EURO BOUNCES OFF MAJOR 120 SUPPORT -- WHILE EUROPEAN STOCKS NEED A STRONGER EURO, US STOCKS NEED A STRONGER EUROPE -- A RISING AUSSIE/YEN CROSS SHOWS MORE OPTIMISM
A LONGER TERM VIEW OF THE EURO... Since the Euro is the best barometer of problems in the eurozone, an analysis of the European currency is crucial to any analysis of markets in that region, and global stocks in general. That being the case, a chart analysis of the Euro should help to determine if yesterday's positive market reactions to comments by the ECB president to support the Euro were just another short-lived reaction to promises to make things better, or a more serious shift in market sentiment for the better. Tuesday's message showed the Euro testing important chart support at its 2010 low near 120, and suggested that would be a logical spot for the Euro to attempt a rebound. In fact, it's crucial that the Euro hold above that previous low because a drop below 120 would signal more serious deterioration in Europe. The good news is that yesterday's bounce came right at that support level. The weekly bars in Chart 1 show the Euro scoring an upside weekly reversal from the 120 level. The 14-week RSI line (top of chart) is forming a "double bottom" near oversold territory at 30 (see arrows). The last two times the RSI dipped below 30 (see circles) marked important Euro bottoms. The weekly MACD histogram (below chart) also shows positive divergence (rising trendline). A positive MACD divergence during 2010 led to a strong Euro rebound. All of which supports a rally attempt in the Euro. To really turn things for the better, however, the Euro has to do a lot more than just bounce. It also needs to rise above its 10 and 40 week moving average lines.
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Chart 1
EURO STILL HAS A LONG WAY TO GO TO REVERSE DOWNTREND... Chart 2 shows gives a short-term look at the Euro's decline during 2012. The green circle to the bottom right shows this week's upturn from the 120 level. The daily MACD lines (below chart) also show "positive divergence" since June. [A positive divergence exists when the MACD lines from a higher low while prices fall to a new low]. The July low in the MACD lines are higher than their June low (see arrow). The daily MACD histrogram has also turned positive (lower circle). That supports a short-term rally attempt in the Euro, but not necessarily a major upturn. For an "intermediate" upturn to occur, the Euro needs to clear its (blue) 50-day average. For a "major" upturn to occur, it needs to clear its (red) 200-day line. The shaded area also shows an initial overhead resistance zone that the Euro needs to overcome. The resistance zone is defined by the January lows (near 126) and the June highs (just above 127). It remains to be seen if the Euro is strong enough to do that. Whether or not it can may determine the strength of the global stock market rally, and European stocks in particular.
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Chart 2
EURO DIRECTION IMPACTS EUROPEAN STOCKS ... Chart 3 shows the impact the Euro has had on Europe 350 iShares (IEV) since 2009. Notice that the two Euro drops in early 2010 and summer 2011 led to stock selloffs. The Euro rally during the second half of 2010 accompanied a stock upturn. The chart suggests that European stocks need a stronger (or at least a stable) Euro in order to hold important support of their own. Chart 3 shows the IEV trying to stay above the "neckline" drawn under its 2010/2011 lows in a potential "head and shoulders" topping pattern. In order to prevent a major stock breakdown below that neckline, European stocks need help from the Euro. That makes the Euro test of its 2010 low near 120 that much more important.
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Chart 3
US STOCKS NEED HELP FROM EUROPE... While European stocks need help from a stronger Euro, U.S. stocks also need help from Europe. Chart 4 compares the S&P 500 to Europe 350 iShares (IEV) over the last three years. A positive visual correlation can be seen between the two markets, which is confirmed by an .83 reading in the six-month Correlation Coefficient (below chart). Although European stocks have been much weaker than the U.S. since last October, the peaks and troughs are highly correlated. In addition, both markets usually trend in the same direction. That means that European stocks need to rally some more to keep the U.S. rally intact.
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Chart 4
AUSSIE/YEN CROSS CONTINUES TO RISE... Last Thursday's message explained that the direction of the Aussie Dollar/ Japanese Yen cross reflected the mood of global traders. Chart 5 plots that ratio ($XAD:$XJY) over the last year. A rising ratio means that global traders favor the Aussie Dollar which is a "risk on" currency. A falling ratio shows that traders favor the yen which is a "risk off" currency. That also makes the direction of the XAD/XJY ratio a good barometer of global stock market direction. That same message showed a positive correlation between the Aussie/yen ratio and global stocks. The gray matter below Chart 5 is the Vanguard All-World Stock Index (VT). Notice that the two lines generally trend in the same direction. In other words, global stocks need a stronger Aussie Dollar and a weaker yen -- in addition to a stronger Euro.
