The logic of financial bubbles remains a mystery to most mainstream economists

Tracking risk appetite across bipolar asset markets

WEDNESDAY, AUGUST 28, 2013       16:30:00 GMT

An article in today's FT (August 28, 2013) contains the following gloomy assessment of the tone at the Jackson Hole summit of central bankers.

The world is doomed to an endless cycle of bubble, financial crisis and currency collapse. Get used to it. At least, that is what the world’s central bankers – who gathered in all their wonky majesty last week for the Federal Reserve Bank of Kansas City’s annual conference in Jackson Hole, Wyoming – seem to expect.

Why would such an erudite gathering have reached such a conclusion and why are they right? It is a reflection of the fundamentally misguided view of financial economics which still largely prevails in academia and among policy makers and the financial elite.

Mainstream (neoclassical) economists see economic and financial behavior as manifesting, at the macro level, economically stable equilibria which are the outcome of a utility optimizing function by a collection of rational economic agents. Under this framework, financial crashes are due to exogenous factors. That is, within the modeling tools that they use to explain system wide economic circumstances, there is no explanation, other than abnormal shocks, which are “outside” the scope of their models, to explain why bubbles become unsustainable and eventually burst resulting in very damaging financial crashes. Mainly because they lack a proper framework for explaining the role of money and credit within financial capitalism they can only resort to something extraneous to account for the disequilibrium crash events which have punctuated economic history.

In more general terms, the neoclassical school is unable to explain the nature of credit and its role in the development of asset bubbles precisely because it fails to offer a satisfactory account for endogenous credit creation and the role of credit/debt in financing investments which can and will lead to unsustainable bubbles. Hyman Minsky outlined his intention to remedy this critical defect in the neoclassical tradition right at the beginning of his book Stabilizing an Unstable Economy .

“We will develop a theory explaining why our economy fluctuates, showing that the instability and incoherence exhibited from time to time is related to the development of fragile financial structures that occur normally within capitalist economies in the course of financing capital asset ownership and investment.”

A pithy statement of the opposition to the neoclassical tradition and its marginalization of the insights which Hyman Minsky had with respect to the role of financing in a modern economy – and its associated instability - is also revealed in this quote from Steve Keen during a US television interview. It also alludes to the dispute between himself, Randall Wray and several other economists not within the mainstream (yet), and Paul Krugman which has been ongoing:

You can’t model the economy without including the role of banks, debt, and money. And Krugman’s part of the economic establishment, which for thirty or forty years has got away with arguing that you can model a capitalist economy as if it had no banks in it, no money, and no debt… You just don’t have a model of capitalism if you don’t include those components.

While this cursory discussion may seem abstruse and theoretical a lot hinges on the endogenous/exogenous dichotomy. By situating the "causes" of financial bubbles and their ensuing crashes as due to exogenous factors, the central bankers and policy makers can absolve themselves of the ultimate accountability for creating such bubbles. If the assumptions of the endogenous money creation view were to be fully integrated into mainstream financial economics we might eventually be on a path to ridding ourselves of the recurring nasty shocks that, it is usually claimed from a self-serving perspective, no-one could possibly have foreseen, and which are largely the "unintended consequences" of wilful ignorance.

DAX futures preparing to test key support line from July 11th upward gap

Tracking risk appetite across bipolar asset markets

WEDNESDAY, AUGUST 28, 2013       10:30:00 GMT

The 2008 crisis and its lessons for behavioral finance


How can investors that, in the latter part of 2008, were so traumatized by the complete absence of normal liquidity conditions that they were unable to engage even in short term arbitrage opportunities, where the interval spanned is just a matter of hours or days, be persuaded (or persuade themselves) to become confident again and to engage in long term capital commitments?

Understanding the psychological processes involved in the recovery from a crisis – both in the obvious sense of the emotions experienced directly as a result of a financial crash and the more subtle sense of the trust in inter-temporal commitments, goes to the heart of the “animal spirits” which Keynes wisely decided to leave as vaguely defined. In the early stages of rebuilding confidence it is most likely to be incremental and there can then be abrupt and dramatic shifts in the willingness to embrace risks and make investment commitments in the face of uncertainty which had previously been unacceptable. In essence this highly compressed description encapsulates the current financial environment where, to the dismay of many policy makers, the dynamics required for a re-emergence of the boom phase to follow on from the 2008 bust are still very fragile.


