Wednesday, February 22, 2012

Preliminary verdict: Consolidation and correction

In my last post, I wrote that I was watching the European bourses and the Hang Seng Index for signs of whether we are likely to see a continuation of the bull move or a consolidation period.

The preliminary verdict is consolidation and correction. You can tell the short-term tone of the market by how it reacts to news. On the weekend, China unexpected cut reserve requirements by 50 bp. The Shanghai Composite rallied on the news, but the Hong Kong market was unable to hold its gains and finished the last few days beneath a key technical resistance level.

In Europe, we saw the Greek bailout deal finalized late in the night. Markets staged a mild rally on the news and then sold off. The Dow rallied to kiss the 13K level and wound up roughly flat on the day. Does this sound like a market where the bulls are in control or does it sound like they're exhausted?

In the wake of the easing of financial tensions in the eurozone, can anyone explain to me why the EURCHF exchange rate hasn't rallied and appears to be slowly declining to the 1.20 level where the SNB said it would defend?

The Swiss Franc has long been regarded as a safe haven and the EURCHF rate is a measure of risk appetite so the above chart appears to be anomalous. What does the FX market know that the equity markets don't know?

I generally agree with Barry Ritholz's scenario for the market, though I believe that the Fed is likely to be proactive on QE3:
If the past is prologue (and that cannot be relied upon), we could see a scenario something like this (Note: Wild ass guessing to follow). Markets kiss 13,000, pullback and consolidate. But they are not overbought sufficiently for anything more serious than a modest retracement, and so they continue higher for several months, until the % of stocks over 200 day MA is near 90% (they are at 75% today). That takes us somewhere between March and June. The next sell off begins, lopping 25% or so off of the SPX. The Federal Reserve waits until after the November election to introduce QE3, and the cycle starts anew.

My base case scenario calls for a short (1-3 week) consolidation phase and a grind upward. After that, we'll have to watch how events unfold.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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