US stocks spend a week deep in the red as bonds send a warning sign on future of US economy

We're experiencing a very negative week for US stocks. The DJIA closed on Friday at 24389 points, and that is a staggering -4.44% over the previous week’s close. The same story for the S&P500: - 4.55% at 2633, and for the NASDAQ, which closed on Friday at 6969 points, or -4.9%.

This drop pushed the YTD returns back to almost parity level, with only the NASDAQ still showing a YTD performance around +1.9%. It was a pretty volatile week that opened with a gap up for all indexes in the US and around the world, following the G20 meeting, during which the Trump administration agreed to a 3-month suspension of new tariffs on Chinese goods, so as to give time to work out an agreement. This news was welcomed by stock investors which resumed their buying activity producing the mentioned gap up.

As we wrote last week, we were not very convinced that such movement was based on consistent reasons and, besides the market’s technical tendency towards close gaps, we thought that such a suspension would be a step forward towards a "yes", but it does not necessarily mean that an agreement is close.

The Trump administration has heavily bet on the tactic of putting pressure on China and it is quite unlikely that they will back away significantly from their actual position. President Trump was quick to remind everybody that he is the “tariff guy”, and therefore China should not expect any fundamental change in the US' attitude.

We also mentioned the inversion of the short term part of the yield curve, which is seen as a serious warning sign in terms of expectations concerning the future path of the US economy.

While an inversion involving 10-year bonds would be more meaningful, even considering that the bond market (as the stock market) has been significantly distorted by the quantitative easing (which is being phased out) put in place by the Fed for over 9 years, I still do not think that such a signal from the bond market should be underestimated.

We therefore decide to protect our profits by raising the stop profit of our long positions on the S&P500 and the NASDAQ below the opened gap. Both were taken out as the enthusiasm surrounding the G20 news faded and investors started looking at the situation more objectively. And coming back to reality brought an almost 800-point drop on the DJIA on Tuesday!

There is another sign that should be taken into consideration and that is often overlooked: the performance of the Russel 2000 index, which with last week's drop of -5.53%, posts a quarterly to date performance of -14.45%, sending the YTD performance of this index below -4.5%. In my humble opinion, such a performance by this index, which includes the bottom 2000 small cap / high-growth-potential stocks of the larger Russell 3000 index, signals that investor confidence in the performance of the economy and therefore the stock market, is starting to decrease, and investors are slowly pulling out from the riskier part of their stock portfolio.

To add insult to injury, the news regarding Huawei's Chief Financial Officer being arrested in Canada and possibly extradited to the US showed without any shade of a doubt that the US administration is nowhere near easing its pressure on China and actually seeking to add more of it.

Given this situation, it was no surprise that the US stock indexes were pushed back to test the lows touched in the second part of October and again two weeks ago:

Here is the situation on the S&P500:

The sharp drop after the gap up is clearly visible and took out our stop profits. In all honesty, that triple top was itching to be traded short reversing the long position with a very good risk-to-reward ratio, as the stop would have been not far above the 2820. Add to this our bearish view as explained above and.. we made a mistake by not trading this set up. No excuses here.

Now we are on the opposite side of the wide range, in which the index has been moving since mid-October and we have the MACD continuing to form a bullish divergence. An impulse to the upside could be given by the tendency of institutional investors towards some “window dressing” to embellish their quarterly and, most importantly, yearly reports to their clients, especially when all the gains since the beginning of the year have vanished.

The US economy is still showing strength and besides slightly lower-than-expected NFP numbers, unemployment still sits at 3.7%, a 49-year-low, and wages are starting to pick up significantly. The effect of the corporate tax cuts is still there and the economy is performing fairly well, besides the fact that some warnings have popped up lately.

If investors' attention shifts to the fundamentals, which aligns with the urge to present positive results at yearend, the support of the triple bottom could hold, confirming the bullish set up of the MACD which is continuing to draw higher lows.

