US STOCKS TOPPING OUT

US stocks seem to be topping out based on a couple of technical indicators.
Please see chart below.



There is currently this phenomena of a divergence between the S&P500 price and both the Rate of Change (ROC) and MACD indicators. As the S&P500 heads higher, the ROC and MACD indicators are making lower highs. I drew lines joining the tops of these indicators and found there is some consistency in both indicators signalling that momentum (hence strength) of the advance is weakening. More likely than not, the bears would take over the market soon.

Also, the tapering off of volume (chart below) points to a growing disinterest in the market.



On the other hand, because of near term volatility and the fact that volume is tapering off, it might actually be easier for the market to make another push higher before turning back down - for this, I'd use the blue lines drawn above the ROC and MACD indicators to gauge when the S&P500 will meet resistance.

New Immediate Resistance Level - 1,121 (50% Retracement of '08 high - '09 low)

The 50% retracement (1,121 on the S&P500) could provide strong resistance to this whole rally as in past recessions, the 50% halfway mark between the pre crisis high and crisis low usually sees some stalling of stock indices, followed by months of gradual down moves.

In fact, this level is just 2.6% higher from where we are now, so how the next few days will pan out will be interesting.

The alternate scenario may happen going into the Christmas season is that a Santa Claus rally causing a break above 1,121 will open the way to immediate targets 1140 and 1185, another 4.3% or 8.4% upside respectively though this is the more unlikely scenario for now.

NFP - 6 Nov 09

The mother of all economic data, the non farm payrolls figures showed that the US lost 190k jobs, slightly above the 175k expected. However, the real wet blanker to risk sentiment is that the official unemployment rate surged to 10.2% from 9.7%, a shocking deterioration of the labor market. Estimates are for a decline to 9.9%.

What do I see for the next few weeks for the markets?

- The USD will remain on the defensive as expectations are growing that the Fed will push back hiking rates.

- US stocks to pull in more of a correction as high unemployment will hurt consumer spending and investors' sentiments, but rangey trade overall expected . Only outperforming economic data can move stocks another leg higher. I think the S&P500 might hit a peak of 1,225 (and I mean the peak) as highlighted in a previous post 'How high can stocks go?'; before we see a 15-20% correction like in previous recessionary recoveries

- The fact that stocks remained bouyant inspite of the NFP outcome goes to show that the level of liquidity in the financial system is enough to float anything you throw into it at the moment. It takes tightening expectations for this liquidity to be drawn out, which might take place during Q1 '10

- Gold and AUD to maintain attractiveness, with the latter expecting to enjoy further rate hikes going forward (as indicated by the RBA in its minutes today). This too, to take place as long as the fed doesn't give a stronger hint to raising rates/ or when the US unemployment rate improves

Post FOMC

The Federal Reserve's rate decisions and statements are very important for the markets and cannot be underestimated. Their actions determine to a good extent the amount of liquidity that remains in the system and this will affect risk assets i.e. stocks.

The fed funds rate decision or statements about impending changes affect yields on US treasuries, which ultimately influences the decisions of central banks around the world because US treasuries are the mainstay of global central banks' reserves.

As expected, the FOMC kept its key rate at 0 - 0.25% for an 'extended period' in order to nurture the still fragile economy, citing that credit to households is still tight and that labor markets isn't yet in recovery. This 'extended period' phrase is key to the outlook of any rate hike - and it seems the FOMC has pointed out that it will look to inflation and the unemployment rate to improve before changing the phrase.

A change in the phrase to perhaps 'considerable period' (ala Greenspan some years ago) will have the most impact on USDJPY as the USD and JPY have the closest (and lowest) yields. It will surge on a fed funds rate hike.

Japan's inflation (or deflation) report out this week indicated that the government expects deflation until 2011, meaning the BoJ will likely not raise interest rates until then, so the yen will be the last in the developed world to enjoy a rate hike, putting the currency firmly as the ultimate funding (carry trade) currency for the foreseeable future.

Going back to the fed, even when they are focusing on both the inflation and unemployment rate for monetary guidance, I feel the bottleneck for a rate hike will be unemployment. Because it is hard to determine the peak and the fed historically wait a while longer after the peak before indicating a willingness to raise rates, there is likely to be a good time of waiting - which, to pro dollar investors, is really an 'extended period'. In another words, this fed looks to me to be a pretty dovish one for now, disregarding the change of incoming hawkish voting member(s) next year.

Friday's expected NFP figure is 175k job losses and a rise to 9.9% in the official unemployment figure. The government said unemployment rate is expected to peak above 10%.

Hence, for now, as long as stimulus is in place and extended by governments supporting risk sentiment, I feel the dollar will remain on the defensive and perhaps decline further against its major counterparts going into 2010.