While there is ambiguity in the information being supplied to markets – those who are predisposed to seeing a certain “fact” such as a glass which has been filled to the 50% level with a liquid as half full can take an alternative position to those who perceive the same fact as showing that the glass is half empty. Because politicians, regulators and central bankers have a deep fear of illiquidity, for valid reasons that have only been too well exemplified by the financial meltdown of late 2008, the imperative to promote the right conditions in the financial economy as well as the cultural world (including the media/blogosphere) which will enhance and sustain market liquidity, will drive financial policy measures as well as political debate. This needs to be seen as a major determinant of posturing by policy-makers and entrepreneurs as it ensures the proper functioning of the capital markets.

Ambiguous signals are those which may have intentionally been framed as open to two (at least) interpretations, or that is the way that they are received and interpreted by a consumer of that information. On the one hand it may be simply that two different individuals will find alternate meanings in the same message or, more stressfully, that an individual will perceive that the information is pregnant with alternate meanings. This will give rise to the kind of cognitive dissonance that has the capacity to lead to a breakdown in interval confidence that is manifested in liquidity crises.

Suppose that one reads a headline to the effect that unemployment has declined by a certain percentage point or that 120,000 new jobs were created how is one to interpret that “fact”? What if the participation rate has declined by 250,000 during the same month – does that mean that the fact that the new jobs created has to be adjusted to reflect the fact that more workers have become discouraged from actually looking for work? These are questions that can be, and are, debated by most economic commentators. The essential point is that even the data is open to such widely different interpretations that it could justifiably be claimed to be inherently ambiguous, and that is before the various analysts and commentators add their own “spin” to the data.

Spin is actually the deliberate introduction of ambiguity and a narrative bias to “facts” or “hard” data. Any data, whether it is unemployment data or earnings announcements by companies can be construed as being fundamentally positive or negative, as bullish or bearish. When markets are functioning normally the bulls will run with a positive interpretation, and the bears with a negative interpretation. It is precisely their disagreement that will be reflected in an adversarial contest or battle regarding prices. The resulting battle of wills will be a sign that the market is functioning in a healthy, normal and liquid manner (it is noteworthy that these separate adjectives are more or less synonyms)

When markets are unwilling or unable to accept ambiguous signals – because for example there are questions about solvency – the markets lack the prerequisite degree of fractiousness. Market participants become much more coherent and uniform in their views and, somewhat counter-intuitively this uniformity of opinion gives rise to macro illiquidity which is the instigator and defining characteristic of systemic crises, fire sales of assets and the onset of deflationary spirals. In the wake of extreme evaporations of systemic liquidity markets need to be provided with ambiguous information from central bankers/policy makers in order to lubricate the adversarial dialectic of the bulls and the bears. This lubrication of fractiousness and the presence of disagreements between those who want to sell at the current price and those who would rather buy at the current price are vital requirements for two-way, liquid markets.

In the fall of 2008, after the collapse of several blue chip names in global finance, there was a period during which the investor community suffered from a complete lack of information asymmetry, which provides a fertile environment for constructive ambiguity. The state of the collective mind (which can act as a metaphor for the markets) was one of a symmetry of fear and ignorance. It would not be unreasonable to say that there was almost unanimous opinion about how to value risk on securities and assets. That unanimity or uniformity expressed itself, in essence, in the stance that these securities were over-valued, unattractively risky and that this was not the time to be an heroic buyer of distressed assets for which there was no liquid market – why step forward to catch a falling knife? The coherent and almost unanimous decision to step aside created a liquidity trap in which those forced to sell kept selling into a declining market, and when selling begets more selling the financial system stares over the precipice to contemplate freefall into total collapse.


Emerging from a liquidity trap is not primarily about having central banks injecting limitless amounts of liquidity into the financial system. This mistaken belief lies at the root of the ineffective measures that central bankers have been trying with very little success since 2008. Moving beyond the scarring left by a systemic liquidity crisis is principally a matter of restoring interval confidence from which there will be a willingness to engage in inter-temporal commitments (initially of the short to medium term variety) of resources and emotions. Eventually these inter-temporal commitments must become longer term and involve large scale commitments of risk capital and this is ultimately how the economy emerges from the bust phase and a credit demand band wagon gets started leading to the next investment boom.

From the evidence of abrupt switches in investor sentiment that have become entrenched in the macro behavior of market participants during the last five years, it is more than tempting to conclude that there is a bipolar quality driving the collective consciousness which manifests itself in financial markets The financial markets can be seen metaphorically at least as a collective mind and the kind of behavior which is best described as one of increasing bipolarity. When considering the difficulties presented by some of the almost impossible dilemmas confronting policy makers, central bankers and investors this may well be a lot more than just a transient form of investor behavior.


