Having broken down, USDJPY has rallied back to “kiss” the old uptrend line which is now acting as resistance. A strong Yen will make it hard for Nikkei – and in my view all risky assets – to rally. As I have noted before, USDJPY warrants close attention and is one of the key charts I am watching right now.
Is really struggling at the top of the trend channel and also struggling with round number resistance at 1700:
Loss of momentum is easy to see on a 6 month chart of the S&P (see divergence on MACD and MACD histogram in chart below). A break of 1670 (i.e. the 16th July low) would mark the first lower low and the possible start of a new downtrend - a negative development for equities. I am not calling the end of the bull market at this juncture; rather am observing that the evidence in favour of a pullback is mounting.
Notice how the financials (one of the leading sectors of the US market) have already made a lower high followed by a lower low. In doing so they have diverged with the S&P500. Be alert to a similar pattern developing in the broader market:
The Homebuilders – a sector which lead the market on the way up – look as though they may have broken down (chart below is ITB – iShares US Home Construction ETF)
The chart below shows new 52 week highs on NYSE. Clearly less stocks are participating in the rally as “the market” presses higher (not an encouraging sign for further gains):
10yr US Treasury Yields:
Conventional wisdom holds that "when" the Fed begins the taper next month, UST yields will break higher. This also warrants close attention. I see a risk that even "if" the Fed does begin to taper next month, we could still see 10yr UST yields pull back to ~2.15% before resuming their uptrend. A pullback in equities/risk in general would put downward pressure on UST yields. Always be wary of conventional wisdom.
It’s not all doom and gloom!
I know I said in my last post that valuations don't have an impact on the tape unless they reach extreme levels. Well, Chinese equities look extremely cheap.
When you look at many of the large-cap defensive stocks in the US (e.g. Altria, AT&T, Coca-Cola, McDonalds, the utilities sector etc etc), they appear to have been trending down ever since the Shanghai Composite bottomed. Coincidence? Perhaps. However I think we are at the early stages of a shift in asset allocation away from relatively expensive US defensive stocks into relatively cheap Chinese (and other EM) stocks.
In summary: US equities are due for a pause that refreshes. Remain patient but alert to opportunities in weakness. Valuations on Chinese equities look compelling and the price action is now looking more encouraging. If you are overweight US equities (particularly defensives) consider reallocating to China (and EM).