The investing climate has gotten very uncertain. I run a marketplace service titled The Naked Charts where I solely look at price patterns to decipher where Mr. Market wants to head next. At the moment, the technical charts of a few important markets are flashing risk-off signals. Let me explain further.
The first warning sign is what appears to be an oversold Greenback. For those wondering why the USD is so important to risk sentiment, take a look at the below chart.
Dollar Index (in red), S&P 500 (in orange), AUD/USD (in blue), XAG/USD (in purple)
The USD strengthened in March as equities (SPY) were collapsing as investors flocked to the Greenback for its safe-haven status. Other risk assets such as the Australian Dollar and silver also sold off heavily together with equities.
This was not a surprise as the USD is traditionally seen as a safe-haven asset that investors flock to when the market is facing a high level of stress. The strengthening USD hit the AUD and metals space hard. The former is a liquid proxy for risk sentiment and also reflects the fortunes of China, which was widely recognized as the epicenter of the coronavirus.
It also does not help that the world is swimming in USD-denominated debt. Close to three-quarters of the world’s debt is denominated in the Greenback, which means demand for the USD tends to soar when market participants all need to get their hands on the currency to meet their debt obligations. Despite the rise of China, it is still pretty much King Dollar in the world of credit.
Credit to the Federal Reserve – the central bank swiftly intervened by introducing ultra-accommodative monetary policy and slashing interest rates close to zero. The Fed also set up multiple lending programs and FX swap lines with other countries to put a stop to the USD liquidity crunch. Oh, and it is now dishing out “unlimited QE” – which basically entitles it to buy an unlimited amount of government debt. Risk assets promptly rallied while the USD sold off.
This trend has prevailed, till now.
After forming a bearish top double pattern and breaking through the 95 to 96 neckline, the Dollar Index appears to have reversed course and now looks to be in the midst of an excursion to re-test this breakout zone. If the 95 to 96 zone manages to repel the USD lower, that should be good news for risk assets.
What worries me is the widespread acknowledgement and acceptance that the Federal Reserve will continue to keep the USD weak and keep the world flushed with liquidity. The market is expecting interest rates in the US to remain unchanged (close to zero) for the next three years at least. Basically, it is incredibly difficult to find reasons to buy the USD at the moment. This expectation has manifested in the highest net-long EUR positioning since 2008. The EUR is the largest component in the Dollar Index.
Market participants appear to be jumping onto the short-USD bandwagon, and now positioning in this trade looks very crowded. This provides a very combustible backdrop where if we get a short squeeze in the USD, the short-USD trade can quickly unwind and hurt risk sentiment.
Another market that is in a stealth bear market is WTI Crude Oil.
WTI Crude Oil
WTI Crude Oil (USO) has been in a bearish descending triangle pattern since 2008, with the $34 to $43 continually providing support. In April this year however, prices plunged through this zone and we witnessed the unprecedented scenario where prices fell below zero. Sellers were actually paying buyers to take oil out of their hands!
The market has since seemingly recovered, and is now back at the $34 to $43 danger zone. This area looks like it will present very strong resistance, and I am expecting prices to fall from here.
What may be driving this bearish price action in Crude Oil? I borrow the below chart from Seeking Alpha contributor Oleh Kombaiev’s recent article. Forecasts for oil demand have absolutely collapsed since February. If oil prices plunged below zero in April due to ailing demand for oil, then we are by far not out of the woods yet with demand levels plunging even further in May and June. Forecasts for 2021 are not optimistic as well.
If crude oil prices fall, there is the element of surprise because the market is not focused on this sector now. Everyone is arguably watching Technology stocks like hawks and have their crosshairs trained firmly on the big event risk down the road which is the US Presidential Election. If oil prices fall sharply from here, market participants will be caught by surprise.
A good question to ask is: With Crude Oil prices back at March levels, is the global economy faring much better and much closer to re-opening since March?
Even though new deaths per day have been relatively suppressed, new infection cases per day continue to climb, and this will very much hamper the re-opening of economies around the world in the near term.
Overall, these charts are telling us that there could be danger afoot in the market that participants are not alert to. Even though technology stocks sold off in September, I think there could still be more downside for the equity markets. We have not even seen “blood on the streets” and fear in the markets yet (i.e. no “limit-down” days yet). If we do, that would be a better time to buy up risk assets.
For now, a very crowded short-USD trade and the prospect of oil prices being much higher than they should be are two elements that the market may not be alert to right now.
Since launching on 1 June 2019, my technical analysis service has banked an absolute return of +117% with 82 trade recommendations as of 21 September 2020 with an average holding period of 4.75 weeks per trade. Do check out my Marketplace Service at The Naked Charts!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.