It is plausible that a bipolar market is the appropriate response to a deeply conflicted matrix of economic circumstances and policy initiatives. Binary risk on/risk off trading, so prevalent in the first three or four years following the Lehman collapse and still immanent in mid-2013, arises precisely because the dilemmas facing policy makers and strategically placed decision makers, and the messages that are being communicated from them, are inherently conflict laden and contradictory and create an irresolvable cognitive and emotional environment for investors in financial markets. In this perverse sense a binary, bipolar pattern of market activity is a legitimate and pragmatic response to capital markets, especially debt markets, which are perceived to be either already in, or fast approaching, a no win predicament.

$EURGBP - preparing for test of 0.88 level

Tracking risk appetite across bipolar asset markets

TUESDAY JULY 9, 2013       10:40:00 GMT

The daily chart for EUR/GBP indicates that the euro has moved above a resistance level and would appear to be headed for a re-test of the 0.88 level. In anticipation of a struggle to break through the 0.88 barrier a target of 0.8770 would be suggested which represents about 120 pips above current levels.

Japan's Nikkei $N225 and yield on US 10 YR Treasury note $TNX - drifted apart - now ready to converge again?

Tracking risk appetite across bipolar asset markets

MONDAY JUNE 3, 2013       18:30:00 GMT

The monthly chart tracks the very close co-movement of the Nikkei 225 and the Yield on the US 10 year Treasury note. For an explanation as to what the fundamental factors are which might help to "explain" this high degree of correlation - which is evident on the chart up until the last few months - the reader might want to consult my recent publication which is referenced at the top of this posting.

In recent months there has been a notable divergence in the paths taken by the two instruments. The evidence of the last couple of weeks is pointing to a reversion to the more typical paths of co-movement. The implication is that yields on the US Treasury note seem destined to continue rising while the Nikkei might have to continue correcting.

I shall revisit this rather extraordinary correlation in a few weeks to re-examine the extent of the expected reversion.

UPDATED ON JUNE 14th 2013 As anticipated in the post from almost two weeks ago the paths taken by each of the Nikkei 225 and the yield on the 10 year US Treasury note have moved further back towards the longer term trend which is evident on the chart below

$EPP, $EWA, $TUR - rolling over like many other indices

Tracking risk appetite across bipolar asset markets

SATURDAY JUNE 1, 2013       13:30:00 GMT

The close of trading on the last day of May brought a sell off in US equities, a stronger US dollar and underlined the erosion in the prices of emerging markets - particularly the debt market ETF's such as ELD and PCY - as well as several other key geographical indices.

The weekly chart below for EPP, an MSCI tracker for Asian markets excluding Japan, reveals the sharp negative divergences on the MACD chart which preceded the recent topping out pattern. As the dotted lines indicate there are plausible near term targets at both the $44 level and at $41.70 which coincides with the Ichimoku cloud top as well as potential support from the upward sloping trend line through the weekly lows

The MSCI Australia index as captured by the exchange traded fund, EWA, illustrates the same divergence as noted above and the indications suggest that in the medium term a short position would still be quite profitable.

I have previously been bullish on Turkish equities but the weekly chart below for the exchange traded TUR suggests that this index may have registered an intermediate term peak and could head towards the $60 level in the coming weeks.

$FTSE - archetypal negative divergences preceded current correction

Tracking risk appetite across bipolar asset markets

THURSDAY APRIL 4, 2013       16:30:00 GMT

The FTSE 100 closed today's session (April 4th) with a 1.2% loss and more or less on its low for the day. The daily chart reveals two archetypal negative divergences as revealed in the bottom two segments of the graphic. While price continued its climb throughout February, the arrows on both the MACD and RSI chart were sloping downwards indicating a lack of momentum and conviction behind the move to highs not seen since 2007.

[Click graphic to enlarge ]

Today's close violated the 50 day EMA (red line on chart) and while there is evidence of support around 6300 from the top of the cloud formation and the lower BB band, a feasible medium target would be an eventual test of the base of the cloud in the vicinity of 6140.

$EURGBP - valid medium term target is ~ 0.8

Tracking risk appetite across bipolar asset markets

MONDAY APRIL 1, 2013       13:40:00 GMT

Using some very simple TA metrics the current formation on $EURGBP suggests that if vital support around current levels is broken, the distance down from the top (indicated by the upper limit of the top arrow) when projected down from a violated neckline would bring us down towards (and perhaps just beyond) the 0.8 level.

[Click the graphic to enlarge]

This would be a feasible target during the next three to six months.

Reader review for Systemic Risk and Bipolar Markets

Tracking risk appetite across bipolar asset markets

MONDAY APRIL 1, 2013       10:40:00 GMT

The following review appears here at the website:

5.0 out of 5 stars Really Informative and mesmerising !!! Must Read for all serious traders March 31, 2013 By JHMC Format: Hardcover

The author provides a really great narrative explaining Flash Crash, 2008 crisis, what indicators to look for (e.g The Volume Synchronized Probability of INformed Trading that forecasted the crash 1 hour in advance[...], what to do with tail risk etc. Each chapter is filled with many charts ,quotes and references from the latest research on investing done by universities professors and firms from buy side and sell side.

