Rudi’s View: Two Trend Changes For July?

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By Rudi Filapek-Vandyck, Editor FNArena

Typically, when financial markets and economies are at the juncture between fast forward and losing momentum, usually reliable indicators are providing both optimists and nay sayers with plenty of guidance to see things their way. July 2010 is not proving an exception.

Global equity markets have started to claw back some of their losses in July, but it's all happening on extremely low volumes. Forward looking indicators are still suggesting the underlying trend for the world economy is down. Market technicals continue to look ugly. Many insiders are pointing at more evidence of short term pressures in markets such as iron ore, copper and steel.

Within such a context, it's not hard to see why most investors prefer to sit on the sidelines. In fact, if the latest sentiment readings in the US are correct, investors have once again adopted a negative view on the route forward, which oddly enough suggests financial markets might have seen their bottom.

Yet, sometimes the real message lies not where the majority of market commentators is looking. I have cherry picked two indicators that have caught my attention this week. Both might be pointing into the direction of a new trend for global risk appetite, which ultimately should bode well for equities.

I have a long standing observation that currency markets have been leading most other markets through the global bust that turned into a big rally upwards from GFC crisis depts. So, if currency markets remain true to their leading role, this week might mark a significant change in global risk aversion.

At the centre of my observation is -of course- the US dollar, or to be more precise: the US dollar Index. A few weeks ago it appeared EUR/USD was on its way to 1.15 and lower, but instead the cross has bounced back swiftly to beyond 1.27.

Funny how we don't hear anyone mentioning “parity” anymore. Instead, what we have is FX experts talking about 1.30 in the near term (some of them). If these people are correct, the new environment for the euro could mark a much broader return of global risk appetite than most commentators and experts are at present willing to consider.

What caught my attention this week is the fact the USD Index has now broken below its Ichimoku cloud on daily charts, usually a strong signal that the previous trend has reversed. Now, one technical signal does not make for a decisive trend reversal, but all greater trend changes ultimately start from small beginnings.

Remember, it was the US dollar that signaled in late November last year to everyone who cared to pay attention that the strong uptrend in risk assets was coming to an end.

I note, for example, the USD Index rose above 88 in June, only to fall back to 84-something this week. On its way down, the index crossed the 200 day moving average which subsequently proved too strong resistance when the index tried to climb back above it.

Has the underlying trend changed for the US dollar? If so this will instantly remove one of the main impediments for precious metals, for industrial commodities, for agricultural products, for growth-related currencies like the Australian and New Zealand dollars, in fact, for practically everything that carries more risk than the yield on US Treasuries.

Note that in April, when risk assets peaked for the second time this year, the USD Index was still below 81. In January the Index was at 78. Also note that the main constituent of the basket behind this index, the euro, is facing some formidable technical resistance at 1.2785.

Before drawing any hard conclusions, it's probably safer to wait and see whether EUR/USD can rise above resistance. My guess is the euro will have an honest attempt, but resistance will prove too strong. For now, at least.

Having said so, I have also observed technical charts for base metals suggest base metal prices are likely to have seen their low points in May this year. Amidst a flurry of other technical signals, it would appear most metals are gradually carving out a reverse head-and-shoulders formation on price charts, with one shoulder in April, a head in May (low point) and another shoulder in June.

Again, this is as yet not a fully confirmed technical pattern, but it's getting closer every day. Could it be that while investors worldwide were focused on a potential head-and-shoulders formation on price charts for equity indices, they completely overlooked the signal that is seemingly building a base underneath base metals prices?

Note that in early 2009 a similar queue of price charts with head-and-shoulders-in-reverse indicated commodity prices had bottomed, after which the mother of all rallies took off.

Investors should also keep in mind that in my personal observations head-and-shoulders signals tend to have a relatively high accuracy; both straight and reverse. BHP Billiton ((BHP)) shares put a H-and-S signal on price charts in late 2007 and again in 2008 (I wrote about it back then).

The key to these signals is that the longer they take to complete, the more powerful they usually are. If the current signal completes shortly, it will have taken more than three months. That seems like a solid base for the months ahead.

Of course, we could throw in dozens of other indicators that are still looking scary, if not damn right bearish. Note the Baltic Dry Index has now more than halved from its level in May and the index has weakened day after day non-stop since the beginning of June. Do we agree this index has lost its accuracy because of new supply of vessels? Yes, we do. But why are other indices such as the Baltic Capesize Index and the Baltic Panamax Index equally in free fall when they do not suffer from a similar vessel oversupply?

And what to think from the ever declining leading index published week after week by the Economic Cycle Research Institute (ECRI)?

My read of the combination of all of the above is that investor optimism will continue to be put to the test in the months ahead. Don't forget we still have the traditionally weak September and October months in front of us.

At the same time, it would appear valuation support has started to increasingly play its role. It has become a widely mentioned motivation in share markets and technical signals for base metals (see above) seem to suggest likewise.

The immediate direction for the euro, however, would seem to suggest it is yet too early to start talking about a sustainable rally. Of course, market optimists would say all that could change easily (see 1.2785).

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