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Thursday Market Review: Credit Market Divergences

  • Written by Syndicated Publisher No Comments Comments
    December 30, 2011

    Without sounding too redundant the equity trade right now is divided between two camps. It is either a credit event trade or a simple consolidation where price is setting up for a new leg higher in the coming months.

    If you read various market analysis I would argue that the vast majority view this trade as the latter. Price action such as today would on the surface confirm that is the case. Yet if you look beyond the headlines such as “The Dow reversed Wednesday’s gains” confirmation of the credit event trade is also found.

    Which trade is the correct one only time will tell but I would argue that the answer will be known rather soon. Many asset classes are diverged from equity and sitting at key support and or resistance levels. Within equity there are also divergences and probably most telling of today’s action was that the RUT futures remain below their breakout level unlike the other “headline catching” indices.

    I’ve made it clear how I view this trade. Days like today do not make it easy to say we are in a credit event and equity will soon be faced with a rather large selloff. But if I look beneath the surface of today’s price action and as discussed in yesterday’s Market Recap the thesis for this trade is still valid. None of the indicators have violated the thesis. All that happened is the two trades diverged from one another.

    Treasuries

    The “meat of the curve” the 10 and 30 year treasuries are very close to breaking out to all time highs in price, low in yield. In fact the 30 year looks as if it has just finished a breakout and backtest and will soon test the all time highs set just a few weeks prior. The 10 year is not far behind from the same set up.

    Many pundits claim that equities are the better investment over treasuries yielding 1.8% for 10 years or under 3% for 30 years but there is both safety and a capital gain associated with investing in US debt if in fact a new leg of the treasury bull market is about to start.

    10 Year Futures – 6 month daily

    30 Year Futures – 6 month daily

    Currencies

    Equities may have reversed Wednesday’s losses but currencies certainly did not. After a big move on Wednesday the USD and EUR simply took a breather. Both broke out of two patterns on Wednesday (bear and bull flags and a wedge) and show how powerful their moves are and the implications for equity.

    Today’s move in equities should have equated to a major breakdown in the EUR and USD but they did not.

    USD (DXY) – Just pennies away from a 2011 high.

    EUR/USD – Bounced off support today of a multi month downtrend. Failure to hold here will see a nasty selloff in short order. This level where EUR bounced was probably the biggest factor in USD price action as well. A clean resistance level but don’t be fooled by this being a new leg up in the EUR. Two powerful patterns failed on Wednesday and price targets have not been met.

    AUD VS EUR – AUD is the “risk on” currency. It is very stretched from the EUR right here. If the EUR breaks down further the risk on trade is in further trouble. (AUD is red, EUR is blue).

    Images: Flickr (licence attribution)

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