Given the author is a trader, one could say this book is probably more useful, practical and probably better than 95% of all trading books out there.

I have learned a lot just from reading the chapter on the alternative way or cheapest way to hedge equity using correlated currency instead of expensive tail risk products. e.g 20% of portfolio shorting AUD/JPY. People should check it out in their local bookstore !

Can't believe I am the first person to rate this book! Considering the amount of information, the lucid writing, this book is extremely underrated!!!

Nikkei retraces 50% of 5 year high/low

Tracking risk appetite across bipolar asset markets

SATURDAY MARCH 23, 2013       16:16:00 GMT

During last week's trading the Nikkei 225 achieved almost exactly the target discussed here more than a month ago. The adjacent chart shows how the top of the cloud coincides exactly with the 50% retracement of the distance covered between the five year high and low for Japanese equities. The reason for this exact coincidence results from the method of calculating the key Ichimoku levels rendered on the chart. Senkou Span B - which is one of the two metrics from which the cloud is plotted - is derived from the highest high plus the lowest low over the preceding 52 periods. This calculation - given the 52 month period that has elapsed since the 2007 peak - will exactly coincide with the 50% fibonacci retracement.

Last Thursday (March 21st) the intraday peak level reached was at 12650 just 15 points beyond the level of coincidence seen on the chart.

The extraordinarily high inverse correlation between the yen and the Nikkei is very well documented and has been discussed in my commentaries frequently. From reviewing the weekly chart on USD/JPY the two most recent weekly candlestick formations give a strong hint that there could be some respite from a continually weakening yen in coming sessions.

Given the almost parabolic rise in USD/JPY since last November it is not easy to discern where to target a bout of yen strengthening might go, but a re-test of 90.86 level seen in late February is quite conceivable. In harmony with this move in the Japanese currency it would also be feasible to see the Nikkei retreat - possibly as far as the 38% retracement level around 11,300.

Macro risk aversion might well be a contributory driver to both a stronger yen and weaker Nikkei in the intermediate term, and in addition there could well be a challenge to the resolve of many large hedge funds that have become too complacent with large bearish yen bets.

Systemically significant banks cannot be a little bit insolvent

Tracking risk appetite across bipolar asset markets

WEDNESDAY MARCH 20, 2013       11:16:00 GMT

In the unfolding Cyprus on the brink saga a comment yesterday (March 19th) by the governor of the country's central bank struck a discordant note. He claimed that when the island's banks re-open (when that might be still remains unclear at the time of writing this) there was a suggestion that distressed deposit holders might withdraw 10% of their deposits. It is unclear where that percentage estimate came from but the suspicion is that the number was just plucked out of thin air. The reliability of such an estimate raises an issue that can be summarized as follows:

When circumstances become critical there is no longer a continuum for trust -> distrust or solvency -> insolvency. After a certain tipping point there is a dramatic discontinuity in the willingness to consider mitigating factors or compromises in the judgments we make. We may start out, if transactions are small and inconsequential, in overriding any discomfort that we may be experiencing about having to make a critical decision as to whether to trust the solvency or ability of counter-parties to honour their obligations. However once we move beyond a certain threshold and when more critical circumstances (the risk that one's life savings might be lost) present themselves to us there is absolutely no propensity to tolerate doubts or mistrust. The discontinuity a jump from a linear to a non-linear method of weighing up the risks/benefits of having trust in a counter-party (or bank).

As an example, in September 2008 counter-parties that were dealing with Lehman Brothers completely lost trust in the company, refused to fund it in the money markets, and quite rapidly the overall market realized that the company was insolvent. Traders and investors were no longer prepared to tolerate self-serving statements from the company’s CEO and its management team that its balance sheet was sound and that it could fund itself. There was a total breakdown in trust of the company’s declarations regarding its financial position. In such circumstances, there are no degrees of solvency – a company, especially a bank, either is solvent or it is not – there is no halfway house. It is this unwillingness to tolerate any ambiguity regarding solvency that explains why companies can be full of employees in opulent offices one day and then bankrupt the next with the employees walking out of those same opulent offices with cardboard boxes with their hastily packed personal possessions.

The real catch 22 for the Cypriot central bank and the chances that a white knight (ECB, Russia) might ride to the rescue was neatly summed up in this remark which came from FT Alphaville's insightful commentary this morning. Alluding to the iconically absurd Monty Python sketch about a deceased parrot the article raises the real question mark about the survivability of Cyprus as on offshore financial haven.

