonstrating that in reality, all stocks markets are being manipulated by levels of liquidity available to the big guys. If there are funds lying around, then buy anything!
Of course, much support of DAX is a result of the plunging euro. In dollar terms, the DAX is not so frothy, but still is out-performing US.
But of course, this is totally unsustainable. When enough investors wake up and realise they have blindly bought at crazy valuations, given the weak underlying fundamentals for the global economy, there will be a tsunami of selling. This is what always happens when a massive bubble bursts.
Not only that, but has anyone noticed in hedge fund land that the euro is plunging? Yes, this may well translate into a huge currency gain for German exporters (if they are unhedged, that is). But their main export market, China (which has gone off the radar recently) is slowing rapidly. Maybe they have just woken up to the fact that they have built too many empty cities, tower blocks and airports lying there doing nothing.
The key is the yuan
And the pressure on the Chinese to weaken the very strong dollar-linked yuan is building all the time. The pressure to devalue in the face of weakening exports is immense. Something has to give and when they do relax their dollar peg, it will create tidal waves of selling in stock markets around the globe – especially the DAX.
The likelihood is that this will be done on a weekend – the traditional time for major market surprises. We may wake up one Monday and see markets in turmoil.
Nations are in a currency race to the bottom globally in an attempt to keep competitive advantage in the face of tepid demand. EM currencies are being decimated, the euro and even GBP are weak vs the dollar and the only major hold-out is the yuan. It’s just a question of time.
Is bad US news bad again?
Under the aegis of the Fed, all news – bad and good – was considered good for the stock market. But last week, we had a really dreadful Retail Sales report (again) with sales down hard vs an expected gain. Then yesterday, Producer Price Index came in way below estimates. Here is a revealing chart:
The consistent move below zero is clearly deflationary – and the large Feb bar down is minus energy and food, so oil weakness isn’t to blame. The pressure is on to cut prices everywhere. This will have a major impact on stock valuations when the penny drops.
Next week will be wild
With the dollar rising vertically (DSI last week was 97% bulls!), US interest rates set to explode (see T-Bond chart), and on Wednesday, the Fed will (or won’t) expand on their disguised intentions to raise the Fed Funds rate in June (or July. or September???).
The point is, the market treats this kind of event as a potential game-changer and the markets will become even more volatile in the week. In addition, the vernal equinox (next Friday) is often the period when big bull or bear markets make their turn if sentiment extremes pertain – as they surely do in currencies and US stocks and Treasuries. In the wings lies gold where DSI sentiment has dropped to 8% bulls. Hmmm.
Nice rally pull-back to wave 2 high along my superb tramline trio on the hourly:
Note the large momentum divergence at the wave 2 high. A break of lower tramline will mean we are in wave 3 down. This should take yields up very smartly. The Fed Wednesday report could be the catalyst.
I added to shorts at the wave 2 high.
It has been virtually straight down of late, but if my EWs are correct, we are very close to a major turn:
My tramlines are not picture-perfect, but the hit on the lower tramline plus the large increase in spec short positions (see latest COT data at cftc.gov), and we are near the end of the major bear run.
For this reason, I decided to take partial profits for VIP Club members on my short trade from the 1.55 area last week at 1.47 for a tidy 800 pip gain.
Remember, I expect next week to be wild and woolly, so hang on to your hats!
And if you want to receive my trades in real time as I make them, drop me an email at email@example.com and I will send you details of membership in my VIP Traders Club.
Have a great weekend!