As we wait for the Fed decision, I am seeing a technical picture of cyclical strength and diminished tail-risk, all of which are setting up the conditions for the Fed to take its foot off the QE accelerator. First, the broadly based NYSE Composite has staged an upside breakout to new all-time highs:
The upside breakout has been confirmed by a breakout in European stock averages:
J.C. Parets did warn yesterday, however, about the dreaded black candles in the Japanese candlestick charts at around key resistance levels and interpreted the candles bearishly. The black candles were present in the two charts above, but Parets qualified his statement:
So how does this get worse? and How does this get better? These are the questions we should all be asking ourselves.
In my opinion, a gap lower Tuesday in these averages leaving this one black candle standing alone is probably the worst case scenario. This would create an island reversal of sorts, another bearish pattern, which would confirm Monday’s action and would probably lead to a fast and violent sell-off. How do we invalidate the black candle? I think if we have an inside day Tuesday and kind of chill out for a few days before eventually taking out Monday’s highs, that would be really constructive.
The fact that the markets did move higher should be viewed constructively.
Cyclical strength, falling tail-risk
In addition, the charts are telling a story of cyclical strength. The relative returns of the Morgan Stanley Cyclical Index (CYC) against the market shows an upside relative breakout indicating that cyclical stocks have assumed the market leadership mantle. I interpret this as Mr. Market telling us that the cyclical part of the economy is taking over the heavy lifting, which should be viewed bullishly for the near-term equity outlook.
As another confirmation of my bullish trading call, Ed Yardeni showed that Street consensus forward earnings estimates continue to rise across the large, mid and small cap spectrum of the US equity market.
As well, emerging market tail-risk is diminishing. I had been concerned about EM risk, as it has the potential to lead to another Asian-style currency crisis (see Forget Syria, watch EM for tail-risk). Recent signals from the foreign exchange markets indicate that EM currencies are rallying. The chart below of the EM currency ETF shows that it has rallied out of a steep downtrend and begun to turn upward:
Putting it all together, Mr. Market is telling us that the global economy is recovering and tail-risk is falling. These are ideal conditions for the Fed to taper.
Mr. Bernanke, bring it on!
Disclosure: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”
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