Already risk managers in London are sending internal mails quietly removing Cypriot counter-parties from acceptable trading lists. As go the deposits, and the trading entities so go the jobs in law and accountancy. Even if the system survives, the sector looks very vulnerable. No, Cyprus The Financial Centre is not resting, it’s shuffled off this mortal coil, run down the curtain and joined the bleeding choir invisible.

The article's conclusion has a question which should resonate through Berlin Brussels and Moscow

Why bother to protect foreign deposits if they’re on their way out already?

Will US dollar and S&P 500 remain inversely correlated?

Tracking risk appetite across bipolar asset markets

FRIDAY MARCH 8, 2013       14:52:00 GMT

The chart below showing correlation between the US dollar index and the S&P 500 is cited as confirming evidence by Joe Wiesenthal to substantiate his claim in the modestly titled article "The Most Important Dollar Chart In The World Is Saying That The Economic Crisis Is Finally Over" (capital letter emphasis is in the original)

Here's the reasoning for Wiesenthal's view that everything is now fixed:

That's because during the crisis years, when people were in panic mode, they would rush to hold safe-haven dollars, dumping everything else. And then when they were panicking less, they would step out of dollars, and buy other stuff. But the chart above means the crisis is coming to an end, or has come to an end. There's no longer this phenomenon where the dollar represents something you hold when you're panicking about everything else. You can buy stocks, and also feel eager to hold dollars.
Not wishing to be a party pooper for its own sake, but let's try out another scenario where the US dollar continues to strengthen and it is entirely in accordance with the inverse correlation between US equities (and other risk on assets) and the USDX. Since 2008 central bankers have added more than $10 trillion to their balance sheets and have been virtually giving money away. The largest single systemic threat ahead of us (not in the rear view mirror) is the cessation of such a super generous monetary policy - the so called exit strategy problem.

The trigger for a new financial crisis might not even require an announcement by the Fed that they plan to begin a selling program of UST's - as suggested here but simply a recognition by the markets that the Fed will no longer be topping up the punchbowl. In the Alice Through the Looking Glass world where bad news has been good news for markets for so long, a strengthening US economy and a stronger US dollar could well lead to a sell off in risk assets as the Fed will be hard pressed to find new measures to prevent chaos in the Treasury market, even if that does require higher interest rates.

It's even conceivable that the Fed could continue to buy UST's and ratchet up short term rates at the same time...not something that may have been already "discounted".

$UUP: Reasons to be bullish about the US Dollar

Back on February 8th I suggested here that there was convincing technical evidence that the US dollar was emerging from a basing pattern and that I would expect a steady increase in the value of the US currency against a basket of currencies over coming months. The technical picture is improving although the dollar (and DX futures contract) may be temporarily over bought. The weekly chart for the futures contract shows that there is a clear triangular pattern from which an upside breakout would confirm that the basing pattern has been completed and again from which there could be an enduring (lasting perhaps years) and perhaps vigorous dollar rally.

Several other factors would lend support to the technical pattern and point to a key turning point for the US currency and I shall list them with only minor comments

  • The US was the first in to QE in an aggressive fashion and the underlying economy in the US may be the least ugly sister of the major economies in the world. This would suggest that while the Fed will almost certainly maintain its very accomodative monetary policy the tide may be turning towards a more "normal" policy within the next 24 months.
  • The Europeans have not undertaken any meaningful structural changes to the Eurosystem's architecture despite the relatively calmer conditions for the single currency since Signor Draghi's "we'll do whatever it takes speech" of last July. Macro economic conditions within the EZ continue to weaken and there has been no real progress on the required structural and political changes which would ensure that a currency union has the necessary fiscal architecture to become irreversible as Draghi has claimed.
  • Japan seems committed to a policy of debasing its currency to protect its trade competitiveness - a program at which it may or may not be successful and where the yen will most likely drift downwards unless there is a new systemic crisis at which point its risk off status may re-asset itself.
  • The conditions under which the Federal Reserve will exit its QE policy are looking murkier and, along with others I am beginning to doubt whether there really is a properly conceived exit strategy to unwind the Fed's multi-trillion dollar balance sheet.

    The Fed is now the largest single holder of US Treasuries, the duration of its portfolio is being extended and the hit to its balance sheet from even a one percent rise in long term rates would be considerable - let alone the havoc that could be created as the Fed tries to find buyers of all the bonds that it would need to sell. The likelihood is that at some point the Fed may taper its purchases of new UST's but refrain from trying to unload its existing holdings and allow these to slowly mature.