At the moment, futures are signalling a slightly negative open in the US, but recovering from the daily lows, and we will wait to check on Monday close to take a decision on a possible tactical long, which again could have a good risk/reward ratio given the stop to be eventually positioned not far from the actual price below 2590 with a possible new test of the upper band of the range.

The situation on NASDAQ is not that different from a technical point of view:

Here again a possible bounce off a support, with the MACD showing an even more bullish tendency.

It is also true though that prices are considerably off the 200-period moving average and the rally that brought the prices up until Monday last week and the subsequent drop seem to have formed a false break out. Therefore, though the temptation to go long here is strong, we have to resist and exercise patience. I do not see any definitive set up here so we will wait to see how the situation unfolds the first two days of the week before eventually take a trade decision.

Talking about false breakouts, which often lead to a strong reaction to the opposite side, here is the situation on the DAXA30 index:

During the week we have been monitoring our long time short, and we are trailing the stop profit on half the original position.

Over the week we tweeted our updates and signalled a possible false breakout of the dynamic resistance (marked in orange in the chart):

The index continued its drop, weighted down by the news regarding banking giant Deutsche Bank's possible misconduct and involvement in money laundering schemes, which led to the German authorities raiding the bank’s headquarters on the 29th of November, as well as the questioning of officials and seizure of documents. Add to this the derivative time bomb the bank holds, the size of which is difficult to determine, and there is more than enough to curb investors' enthusiasm.

We will continue to monitor the situation and should the index continue its drop to successfully test the closet ex-support at 10800, we will lower our stop profit to secure more profits. We will keep you posted on our social media pages.

As far as Brent Oil is concerned, as you might remember, we closed off our short trade last week, after an amazing run and lots of profits.

This week OPEC met to address the sharp drop in oil prices. A production cut of 1.2 bpd (barrel per day) was agreed, as widely anticipated, and many expected a sharp rise. We were not of that opinion and remained flat. Here is the situation after the meeting:

As you can see not much has happened here. The gap opened on Monday was closed before the meeting and then we had a bullish reaction on the test of the dynamic ex-resistance. Again, not much to be seen here and prices seem to be going back to the downside again.

Why is this happening despite the production cut? As far as we are concerned, if our analysis on the economic slowdown as described earlier makes sense, then the problem could be in the forecast of the demand side. A slower economy might lead to a lower demand of energy especially in energy intensive activities, which has already been impacted by some of the tariffs imposed by the US. This week will probably give us some hints on possible future moves, but so far we are not taking positions and remain flat.

We are approaching an interesting set up on EURUSD:

The cross tested the support at 1.13 area and bounced back to test the resistance at 1.1430. We are again on the verge of completing an inverse head and shoulder. The MACD seems to be following suit, so if the cross breaks above the resistance band (in blue) we can consider a long here.

Should this trade materialise, there are chances that the stock market would also be experiencing a relief rally.

Last week we opened a trade on JPYUSD, following the breakout of one of my favourite patterns: a triangle!

 

We announced this trade live on the 6th of December.

At the moment, the cross is still hovering around the entry point. It tried to break down below the support zone, but was rejected a few times. Highs continue to decline, and this is a positive sign for our trade. We need the cross to go below 112 to enhance our probabilities of another successful trade. Our risk is set, and consequently our stop loss is in place. Should the log on EURUSD materialize, we should see USDJPY go lower amid the usual inverse correlation between the two crosses.

On the macro-news front this week, we need to signal the vote on Brexit to be held in the UK. It will be tomorrow 11th. The latest news is that the vote could be announced around 8:30 PM, but the time may change. Be very careful in managing your risk on the British pound. Also the euro might be severely impacted by the decision of the UK Parliament. We do not speculate on the direction and we will just stay away from the market or reduce our exposure.

Other news to keep an eye on are US CPI on Wednesday, the monetary policy announcement and press conference in Switzerland, and the interest rate decision, statement, and press conference for the Eurozone on Thursday, retail sales in the US and China (which will also announce the industrial production), and the PMI data in the Eurozone on Friday. Next Monday, the Eurozone CPI data will be announced.

 

 

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