Vatsal Srivastava in his column Currency Corner says US stocks look set for short-term technical correction
Last week saw immensely important announcements and data flow for the currency market. On Thursday, the ECB decided to cut interest rates to record low levels and hinted towards unleashing Quantitative Easing (QE) if inflation expectations do not remain well anchored in the coming months. This has made the euro all set to gradually depreciate as the year progresses. On Friday, the US jobs data for May should also support the recent dollar strength. The US Labor Department said that the economy added 217,000 jobs in May. It marked the fourth consecutive month employment increased by more than 200,000, the first time that’s happened since early 2000. The headline jobless rate held at an almost six-year low of 6.3 percent. Analysts expected 6.4 percent according to Bloomberg. Government jobs increased by 1,000 after inching up by 12,000 in April. Average weekly hours were unchanged at 34.5. Average hourly earnings improved to a rise of 0.2 percent from flat in April.
Looking at the daily candlestick charts, the S&P 500 looks all set for a short-term correction. At 1,950, the latest daily candle has broken the upper Bollinger Band. (A Bollinger Band is a chart overlay that shows the upper and lower limits of normal price movements based on the standard deviation of prices) The Relative Strength Index (RSI) is currently 76, a level associated with overbought conditions. This is simply pointing towards a short-term correction for the US markets with the secular uptrend still intact. One can look to enter short position at levels of 1,950 with a target of 1,926 and 1,912 in extension. Another reason to be bearish in the coming weeks is that the recent run up has been on low volumes. About 1.8 billion shares traded each day in S&P 500 companies last month, the fewest since 2008, according to data compiled by Bloomberg.
If one is bearish on the US economy or is expecting a short term correction within this secular bull-run which is now in its fifth year, a long position in the VIX can be initiated. The Chicago Board Options Exchange Volatility Index (VIX) is currently trading at a seven-year low of 10.73. It is just two points away from an all-time low. Any bearish data flow in the coming weeks can easily push the VIX up by at least 10 percent even if the S&P corrects by a mere 2-3 percent.
Two things are very clear now. First, that the US Federal Reserve is on course to wind up its monthly purchases of bonds and mortgage-backed securities. This was the base case scenario but a few pessimists did expect the economy to lose momentum, which would force the Fed to withdraw its tapering. However, with the latest jobs data, this scenario will not play out in all probability. Secondly, it is now evident that the markets can keep rallying on the back of liquidity being sucked out of the financial system.
We may have also witnessed the bottom in US ten year yields at 2.5 percent and the US Dollar Index at 80. As Currency Corner has argued in recent weeks, what remains to be seen is whether the rise in yields is gradual or a 1994-style rapid up move. The latter case won’t be good for equities.
For now, the technical picture is pointing towards a short-term correction in US equities. The longer-term trend is still in place. Positioning must be long US stocks, US dollar and US bond yields.