    While this vital part of the capital markets would therefore continue to be "manipulated" by the US central bank (creating further distortions in price discovery in other asset markets) it would still be US dollar supportive as there would be a reduced risk of having to sell off legacy debt at distressed prices. For these reasons, and for the simple reason that in a more challenging financial environment for other developed markets which seems to be the most likely scenario in the medium term, the US dollar could be embarking on a sustained rally which might stretch out for some considerable period.

  • $SPX: near term outlook for S&P 500

    Tracking risk appetite across bipolar asset markets

    THURSDAY FEBRUARY 21, 2013       19:50:00 GMT

    After some weak economic data in the US (the Philadelphia Federal Reserve index) the presumption was that the anxiety about a phasing out of the Fed’s super accomodative monetary policy, which had preoccupied traders after the FOMC statement on Wednesday (20th), would be relieved with a renewed conviction that QE would not be brought to an early conclusion and that bad economic news was - as it has been for a very long time - good for equities and bad for the USD.

    As Thursday’s trading progressed that presumption became questionable as there were a succession of time stamps when $AUDUSD, $NZDUSD, $AUDJPY, $NZDJPY, $EURUSD, $ESH3 and $NKDH3 were registering synchronized LOD’s.

    It would be too far, in my estimation, to overstate the significance of the FOMC statement - some were claiming that it was a watershed event when the music stopped playing! - but there was a rhythm to trading today (21st) which suggested that the tide was turning towards one of selling rallies rather than buying dips.

    The daily chart of the S&P 500 futures suggests that a near term correction down to the 1475 level is feasible but until there is real evidence of a more robust US economy it would be imprudent to bet on much lower prices for US equities.

    $AUDSGD: good proxy for risk appetite

    I have been watching some very lively action today (20th) in commodities, precious metals and key FX pairs. Of particular interest is the price behavior of AUD/SGD - the Aussie dollar against the Singapore dollar. Since the yen is following its own logic at present, the Singapore dollar represents one of the best examples of a safe haven (risk off) currency and this is in direct contrast to the Aussie currency which is a great barometer of risk appetite.

    The daily chart captured at 16.10 GMT shows the Aussie breaking below a key upward trend-line which dates back to last September and this negative development is underlined by a noticeable failure to break above the cloud formation and also the intersection of the 50 and 200 day EMA.

    I would suggest watching the resource currencies in coming sessions - especially AUD - as the performance of many commodities (notwithstanding rumors about a possible fund blow up) are pointing to a less than buoyant macro outlook for China and frontier markets.

    Updates on sterling and the Nikkei

    Tracking risk appetite across bipolar asset markets

    WEDNESDAY FEBRUARY 13, 2013       18:09:00 GMT

    Two charts that caught my eye as they reveal interesting patterns are the monthly chart for the Nikkei 225 and the weekly for GBP/USD.

    A long term view of the Nikkei stretching back to the late 1980’s with the all time high coming on the last trading day of 1989 shows an almost uniquely spectacular and extended bear market in Japanese equities - with a decline from the peak of more than 75% seen since the 2008 crisis.

    By focusing just on the more recent time frame and taking the mid 2007 peak and the 2009 trough it is remarkable that the 50% retracement of those two data points exactly coincides with the top of the cloud formation on the monthly chart. As can be seen the current level sits more or less astride the 38% retracement level where it is feasible that some resistance could be seen but I am confident that the 12620 level will be seen within the next 3-6 months. Different ways to gain exposure to Japanese equities are via the Nikkei Futures contract and a somewhat imperfect substitute, but with the benefit that it is US dollar denominated, is the EWJ traded fund.

    Sterling looks poised for a test of the lows seen in January 2012 and June 2012 in the vicinity of $1.5270 and marked by the arrow on the chart. The highlighted section on the weekly chart shows the most recent failures by sterling to move above $1.64 which is the 38% retracement level (from the November 2007 high to the March 2009 low). Also evident on the candlestick pattern is the gravestone doji formation registered in mid December of last year followed by the shooting star pattern two weeks later which again failed to break through the 1.64 level.

    I have previously mentioned here the fact that there is a well formed triangle pattern on the weekly chart which extends back to the March 2009 low - and since writing that piece this triangle has now been decisively broken. Longer term I would suggest that from a technical perspective and with weak macro economic fundamentals and a diminution of sterling’s safe haven status (assuming that the Spanish and Italian governments can keep their ducks in a row!), it is quite conceivable that sterling could have a 1.40 handle.

    $AAPL - a rear view mirror on technical divergences

    Tracking risk appetite across bipolar asset markets

    FRIDAY FEBRUARY 8, 2013       16:52:00 GMT

    The following weekly chart for Apple (AAPL) demonstrates - convincingly to my mind - the value of technical analysis and in particular the reason why being vigilant for negative (and positive) divergences can be very rewarding.

