Charts I'm Watching: January 23, 2012

UPDATE:  12:15 PM

We're seeing a little weakness on SPX, off 5 after topping out at 1322 earlier.  We got within 7 pts of the Crab objective and, depending very much on how you draw it, possibly tagged the Oct 2007 fan line.   Those who want to capture most of the move down are already short by now, while those who want to nail the top are probably scaling in.

As always, we won't know it was the top until after the fact.  But, my best guess is still 1329, with a possible dip on either side just to fatten out the rising wedge into a channel.  Here's what I mean:

We've been faked out multiple times on the way up playing rising wedges.  Every time we complete a perfect looking one, it expands into a channel and begins a new, less perfect wedge -- the better to suck more bears into the game.  Right now, it's looking pretty good.  And, we're obviously approaching the fan line (however you want to draw it) and horizontal resistance.

I think the MMs will likely allow a little dip just to excite those of us who are looking for a break down from the wedge, then reverse it at a point where it'll take on more of a channel look.  Whether they do this before or after 1329 is anyone's guess, but I think it's coming.  The only positive is that it will very likely establish some nice, fat negative divergence -- a signal that's been AWOL on the daily chart.

BTW, XLF just busted one of the harmonic patterns we were watching.  By exceeding 14.17, we have a Point C higher than Point A on the Butterfly/Crab.  Although, as discussed last week, I'll usually wait for a more sizable excess before calling it quits.  After all, 1.0 is a Fib level, and we only reached 1.037.  Could we reverse quickly?  Sure, take a look at BAC.

I hate to kick a stock when it's down, but in BAC's case I'll make an exception.  It's forming a double top as it back tests a falling wedge and, so far, has failed to breach a TL from 2006.

UPDATE:  11:35 AM

AUDUSD has slightly overshot our Gartley and Crab pattern objectives and seems to be leveling off.   This should be it for the upside, but always remember to use appropriate stops.

ORIGINAL POST:  10:20 AM

EURUSD has broken out of the very tight channel it's been in since mid-October.  I've adjusted the fan line from the July 08 high (highlighted in white) to reflect the turn at and am looking at the next fan line higher (highlighted in purple) and/or the previous wave low at 1.3145 to provide the next turn. 

Note that this would complete a back test of the last diagonal on our stair step lower and probably tag the SMA 50, too.

Any time we break out of a channel, it's a good idea to reexamine the channel and any related underlying assumptions.   Initially, I wondered if we were seeing an expansion of the channel -- much like occurred in Mar 2010 (in the middle of the middle impulsive channel (purple) below.

I was disturbed that we were seeing a sizable bounce prior to reaching the fan line off the 2002 low.  I was also having trouble reconciling a breakout from an apparent falling wedge.  When we look at the same chart in log scale, however, we see a perfectly nice touch on the fan line (redrawn in solid red) and the channel is still very much intact (using the 2008 impulse channel slope as a guide.)

Curiously, in log scale the last fan line provided a bounce on the downside but not the subsequent rise.  In arithmetic scale, it provided no bounce on the downside, but a big one on the way back up.  I can only surmise that the algo's driving much of the EURUSD trading out there watches both.  So, I will too.

I examined this with respect to the equities market in an earlier post [see: To Log or Not to Log] back in October, and determined that using log scale was part of the reason I was often early.  I think the best approach is to use log scale for longer term patterns (a 9-year fan line qualifies!) but confirm with the arith scale before doing anything crazy in the short run.  That still seems to be the scale most short(er) term equities traders use.  Here's the daily chart close up with log:

We still have a ways to go on our Crab pattern (Point D @ 1.2464) and, of course, there's the gigantic flag pattern to complete somewhere around 1.13 (depending on timing.)  From 1.3145, 1.2464 would be over a 5% drop -- a great way to kick start a nice equities correction.

Some of you might recall we're watching a fan line off the 2007 high on our SPX chart, too.  Again, using log vs arith scale can make a small difference.  Here are the two options, each showing a fan line off Oct 11, 2007 through the May 2, 2011 high - both with and without shadows.   Today's values with log are 1333.90 and 1327.50; with arith they are at 1330.65 and 1324.40.

More later.

Lightning Always Strikes Twice

It was Saturday the 14th -- the day after we usually expect the Universe to throw us a curve.  My brother-in-law and I were day-hiking Mt. Whitney.  It's a 22-mile scramble from 8,360 up to 14,496 feet and back, not the most relaxing way to spent a day.

Before long, we came across two brothers and their best friend.  We took turns passing each other, sharing words of encouragement and speculating as to how hot the waitresses serving margaritas at the summit would be.  At about 14,000 feet, my brother-in-law's hypoxia forced us to rest and the others pushed ahead.  Unfortunately, none of us could see the huge thunderstorm racing in from the blind side of the mountain.

