Monday, November 12, 2012

How Will Equities React When QE-Infinity Liquidity Hits This Week?

Liquidity is the main driver of equities prices, since excess liquidity usually finds its way into assets, while a paucity of liquidity usually necessitates their sale.  The QE-Infinity liquidity will start hitting the market this week.  The first MBS purchases are scheduled to settle on November 14, so now we'll finally see how this will impact the market.  As noted on Friday, several markets are hovering near long-term support levels, but this zone is a key inflection point, and breakdowns of support here could lead the market into a rapid drop.

The chart below outlines several markets, and the bottom line is bulls need to make a "last stand" here or risk a panic sell-off.

The S&P 500 (SPX) chart below notes the potential air pocket beneath this price zone.  This results from the overlapping summer price range -- markets can race rapidly through such ranges, so a failure of support here could drop SPX quickly into the 1320's.

So... is there any reason for bulls to have any hope here?  This is a dangerous position for the market, so while I'm not encouraging front-running, there are a few signals that bulls could capitalize on, which I'll outline below.  It's a case of potential energy, but it's up to bulls to grab the ball and run with it.

In addition to this price support zone, there are a several reasons for bulls to feel all is not yet lost.  The first is the fact that, as noted, the QE-Infinity liquidity begins reaching the Primary Dealer accounts this week, and that usually translates into an inflationary reaction (equities up; dollar down).  Notably, the potential does exist for a complete (or nearly complete) corrective fractal from the 1474 print high (noted below as the double-zigzag).

Also interesting to note the US dollar seems to be forming a rising wedge, which is usually a bearish pattern: (continued, next page)

Of further encouragement to equities bulls, the Dow Jones Industrials Bullish Percent Index (BPINDU) is very close to forming a bullish MACD crossover from an oversold position, though this cross hasn't quite happened yet.

So there are some signs that bulls could find support here, but I would like to reiterate that this is a dangerous market for the inexperienced, and it's easy to fall into the trap of buying "the whole way down."  Accordingly, the chart below outlines the bearish potential of this wave structure, and should serve as a warning to the over-eager.  While an oversold rally could begin at the drop of a hat, it's simply not clear which direction the market will head from here, and the intermediate trend still remains down.

Interesting to note the still-neutral position of the Dow Jones Transportation Average (TRAN), which continues meandering about within a large triangle.  This further underscores the fact that the broader market is still undecided.  It does seem TRAN has clearly defined the triangle boundaries now, so is likely to run with the next breakout.

In conclusion, I feel part of my job to note potential turn zones, and the market has reached one.  That said, the intermediate trend is down, so this is by no means an "all clear" for bulls -- it's simply a zone where a reversal of trend is possible.  With that in mind, the central bank liquidity pumps are due to start flowing this week.   So while many traders are quite bearish, I'm not completely sold on the bearish outcome yet.  But I'll let the market dictate its plans -- I am remaining quite cognizant of the fact that if support fails here, the market could easily experience a panic sell-off.  Trade safe.

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