    In particular as the large arrows on the different panes of the chart reveal there was a failure for the upward price trajectory - especially noticeable in Q3, 2012 - to be confirmed by three key technical indicators. The arrows for MACD and RSI have a very striking downward slope, and even that for the weekly MFI which has a less divergent slope but rather a plateau formation is indicating that accumulation was not taking place during the run up to the $700 level.

    $UUP - long US dollar position looks tempting but not for the impatient

    Tracking risk appetite across bipolar asset markets

    FRIDAY FEBRUARY 8, 2013       10:40:00 GMT

    The US dollar is displaying signs of a basing pattern against a basket of other currencies and this is reflected in the daily chart for the exchange traded fund UUP. The euro/dollar exchange rate is by far the largest component in the basket and there is evidence that euro weakness may lie ahead which would also impact the Swiss franc which is another component in the basket. The wild card is the USD/JPY rate which has already seen considerable strengthening of the dollar against the yen, but where perhaps, for political reasons, the Japanese government and BOJ may want to temper the FX market’s view that being short the yen was a sure one way bet.

    Technically the pattern shown on the chart shows several bounces off the $21.60 level in what appears to be a basing pattern with a positive divergence on the MACD chart. There are definite technical hurdles to overcome including the need for a definitive break above the dotted diagonal trend line and then resistance from the 200 day EMA (green line).

    Expectations should not be for any dramatic upward moves for the reasons alluded to, but a long position would be my preference for a longer term positional play.

    $AUDJPY: Aussie/Yen topping out?

    Tracking risk appetite across bipolar asset markets

    THURSDAY FEBRUARY 7, 2013       16:46:00 GMT

    The 60 minute chart for AUD/JPY shows a very well formed H&S pattern with a clearly visible neckline.

    Using the standard yardstick for a possible correction - should the neckline be violated - the distance from top of the head to neckline would put 94.70 as a feasible target. This could be a fake out move and I would be looking for more yen strength before getting too convinced about the validity of the pattern.

    $FEZ: Large cap European stocks under pressure

    Tracking risk appetite across bipolar asset markets

    WEDNESDAY FEBRUARY 6, 2013       14:25:00 GMT

    DAX March futures have been on the defensive all morning and are being closely tracked by pressure on France’s CAC40 as well.

    Since January 28th the DAX has dropped more than 300 points, although there is chart support around 7500 where previous resistance is likely to be support and where there is likely (initial) support from the top of the cloud formation

    The daily chart for the exchange traded fund, FEZ, which tracks the EuroStox 50 reveals how this index has dropped abruptly from recent highs and the very tiny star candlestick from yesterday (also an inside day) coupled with the rolling over of the MACD chart anticipated the 2% decline in pre-market US trading.

    The near term target for support is indicated on the chart at approximatley $33.50.

    GBP/USD: Sterling reaches key level against dollar

    Tracking risk appetite across bipolar asset markets

    TUESDAY FEBRUARY 5, 2013       16:14:00 GMT

    In trading Tuesday (Feb 5th) sterling has broken to a new six month low against the US dollar.

    The failure to sustain a move back up above the 1.58 level earlier today (highlighted in yellow) suggests on the daily chart that an eventual target to be tested could well be a check of whether the 1.5270 level seen on June 1st last year provides reliable support.

    However a review of the weekly chart shows that there is a very clear triangular formation extending from the March 2009 lows for sterling - which coincided with the post GFC turning point for most equity markets - and that the current level is in danger of a break below the trend-line through the lows which has now been in place for almost four years. The current testing of this key level is quite critical for the UK currency and a decisive close below it in today’s session would open up longer term targets below $1.50.

    Gold testing a key uptrend line - technical outlook

    Tracking risk appetite across bipolar asset markets

    THURSDAY JANUARY 31, 2013       17:18:00 GMT

    Spot gold prices are preparing for their fourth test of a key uptrend line on the daily chart which extends back to May of last year. From a technical perspective there is some evidence of a positive divergence on the MACD chart which suggests that the momentum to break below this trendline may have dissipated. On the contrary the failure to re-enter the cloud formation above the current price is a negative and the daily price has failed already to regain a footing above the 200 day EMA (the green line on the adjacent chart) and the 50 day EMA is approaching the longer term 200 day EMA setting up a possible bearish crossover.

    The price performance in the near term is quite significant for the intermediate term outlook for the metal. The most favorable outcome for the bulls would be a successful re-test of the 1625 intraday low seen on January 4th as this coincides with the lower 20 day Bollinger band and also the base of the weekly cloud formation. If that level is broken then a more sizable and enduring correction towards the 1500 level is feasible.

