Technicals flash amber as ECB and Fed struggle to validate rhetoric

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By Ambrose Evans-Pritchard


Louise Yamada clinched her reputation as America’s oracle of technical analysis with an emphatic sell warning at the top of the Wall Street boom in 2007.

She is watching the torrid rise on US and European bourses with mounting unease. Retail investors have not taken part. America’s mutual funds haemorrhaged a further $12.7bn in July, the fifth consecutive monthly outflow.


“A lot of this rally is just short-covering by hedge funds. There is underlying weakness creeping into the markets. Volume is low, and going down. You could call it a vacuum rally. New highs against new lows have been deteriorating.”


The US index of transport stocks have lagged the Dow Jones industrials, a time-honoured warning sign. “There is no question that we have a Dow Theory sell signal in place. This is rare and needs to be watched carefully. It tends to accurate, eventually,” she said.

Morgan Stanley’s equity team says stocks are still cheap in historic terms but many of their “sentiment” indicators are nevertheless flashing amber to red. It is as if the great debt hangover has sapped our strength. Europe’s stocks cannot seem to claw their way above a 12-month forward price to earnings (P/E) ratio of 11.

Both the VIX volatility index and the "put/call" ratio on the options market are signalling the sort of complacency levels seen at past peaks.

Speculative long positions on the NASDAQ exchange are stretched. The RSI momentum indicator is back up at nose-bleed heights. Brent crude is nearing the $120 level that short-circuited recent rallies.

“From a valuation standpoint, we are now close to peak levels seen over the past couple of years,” said Graham Secker, the bank’s chief European equity strategist.

It has been a heady summer rally. America’s S&P 500 index is up 10pc since early June. France’s CAC has risen 16pc, and Germany’s DAX 15pc, though both countries are flirting with double-dip recessions.

Italy is up 20pc and Spain up 24pc since mid-July in the face of full-blown depression. The 10-year sovereign bond yield remains more than 400 basis points higher than the growth rate of nominal GDP in both countries, a formula for suffocation.

For this equity melt-up we can thank the "Draghi Put" and the "Bernanke Put", the promise of largesse from the world’s two superpower central banks. Neither "Put" is actually in the bag.

As for China’s "Politburo Put" - the semi-fictional fiscal blitz by the regions - it is for now more believed abroad than at home. The Shanghai composite has continued its relentless slide. It is down 16pc since May.

The European Central Bank cannot start buying Club Med bonds until all the conditions imposed by German Chancellor Angela Merkel under the secret deal have been met.

Italy and Spain must first request a formal rescue from the European Stability Mechanism (ESM) or the old bail-out fund (EFSF), and sign a "Memorandum" ceding fiscal sovereignty to EU inspectors.

Here lies a minefield. If the terms are too tough, Spanish premier Mariano Rajoy may be tempted to tough it out until the crisis erupts again and forces his hand - probably as bond auctions approach in October. “Spain is not Uganda,” he famously texted, threatening to bring down Europe’s house of cards if pushed too far.

If the terms are too easy, the ESM rescue may not be approved by disgusted lawmakers in the German and Finnish parliaments. Or the Dutch, Finnish, Estonian, Slovakian and Luxembourg governors at the ECB may join the Bundesbank’s Jens Weidmann in opposing action on a big enough scale to make any difference.

Looming over all else is the ruling of the German Constitutional Court on the legality of the ESM on September 12. Elga Bartsch from Morgan Stanley said there is a 40pc chance that the court will “ban” the fund. “Markets are not priced appropriately for the downside tail risk of a possible 'no' verdict,” she said with marvellous understatement.

It is frankly hard to see how EMU could survive such an earthquake. Some suspect that Mrs Merkel quietly wants the court to drive a stake through the heart of the euro project before it does any more damage, relieving her of historical responsibility.

Monetary politics are less incendiary in America, yet the Fed’s Ben Bernanke is checked by five or six hawks from the regional banks - an odd replay of the clash with the Chicago Fed from 1930 to 1932.
For the rest of the story follow this link:http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/9515510/Technicals-flash-amber-as-ECB-and-Fed-struggle-to-validate-rhetoric.html