Diary of a Financier

SPX Groping for Support As 2007 Analogue Asserts Itself, Treasuries Fear Fiscal Cliff

In Capital Markets on Wed 14 Nov 2012 at 23:27

Monday night, it became quite clear to me that we’re pursing the path of either the 2007 or the June 2012 market. That means that a reversal out of this slide would have yielded either an 8% rally or a 15% rally, respectively. Recent developments have me leaning [even more] conclusively toward the 2007 bias.

As often occurs in technical analysis, a failed pattern develops into a larger permutation. In this case, the June 2012 iteration is the analogue that’s faithfully guided me through this 8% SPX correction, so far. (As you recall, this analogue itself is a replica of the other major corrections within the cyclical bull rally since 2009’s low–each occurring after a shorter, steeper rally than the last.) SPX departed from this track yesterday after an intraday reversal into the red thwarted the bulls’ attempt at a breakout higher. SPY stretched under the $137.70 1st support down toward the $135 range–formerly 2nd support–and I started buying, a bit premature according to the plan. Independent of static supports and Fibonacci levels, the 15 & 30-minute fractals were both flashing multiday bull divergences at around 12:15, and I accumulated a few more shares (75bps of exposure) of VTI yesterday before I put all trading on hold: the priceaction ultimately never confirmed the indicators’ buy signal. By 3:30, SPY had barely rallied, hence the divergence failed… and equities subsequently slipped lower into the close.

As if I didn’t already have enough evidence to trash the 2q12 analogue, stocks quickly faded a higher open this morning, closing -1.35%. An overlay of today’s market vs. June’s shows a terminal departure from the analogue. By now, I would have expected the early stage development of bull divergence in the daily indicators, along with some lift in the pricetrend, but no such luck:

SPY June v Nov 2012 analogue- suggested +15% rally to new highs, but failed to materialize since pricetrends & indicators have parted ways.

That leaves me with 2007 as the tightest fit to today’s SPY, wherein the comparison shows that a dark candle–a capitulation–marks an initial buying opportunity:

SPY 2007 v 2012 analogue (daily)- expect +8% rally to R shoulder resistance after capitulation.

At this point in the analogue’s progression, the buying opportunity is ephemeral, as an 8% bounce off support ends at the right shoulder of a classic Head & Shoulders top, which should ultimately cascade into a crash lower.

I want to ride that +8% though, so how will I know when to buy this market for a trade?

First, I’m using Fibonacci levels to prepare for the worst case were SPX to gap down. In 2007, a 100% retracement to the preceding correction’s closing low served as a trampoline–eventually marking a H&S neckline–which would imply ~$128/9 (another 5.8% lower) on SPY today. Exactly as in 2007, this level doubles as a a longer term 23.6% Fibonacci retracement from the cyclical bull’s starting point:

SPY 2007 v 2012 analogue (weekly)- 8% rally will bounce off 23.6% Fibonacci support (retracement since cyclical bear market’s bottom).

Be forewarned, this doesn’t necessarily have to be a neat, classical H&S top. In fact, my base case expects a tilted H&S neckline pattern, meaning SPY won’t reach as low as $128/9.

Second, as I already mentioned, I’m looking for capitulation (a dark candlestick and high volume), which qualification today’s cascade might frankly fulfill.

Finally, reversals always begin in the intraday fractals, so I’m looking for bull divergences and reversal patterns there.

~~~~

An exogenous catalyst, a fiscal cliff resolution or dissolution harbors the potential energy to alter the outcome communicated by these technicals. Barack Obama made waves early this morning with his insistence that the government raise an additional $1.6T in tax revenue over the next 10 years (double the $800B-1.2T suggested pre-election). As an encore, the market grew more anxious this afternoon during the President’s first press conference since his reelection. Merely two days ago, everyone had gained confidence that Republicans and Democrats were breaching the divide; now, all seems lost, hopeless… which sounds like a point of maximum pessimism to me.

In the middle of the President’s press conference, the FOMC released its latest meeting minutes, which disclosed the intention to extend Operation Twist beyond its December 31, 2012 term. The Fed’s continuation of this program will be an unsterilized operation, buying long-dated Treasuries and MBS without an offsetting sell/redemption/rolloff/maturity in short-dated paper. Combine with QE3, the Fed will be injecting $85B per month of unsterilized cash into the system.

While $85B is a big number, the market had already priced in that expectation–when it comes to the Fed using its balance sheet to stimulate the economy in ZIRP, we’ve long known that it’s not the stock but the flow that matters. When the FOMC news hit wires, Mr. Obama was still speaking, and SPX ticked +20bps. At that point, SPX was only down 27-45bps on the day, but it eventually faded all optimism, groped new lows, and closed -1.35%.

Why do I tell this story, background and all? First, it’s important to note that the market faded good news. Second, there was no flight to safety: Treasury yields closed higher¹; T-bond prices only nudged into the black on the long-end of the curve, and the positive swing only happened during the last 10 minutes of trading. Dow -185 points and Treasury yields float higher?! Treasuries didn’t catch the safety trade bid?! I can’t help but think that the market thinks that this fiscal cliff issue is a real issue, something that endangers the credit of the United States. I’d take the other side of that trade, but capital is finite, and I think there’s more to be made in risk assets. Treasury credit was downgraded by as few ratings agencies last year, and those very T-bonds rallied… but this fiscal cliff scares bond traders, the smart money?!

I want to go on the record (again): I expect Washington to avert a fiscal cliff. Immediately following his press conference this afternoon, President Obama hosted 35 private sector CEOs for a roundtable discussion about fiscal cliff solutions… positive feedback so far…

–Romeo

¹FVX +2bps, TNX unch, TYX +7bps (CBOE close @ 3:00EST)

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  1. […] guide as neat as a chart analogue, I always get anxious about a correlation breakdown. As was the case most recently–when SPY departed from its 2q12 likeness and recoupled with 2007–I try […]

  2. […] learned my lessons. I’ve employed the ETF today because the fiscal cliff has Treasury bonds acting weirdly (i.e. not catching the flight-to-safety bid I’d hope […]

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