    Japan and South Korea on the front line of a currency war

    Tracking risk appetite across bipolar asset markets

    WEDNESDAY JANUARY 30, 2013       14:44:00 GMT

    Following the widespread adoption of "unorthodox monetary policies" it has been apparent to some commentators that central banks have had as a stealth agenda the depreciation of their currencies in a battle for enhanced exports (among other objectives). A Morgan Stanley analyst has now issued a note that the rapid decline of the Japanese yen may have finally galvanized the attention of mainstream analysts to an outright currency war.

    The following comment from the analyst is cited here

    Japanese policy has changed the game: Japan’s policy-makers now want to end deflation and reinvigorate investment. Given the export-orientation of Japan’s economy, the role of the yen is likely to be much stronger for Japan than the dollar is for the US economy. This creates the risk of bringing into the fray the one, all-important element that was missing before – competitive depreciation. Any further monetary expansion by a major central bank may now prompt Japan’s policy-makers to take retaliatory action to weaken the yen. If they do, EM currency appreciation would be collateral damage.

    The adjacent chart depicts one dimension to the consequences of competitive currency debasement. Illustrated is the relative performance of the Nikkei 225, the USD/JPY exchange rate, the EWJ fund which tracks the MSCI Japan Index but which trades in the US and thus includes the currency conversion from yen to dollars (unlike the Nikkei itself which is of course denominated in local currency terms), the KOSPI Composite Index - the benchmark for South Korean equities, and also the iShares sector fund EWY which tracks the MSCI South Korea index (again priced in US dollar terms).

    One of the most striking correlations in major financial markets is the inverse relationship between the yen and the Nikkei 225 with weakness in the former resulting in strength in the latter. The underlying variable which would explain the very high degree of negative correlation is the conviction that there will be increased competitiveness of Japanese exports as the yen weakens - even more pertinent at present since Japan has moved from a history of surpluses in its overseas trading account to a significant deficit in 2012.

    The Nikkei had a 250 point surge in overnight trading (Jan 30th) and is now above the 11,000 level for the first time since April 2010. Using November 1st of last year as the base date for the assessment of relative performance, the Nikkei has moved up almost 23% while the dollar has strengthened by more than 13% in the same time frame against the yen. Unsurprisingly the EWJ fund - after currency conversion and notwithstanding that the MSCI index composition is slightly different to that of the Nikkei - has registered an almost 10% upward move.

    The currency wars dimension which provides a sharp contrast to positive developments for Japanese stock market investors (both domestic and to a lesser degree non-yen based investors) can be seen in the very subdued performance of equities for South Korea, one of Japan's main trading competitors. In local currency terms the KOSPI has only managed a 2.4% increase since November 1st and for the US dollar adjusted sector fund, EWY, this is barely different with a 4% performance during the equivalent period.

    The EWJ weekly chart shows that the current price has surpassed cloud resistance and the arrows illustrated would provide feasible targets at $10.50 and $11 for more than 5% and 10% profit potentials from current levels. A more adventurous intermediate term strategy, perhaps with lower outright risk, would be to consider a long EWJ/short EWY strategy.

    Updates on recent suggestions

    Tracking risk appetite across bipolar asset markets

    TUESDAY JANUARY 29, 2013       11:34:00 GMT

    Just a follow up on some charts that were discussed here last week. The exchange traded fund, TUR, which tracks Turkish equities was cited as looking over extended with a weekly RSI value above 80 and a weekly ADX reading near 50. Such elevated values are found quite rarely and are good harbingers of the likelihood for corrective price action. Price action during the last two trading sessions has indeed resulted in a more than 5% drop in the stock. The daily RSI chart and the probable support at the 50 day EMA around $66 (also close to the 200 day EMA) suggests that a further drop of another 5% could well ensue. There is no short recommendation at this point, and in fact the preference would be to look at the long side for a trading bounce after the correction has run its course- for an entry keep an eye on a basing pattern to the daily RSI.

    EUR/GBP delivered the initial target value of 0.8550 that was discussed here last week and following a short term correction which is now under way I would still be targeting 0.8660 within the next few sessions.

    As of Tuesday morning (Jan 29th) EUR/JPY has, after an extended and vigorous bullish phase, also begun to correct but as suggested the underlying dynamics for this pair remain solidly in favor of the long side. It is becoming more apparent that, with benign neglect of its own currency being the preferred stance of the BOJ and Japanese government, USD/JPY is ultimately set for a test of the 100 level. Since I do not see much likelihood of a serious correction to EUR/USD the inference for the euro/yen rate is that a rate in the 130’s remains the intermediate target as suggested here