The channel breakout on the S&P 500 in February looked promising. However, stocks have been sucked right back in, which raises some legitimate concerns.
For example, large “head-and-shoulders” reversal patterns are essentially failed channel breakouts (at the head) and often coincide with extreme economic uncertainty.
This time may be “different” but only if at least two issues can be resolved in the short term.
Is the Dollar a Problem?
Short answer — yes. The dollar broke out again as the euro dropped. Institutional currency managers aren’t saying this is panic buying or a “flight to quality,” but the end effect may be very similar.
A stronger dollar can be good for U.S. asset prices in the short term (because they must be purchased in dollars), but a stronger dollar also hurts big U.S. firms in the long term.
For example, most investors know that Apple Inc. (NASDAQ:AAPL) is hoarding a massive cache of assets overseas to avoid a tax hit when they bring it back to the U.S. That money is rapidly losing value compared to the U.S. dollar as it gains in value.
As you can see in the chart below, the S&P 500 broke out following Apple’s rally in January and has followed AAPL stock lower since it topped out last month.
S&P 500 SPDR ETF (SPY) versus Apple (AAPL): Chart courtesy of eSignal
The issues that AAPL is experiencing right now are not limited to the value of the dollar, but that is definitely amplifying other doubts and concerns about a concentrated product lineup and limited growth opportunities. This is a common problem right now for many other firms in the technology and manufacturing sectors.
We Still Aren’t Done With Greece
The Greek government isn’t playing nice with Germany again. There are serious concerns that Greece won’t be able or willing to live up to its commitments over the next four months while further bailout modifications are negotiated. The German government is taking a hardline on austerity requirements, which is exactly what the current Greek government was elected to eliminate.
This impasse between Greece and Germany has ramped up the tensions with renewed calls for reparations for the Nazi occupation of Greece during World War II. While many non-Europeans may be surprised by this news, it has actually been a longstanding source of contention between the two countries for decades.
A lack of stability in Greece throws the stability of the entire euro monetary union into doubt — at least a little. Investors hate uncertainty, which weakens the euro (further strengthening the dollar) and puts pressure on European stocks.
As you can see in the next chart, the S&P 500 (plenty of exposure to the European economy) has followed Greek stocks to the downside since the European indices started getting toppy in late February.
S&P 500 SPDR ETF (SPY) versus Global-X Greek Indexed ETF (GREK): Chart courtesy of eSignal
Other Miscellaneous Sources of Uncertainty
In addition to the issues in Europe and a rising dollar, there are a few other problems that have created a “perfect storm” for traders in the short term.
Labor in the U.S. has been surprisingly strong, which increases the odds for a rate hike in 2015. This has long been seen as a potential catalyst for a decline in stocks.
Next week’s Federal Open Market Committee (FOMC) statement has attracted a renewed focus from investors who are looking for new clues for a rate hike. While an adjustment before October is unlikely, investors will be looking for language that a move in interest rates will be larger than previously expected.
The Federal Reserve’s bank stress tests were due to be released after the market closed on Mar. 11. Although most traders aren’t expecting any banks to “fail” the test, there are still a lot of question marks around what this will do to capital requirements and dividend payments.
Finally, there are serious concerns that the current round of easing and capital requirement changes in China will not be effective for the Chinese economy. A stronger dollar may help, but that is also a double-edged sword because it will continue to increase the risks of consumer price inflation and asset deflation in the country.
None of these issues have come “out of the blue” this month, but it is surprising how negatively investors are dealing with the uncertainty. We aren’t ready to give up on the bull market by any means, but these problems may keep the major stock indices channel-bound in the short term.
InvestorPlace advisors John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.
You can learn more about identifying price patterns – like ascending triangles – and using them to project how far you think a stock is going to move in our Advanced Technical Analysis Program.
