By
Chris Ciovacco
:
When the next rally in risk surfaces, it could produce
impressive gains in Asia (
AAXJ
), China (
FXI
), India (
INP
) and emerging markets (
EEM
) based on:
- Indian reforms to attract foreign capital
- Ongoing liquidity injections in China
- Improving technicals
Stocks Need To Overtake Bonds Again
Prior to adding to our risk exposure, we would like to see some
improvement in several risk-on/risk-off ratios. The three risk-on
vs. risk-off ratios below can assist in monitoring the health of
the current rally.
The chart below tracks the performance of stocks (
SPY
) relative to bonds (AGG). When risk is in favor, the ratio rises.
When defensive assets rule the day, the ratio falls. Four weeks
ago, risk-on broke the "neckline" of a potentially bullish inverted
head-and-shoulders pattern (see chart below). In the last three
weeks, risk-off has been in favor bringing into question the
bullish breakout for risk. Should more weakness in stocks follow,
the ratio has potential support above the green arrow. Until the
chart below recaptures the neckline, we will tread carefully with
our cash.
Another risk-on/risk-off ratio (S&P 500/[[TLT]]) had a "head
fake" Monday. Stocks have completed two of the three steps needed
for a bullish trend change. The ratio recently broke the blue
trendline (see 1 below). Step 2 was a higher low (see slope of
green line). The third step would come if the ratio can make a
higher high above the green dotted line. Early in the session on
Monday, the ratio was well above the green line. However, the bears
started buying Treasuries as the day progressed, which erased the
bullish breakout for risk. We will be more open to investing some
additional cash if step 3 can be completed in the coming days.
Shorts Gaining Ground On Longs
The current rally in risk assets remains intact, but a few more
days of weakness could push our
market models
into correction mode. The chart below illustrates the fragile
nature of the bulls' reign. When the ratio below is rising,
short-sellers (a.k.a. bears) are making more money than traditional
investors (longs or bulls). If the ratio breaks above the
green-dotted line, it will have (1) broken a trendline, (2) made a
higher low, and (3) traced out a higher high. Those are the three
steps needed for a trend change, and thus would signal increasing
bearish momentum. Bulls would like to see the Relative Strength
Index (RSI) remain below 50; it closed Monday at 48. Should the
chart below clear the green line, we would be more apt to sit on
our cash in the short-term vs. adding to our emerging markets
exposure.
Indian Reforms To Attract Investors
Policymakers in India are concerned about slowing foreign
investment. According to a September 23
Forbes
story, some concrete reforms may be coming to address the
situation:
The Economic Times reported Monday that New Delhi is
getting ready to push for capital markets changes in order to
attract overseas capital. For instance, just last week the
government said it would allow foreign companies to acquire
majority stakes in India retail. The latest steps under
consideration include raising the ceiling for foreign
borrowing, easing restrictions on portfolio investors, and
liberalizing norms for overseas borrowings.
From a technical perspective, the news from New Delhi helped
India (PIN) gain traction relative to the S&P 500 (chart
below). The break above the downward-sloping blue trendlines is
supported by the bullish divergence in a popular indicator, known
as MACD (blue bars in chart below). A divergence occurs when price
makes a lower low (red line) and an indicator makes a higher low
(green line). The divergence can be seen by comparing the slopes of
the red and green lines.
Bulls, Bears, and ETFs
This week's stock market outlook video covers:
- High probability ETFs at 01:19 mark.
- What does a bullish resolution look like?
- What does a bearish resolution look like?
The following ETFs and markets are covered: $SPX/TLT at 3:20
mark, AAXJ/$SPX 8:00, AAXJ/TLT 10:03, AAXJ/EEM 11:15, SPY/AGG
12:00, EPI/$SPX 12:40, EWT/SPY 14:21, INP/$SPX 14:45, LQD/$SPX
15:44, SLV 16:51, XLU/SPY 18:10 and IWM 19:02.
After you click play, use the button in the lower-right corner
of the video player to view in
full-screen mode
. Hit Esc to exit full-screen mode.
Bases Tend To Mean Lower Risk
It is prudent for investors to fear "buying near a top." If risk
assets peak, global stocks will suffer, but the degree of losses
can be mitigated if we avoid "straight up" markets. The chart below
shows the performance of India relative to the S&P 500. The
sideways price action is known as a base (see green box). The upper
portion of the box and blue lines acted as resistance for five
months - they may now act as support.
China Joins Liquidity Party
If you can fog a mirror, you have heard about money printing
from the Fed and ECB once or twice in the last few months. Central
banks are injecting money directly into the
financial system
. According to the
Economic Times
, China has started to print as well:
SHANGHAI: China's central bank injected a net 365 billion
yuan ($57.92 billion) into money markets this week, traders
said, the largest weekly injection in history, as regulators
struggle to maintain liquidity without producing inflation as
forex inflows slow.
As shown in the chart below (FXI/S&P 500), China has been
lagging the S&P 500 in 2012. The green arrow shows the recent
liquidity injection may enable FXI to break the current
downtrend.
Asia Breaks Out
The Asia Ex-Japan ETF responded to the liquidity injections from
China's central bank. The chart below shows the performance of AAXJ
relative to the S&P 500. The chart has a bullish look with
several trendline breaks, a healthy RSI (bottom), and a big base
below.
Asia's breakout was foreshadowed by the bullish divergence
between price and MACD (compare slopes of lines A and B). The
longer the chart below can stay above the green line the
better.
Asia vs. Bonds Not Bad Either
We have shown AAXJ making progress relative to the S&P 500.
How does it look relative to bonds? The answer is "good." The
weekly chart below shows the strength of AAXJ relative tobonds .
When the ratio is rising, AAXJ is gaining ground on AGG. The recent
push in the ratio above the blue trendlines is a potentially
bullish signal for Asian stocks.
In order to increase our exposure to the emerging markets space,
we need to see stocks pick up steam relative to bonds. Should the
risk-on vs. risk-off charts shown above improve, then we will be
looking primarily at EEM, AAXJ\and INP. A simple "watch list"
approach to monitoring the health of the current rally is outlined
at the 01:30 mark of the video above. On Monday, the bullish ETF
list outperformed the bearish list of ETFs (think SPY vs. TLT).
However, bullish traction remains tentative and should be monitored
with an open mind.
Disclosure:
I am long [[EEM]], [[FXI]], [[EPI]]. I wrote this article myself,
and it expresses my own opinions. I am not receiving compensation
for it. I have no business relationship with any company whose
stock is mentioned in this article.
See also
Gold, Copper, Platinum Stuck In Contango
on seekingalpha.com