We have been saying for a long time that crude oil has been weighing on markets. We even proved that crude oil is THE driver for the different sell offs in stocks throughout 2015, as explained here. As clearly shown on the chart in that article, each time crude declined at least 10% in 12 consecutive trading days, panic ensued in stocks.
Well, in the same article we showed that all readings in crude oil had reached extreme levels of historic proportions. We called a bottom in crude, and, consequently, in stocks. So far, we have been proven right.
In this article, we look at how our five risk indicators have been trending since we called the bottom in crude and stocks.
Risk indicator #1 is the intermarket dynamic between crude and stocks, and that one is flashing green at this point, as strong buying is occurring at current levels in crude.
The second risk indicator is price behavior in stocks. The S&P 500 has a mega-support area which has been tested 5 times. That support level has held, and, given so many successful tests, it is a bullish sign.
Our third risk indicator comes from intermarket dynamics as well: the Japanese Yen. The Japanese currency is known to be a safe haven asset, and a rise in the Yen is mostly a reliable ‘risk off’ indicator. Two weeks ago, the Yen was about to break through its 90 week moving average. As readers know, the 90 WMA is the only technical indicator in our methodology. Uncoincidentally, the Yen did not succeed in breaking through, running against heavy resistance at right at the 90 WMA. Last week, the Bank of Japan announced an interest rate cut, and pushed rates into negative territory, which resulted in the Yen to sell off heavily. This confirms that the Yen remains in a downtrend, or, in other words, ‘risk on’ still prevails.
Next to that, Yen hedgers in the futures market are unwinding their extreme long positions. As the next chart shows, courtesy of SentimenTrader, extreme positions by hedgers have always led to weakness. Recent extremes in hedging positions are no exception to that rule. That is another ‘risk on’ indicator flashing green.
Risk indicator #4 is the TED spread. It stands for fear in markets. Last August and this January, the TED spread spiked to multi-year highs. However, in last weeks, the indicator has come down sharply, as it reached extreme levels similar to the 2011 euro crisis (just, this time, it was the crude crisis). In conjunction with our vision on crude oil, explained above, we believe this risk indicator has also a ‘green’ status.
4 out of 5 risk indicators are green, according to our interpretation. However, there is one concerning indicator: the bond market. It is the only indicator that is still in ‘risk off’ mode.
The bellwether in the bond market is the 10 Yr. Note. As seen on the last chart, it is attempting to break out to all-time highs. If that proves to be a failed attempt, we got 5 out of 5 risk indicators flashing green, so we are convinced that new all-time highs in stocks will be set in 2016. If bonds surge higher, however, then the ongoing rally in stocks could lose steam as it would near all-time highs.
4 out of our 5 risk indicators have turned green, but the bond market is not participating to that party (yet?). It is imperative that bonds confirm a ‘risk on’ environment before stocks move to all-time highs.
Our readers know exactly what they have to watch in the coming days and weeks.