Market Update 24 March 2013

I am currently out of Dubai on holiday but watching market developments closely.

Last week was an interesting (and relatively tame) week in the markets.  It would appear as of Fridays close the "gut check" I spoke about previous indicates the markets currently believe a successful outcome will result from the Cypriot situation.  By a "successful outcome", this would be taken to mean Cyprus being able to come up with approximately 5.8 billion euros cash through the confiscation of a percentage of bank deposits for those who's accounts exceed 100,000 euros (the current talk is 20% for those deposits at the Bank of Cyprus and 4% on all deposits at all the other banks).  The fact that the majority of deposits of that nature are owned by Russians puts an interesting geopolitical spin on the whole situation.

Having said the above, after the markets closed on Friday it become apparent a deal was further away than previously thought.  Critical meetings are taking place late Sunday night in Brussels with Monday being the last day to come up with a solution unless the current "bank holiday" is extended in Cyprus.

In any case, the outcome for Cyprus is dire and irrespective of the outcome of the current talks the fate of the country is doomed.  The island has set up its entire economy based upon it being a tax "safe-haven" offshore banking entity for foreign deposits (its foreign bank deposits are 7x the countries annual GDP).  Should the current bank deposit confiscation proposal stand there is no chance foreign depositors will keep their money in Cyprus going forward as there is no guarantee this same sort of "bank levy" will not reoccur again at some point in the future.  Alternately, should Cyprus defy the current requests from the Troika (and stand up to defend its banking industry and its foreign depositors) the result will be the withdrawal of bailout funds from the ECB and the collapse of the banking system in Cyprus.  In either case, it is very difficult to see how Cyprus remains within the EU given the current situation.  As such, ultimately the key is not Cyrus but how its eventual collapse and removal from the EU affects other countries in similar dire economic conditions.

I think the key to watch in the next few months is the bank deposits not only in Cyprus but other troubled EU countries.  It is possible what starts as a relatively benign event in a small country such as Cyprus gradually turns into a contagion in the other countries.

CLICK ON ALL CHARTS TO ENLARGE

ACWI Daily Chart:

The short term daily chart turned slightly bearish this week when price closed Thursday below the 20 day moving average (Bollinger Band midpoint).  However, Fridays advance put price back above the 20 dma.

As shown on the chart, there has been a bearish divergence between price and a number of corresponding technical indicators over the past few weeks (shown as red dotted trend lines).  Price has continued to rise while the corresponding technical indicators have been declining.  This is a warning that a downtrend in price could occur soon.

As shown, the 1st test will be the support @ 49.03.

ACWI Weekly Chart:

For the week ACWI declined by 0.80%.  This is a surprising benign response given the potential market turmoil that will result from a messy conclusion to the Cypriot situation.  

The medium term chart remains bullish but overbought.  I have shown on the chart the previous 2 times the weekly RSI has exceeded 70 (Oct 2010, Feb 2011).  In both those cases prices declined back to the test the weekly Bollinger Band midpoint (20 week SMA).  As of last week price had again pushed above a 70 RSI (overbought) and given the 2 previous declines it can be assumed a similar decline would occur in this current case (back to the BB midpoint; current @ 48.68).  This area is also associated with previous support (yellow band 48.38-48.67) so a short term decline to at least this level should be expected (as indicated on the chart, an approximate 5% decline from the current top).

ACWI Monthly Chart:

The long term monthly chart remains bullish with price well above the 8 month SMA.  However, once gain it can be seen the RSI (in this case the monthly RSI) has risen above the overbought level of 70.  The last time this occurred was in May 2011 and what followed was a decline of 27% to the bottom in October 2011.

While the long term technical indicators remain bullish, note the decline in the Force Index as price has continued to advance.  This indicates the current momentum is lagging but is not yet confirmed by a MACD Histogram bar reversal (which remains bullish as shown on the chart).  A monthly close with a lower Histogram bar would be an indication a long term trend reversal is occurring.  As of today this has not occurred.

Euro Weekly chart:

As it is obvious ground zero for any sustained market decline will probably come from Europe, it is important to watch the Euro for clues.

The weekly Euro chart clearly shows the declining trend channel the Euro has been in for the past 2 years.  Recent Euro strength has taken price up near the top of the current down trend line and reversed over the past few weeks.  It appears strong support at the 126-127 level needs to be tested as early as next week.  A break below this level and the lows near 120 are the new target.

Euro 60 Minute chart:

Short term it is interesting to note the strong volumetric zone on the Euro ETF.  Price is currently right at this strong area of support/resistance.  A break above the upper level @ 129.50 would be very bullish; conversely a break below the level of 128.20 would be bearish.  In addition, until the 10 ema crosses above the 200 ema the current short term direction of the Euro is down.

Sentiment:

I have noted previous how I use a number of sentiment indicators to judge the relative dangers in the market.

The investors intelligence indicator is a measure of the relative bullishness of financial newsletter writers.  Ironically at market tops the majority of these writers tend to be bullish and at market bottoms most tend to be bearish.

As can be seen on the chart, when the percentage of bearish newsletter writers drops below 20 (in other words, most newsletter writers are currently bullish) the result has been market declines.  Ideally I would like to see the percentage of bullish writers exceed  55% or more (giving a bull/bear ratio of > 3.0; currently @ 2.55) to say with certainty we are near the top.  We are not quite there yet so this chart is indicting a "watch carefully" signal vs. an actual top signal.  However, we can say we are closer to a correction than we are to an advance given current bullish sentiment.

Bottom Line:

-the markets remain overbought on both weekly and monthly charts.  Previous overbought readings in the past 2 years have resulted in market declines (5% shorter term, 27% longer term).

-the outcome to the Cyrus situation remains in limbo as of today with possible contagion spreading to other EU countries.

-market participants are more bullish than they have been in months (since April 2011; just before the substantial decline in the summer of 2011).

Given the above, I remain moderately bullish yet on guard.  Current technical indicators and sentiment preclude me from increasing my equity exposure yet there is insufficient technical data to indicate a reduction in equity exposure is warranted at present.  As such, I am very comfortable with maintaining my current exposure at a tactical 50% equity/50% cash position as follows:

-Russell Global 90 Fund: 40%

-Fidelity International Fund: 10%

-Russell USD Liquidity II Fund: 50%


As indicated, I am currently on holiday but monitor the markets daily.  Should there be any technical developments over the next few weeks I will update the blog accordingly.

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