FYI | Feb 25 2012
By Kathleen Brooks, Research Director UK EMEA at FOREX.com
Risk is back on and some indices are hitting fresh multi-year highs as I write this. Of course the big headline is the Dow Jones hitting 13,000. But the all-important NY close this evening will be pivotal to whether these gains are sustainable.
So what’s driving the move? Firstly better growth signals from Germany and the US since the start of the year, and secondly the proximity to the ECB’s LTRO auction in the middle of next week. Markets adore liquidity and growth – so this is a heady cocktail for stocks right now. Although we are concerned that markets are a bit too blasé about concerns in Europe and Iran, both of which have the potential to de-rail the growth recovery, price action tells us there may be more to come in this move.
Let’s take a look at some of the lead indicators. Firstly, the NASDAQ and the Russell 2000 tend to be lead indicators since tech firms and small businesses are very sensitive to 1, changes in economic conditions and 2, risk sentiment.
Both of these indices are higher right now as you can see in the chart below. This chart has been normalised to show how the two move together, and as you can see they have a very close relationship and are both pointing higher.
Base metals are also a lead indicator as they indicate the state of the economy. The chart below shows the Bloomberg base metals index is testing its 200-day moving average resistance. Above the yellow line on the chart below, would open the way to further gains.
Interestingly, over the past year the SPX 500 has had the strongest positive correlation to the Russell and the NASDAQ, and the relationship between the SPX and base metals has pretty much broken down since the start of this year, with base metals lagging the overall recovery in US stocks. For now this is insignificant, but going forward people may wonder if this is a warning sign that all is not well in the world. After all, the EU now expects the currency bloc’s economy to contract this year, China still looks worryingly weak and the US’s recovery is on the right track but could easily be de-railed.
The chart below shows the SPX (orange line) and the Bloomberg base metals index, it has been normalised to show how the two move together. As you can see, the SPX has surged ahead of base metals after having a pretty close relationship for most of last year. We will have to wait and see if this is telling us anything about the future performance of stocks.
The important things to look out for in the coming days are weekly closes as we approach some important levels. In the SPX 500 1,400 now looms large, in the Dow it’s 13,500 (if we stay above 13,000) and for the FTSE it’s 6,000. These are all key psychological levels and need to be respected by the market. These indices have been on the rampage this week and gains may slowdown in the near to medium term. Also, with all of the uncertainty next week (G20 this weekend and EU summit on Thursday/ Friday) we could see some profit taking so keep trailing stops if you want to protect those profits.
In Europe indices have followed the US higher, albeit at a slower pace. Even Europe’s bank stocks are performing well. However, the Eurostoxx index has massively underperformed the SPX – could this mean that European markets play catch-up if we get a positive outcome from next week’s LTRO and EU summit? The SPX may start to slow down, which could give the SX 50 a chance to gain some
ground. Watch this space for more updates to see if a relative value SPX/ SX50 trade could be an idea for next week.
PLEASE NOTE THESE ARE ALL BLOOMBERG CHARTS AND DO NOT REPRESENT THE PRICES OFFERED BY FOREX.COM
All views expressed are the author's, not FNArena's (see our disclaimer).
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