There was a compression in Nasdaq futures yesterday, arguing that the range-bound trendless price behaviour of the last month will soon break into a new trend. We cannot ever know which way compressions will break as they are moments of maximum uncertainty, like the edge of a watershed. In this case however there is a prior signal at a higher time frame – a weekly-scale top extension, also in a Nasdaq instrument only three weeks ago. This indicates that prices will have great difficulty in sustaining any strength for three months or so. This might still mean that US equity prices could move higher out of this compression but it does also mean that any rally would soon stall:
Within the current equity market trading range there has been a rally in the last two days and this has brought the Eurostoxx index up to the level of some daily-scale compressions. When prices fell through the bottom of these compressions a week ago, three days of weakness was the result and now we expect that the same compressions will provide resistance to further strength, as is normal:
We have already advised holding on to short positions in Southern European equity markets. This offers a chance to take new short positions for anyone not yet short. Stops should be placed above the compressed levels.
Meanwhile there have been more compressions in US Treasury notes, at a daily scale in the 5-year yield and at a weekly scale in the yield series of 30-year bonds:
This situation is now becoming potentially explosive. Pressure for a large move is building and the consequences will be far-reaching. The economic arguments are well-rehearsed but do not give a clue as to the direction of the break – the ‘tapering of QE’ is obviously bearish for bond prices but the looming threat of deflation is bullish. We always recommend ‘going with the break’ when compressions occur and when they happen during the life of a recommended trade, they offer a chance to tighten protective stops - this is the case in both fixed income and equity markets here and so stops may be tightened on short positions in both.
One point that we have not seen mentioned is that the quantity of bond and notes bought through QE at the maximum rate of $85bn per month was roughly in balance with the rate of new notes and bonds sold by the US government. Reducing QE could therefore have a greater marginal effect that would otherwise be expected…
Elsewhere, energy prices have been falling a bit but we have not yet seen a convincing 'sell' signal, although we have expected one. Heating oil did drop through a daily-scale compression two weeks ago but crude oil also broke up from weekly-scale compressions:
We could not reconcile these two conflicting signals into a coherent argument so we waited and are still waiting. The Russia vs. EU&US standoff will doubtless result in normal oil and gas flow from Russia to its clients in Europe as there is nothing but empty threats to wave at Putin. German industry is the main engine keeping Europe's paupers alive and Russian gas is its fuel. Everyone knows this so we don't expect much in the way of supply interruption.