That which has been is that which will be,
And that which has been done is that which will be done.
So there is nothing new under the sun. 

Ecclesiastes 1:9, 200 BCE 

The weather went from 50 degrees and sunny to sleet and snow mixed with lightning -- lots and lots of lightning.  At that altitude, we were in the thunderhead.  Just above us on the summit, the others took refuge in a tin-roofed stone observation hut.  As the storm raged around them, one of the brothers tried to lighten the mood.   Don't worry, he laughed, when he was young he was hit by lightning while boating and everyone knows lightning never strikes twice.

He had intimate knowledge of the dangers of lightning.   He knew not to be out in the open and exposed when a thunderstorm came along.  He was even in the company of several people trained in CPR and survival skills who would stop at nothing to save one another.   None of this changed the fact that they were nearly three miles high in the middle of a thunderstorm.

The more things change, the more they stay the same.

Alphonse Karr, 1849

An average lightning bolt carries 30,000 amps and a trillion watts.  The air in the immediate vicinity literally explodes when it's heated to 36,000 degrees -- three times that of the surface of the sun.  During this particular storm, there were hundreds of lightning bolts registered in a couple of hours.  There was nowhere to run, nowhere to hide. 

Moments later, the hut was struck by a bolt so massive that a ball of lightning appeared inside, floating around the ceiling for thirty seconds until it exploded, shocking everyone in the hut.  The brother who'd been joking went into cardiac arrest and, despite five hours of CPR by his brother and his best friend, died that day.

The Federal Reserve is not currently forecasting a recession.
Ben Bernanke, Jan 2008

Despite his experience and expertise, not to mention a well-worn idiom, he was unable to avoid the inevitable.  I think about him from time to time, especially when contemplating our economic future.  Our Fed Reserve chairman, a renowned expert on the Great Depression, has assured us that depressionary lightning won't strike twice.  But, it shook our confidence when, in the year following the above quote, we saw stocks lose over half their value.

In 1933, when Roosevelt took the US off the gold standard, loosened monetary policy and greatly expanded federal spending, markets soared.  Federal expenditures tripled, but GDP kept pace.  Federal debt to GDP maxed out around 40%.  Employment dropped below 20% and deflation abated.  The country had turned the corner and sentiment improved, much as it appears today.

In 1937, however, the wheels came off the recovery express.  Unemployment jumped from 14.3% to 19%; industrial production and the stock market both plunged over 30%.  The causes are subject to great debate.  Depending on whom you believe, monetary policy was either too accommodative or restrictive; taxes were excessive or regulation was too lax; spending was too high or not high enough.

First comes spring and summer but then we have fall and winter.
And then we get spring and summer again.

Chauncey Gardiner, Being There

Like storms, economic cycles are a fact of life.  We try to prevent them with stimulative monetary policy, deregulation and lower tax policies.  But, we invariably overcorrect or undercorrect; we take wrong turns and run down blind alleys.  It's human nature at it's finest.  As anyone who's ever ducked into a tin-roofed hut to escape lightning would tell you, unintended consequences can be a bitch.

Witness the continuing fallout from overly lax real estate lending.  Despite Bernanke's March 2007 analysis that "problems in the subprime market seem likely to be contained," real estate remains locked in a deflationary spiral.  Nearly five years later, amid a meltdown that saw his own boyhood home sold at foreclosure, prices are back to 2003 levels.

Personally, I don't think we're anywhere near out of the woods.  I think we've come to a cyclical clearing that precedes a denser, darker, scarier forest than anyone alive today can remember.  I don't believe issuing more debt can cure a debt problem any more than buying a guy a scotch can cure his alcoholism.  So, forgive me when I question Bernanke's repeated assurances.

Whether you believe him or not, know that everything you hear from the Fed, the White House, Congress, the ECB, the IMF, the WSJ or CNBC serves one purpose and one purpose only: to produce optimism.  If we forget about the inevitable cycles, the ludicrousness of the cures being proffered, the quicksand into which the political process has sunk -- maybe we'll start buying Chevy Volts, iPhones and big-screen TV's in numbers sufficient to part the storm clouds.

See, in my line of work you got to keep repeating things 

over and over and over again for the truth to sink in, 

to kind of catapult the propaganda.

George Bush, 2005

As a wise man once said, question everything.


*****

Turning in for the night, but couldn't help notice AUDUSD is closing in on our Gartley & Crab targets identified last Wednesday.

Look for a potential reversal in the 1.0519 - 1.0534 range.  This could be the last hurrah for AUDUSD, the third in a row to correspond with an important equities top.  As we discussed last Friday, there's a Butterfly waiting to take prices down to .9015 if it breaks through the channel at .9542ish.