Friday, June 20, 2008

The witch's hat

It's triple witching day today in equity land, and on the evidence so far the old crones have cooked up a stonker. The bubbling witches' cauldron has been aided by a rather amusing game of banking "nickie-nickie-nah-nah", wherein one troubled institution downgrades another: UBS has lowered Citi this morning, while the embattled Lehman has downgraded Deutsche, Credit Suisse, and- you guessed it- UBS.

So there's been a few fireworks in Europe this morning, which has no doubt left various holders of index option positions either celebrating or gnashing their teeth. The morning action in Eurotstoxx was pretty mundane leading up to expiration (the settlement time is marked by the arrow in the chart below), after which the index has fallen off a cliff.

From a longer term perspective, the Eurostoxx is at pretty crucial levels. On the weeklies its sitting on the neckline of a head-and-shoulders pattern, a formation which also happens to resemble a witch's hat. A weekly close below the 3440-ish level would theoretically target the low 2000's eventually. Yowsah!
While the SPX doesn't have such an obvious witch's hat formation threatening to cast a hex, it, too, is at pretty crucial levels. While logarithmic charts aren't really used in day-to-day charting, they are pretty handy when looking at long time frames of data. And as UBS' Andy Lees has pointed out recently, the SPX is basically sitting on the uptrend from the (in)famous 1982 Granville bottom on the logarithmic monthlies.
A conclusive monthly close below this trend line at 1330 would be fairly ominous indeed, and threaten to turn the SPX into a pumpkin. Yesterday's Philly Fed, which showed weaker activity, higher input costs, and lower prices received, provided a heady witches' brew for the macro equity bear.

Of course, the trick in this game is to avoid Macbeth's fate and follow the witches' guide to one's doom. Then again, badly limping financials, a struggling US consumer, and rampant global headline inflation are substantially less formidable an opponent than Macduff. For now, Macro Man is content to follow the witches' prophecy but not force the issue; if the brim of the witch's hat gives way, there will be plenty of opportunity to add risk.

9 comments:

Anonymous said...

I was short some June Dax futures, and (fortuneately for me), they started to break down about an hour earlier. I didn't catch anywhere near all of the drop (maybe a third of it), but after seeing what happened in the Eurostoxx at expiration, I won't complain.

Anonymous said...

Never mind. The Eurostoxx future expires an hour earlier than the Dax future. I will take luck over skill any day. :)

Macro Man said...

Tell me about it. I was short a bunch of 3500 SX5E puts against my other positions...I'd be much less happy right now if the big dump had happened 45 minutes earlier....

Anonymous said...

by the pricking of my thumbs, something whipsaw this way comes

Barry Ritholtz said...

I have a little bit of a problem with the trend line drawn on the 1982-2008 chart, primarily because there is but one touch from the period 1982 to 1994, then 99 up to 2003.

It is a long-standing tenets of technical analysis and trend watching that the more touches you have to a trend the more valid that trend line is.

I would draw this trendline very differently: From 1982-1994 was a consistent trendline drawn at a slightly greater angle than the current line that is drawn.

Then from 1994 straight up to the peak in 2000 you have a much more aggressive trendline that broke some time after March 2000.

And finally you have a neutron line from the March 2003 lows to sometime in the fourth quarter of 2007 that was broken.

There are obviously a myriad of ways of drawing trendlines, and they are all subjective. However a trendline with no touches for 21 years may not have a whole lot of validity

Macro Man said...

Barry, I'd concur that the SPX chart is more speculative that, say, the Eurostoxx chart, because of the rather contrived trendline. Still, it's a perspective that I imagine not a lot of non-pure equity guys have seen, and it is something that's being referred to in some quarters. In any event, if we can go through this 1320-30 region, there's not a whole lot of support between there and the January lows....

Anonymous said...

I have to agree with Barry, trend lines tend to be quiet subjective and there are multitudes of ways of drawing them, I do think the psychological line in the sand is 1270 low to 1320 close. This is also the "Fed Line" ; a lot of intervention and easing has occurred at this level, and a break under would almost imply a lack of faith in the Fed's actions- I think this would also be a USD negative.
Although, the psychological importance of this is precisely why I think we can probably hold out and bounce back some here once again.

On a break, if we grind lower, might look for some support at 1170 at the 50% retrace of the 03-07 bull run, around 1090 if we crash in a panic, about 10K on Dow, and 1000 on s&p you have to think the market would be down to 11P/E, close to fair value some would argue, recession bottom levels even?

Anonymous said...

On the issue of the SPX chart, the Financial Forecast Short Term Update (edited by Steven Hochberg) posted by Elliot Wave International on Friday shows one starting from Dec 74. The 34 year trend line was broken on Friday. Will have to wait for couple of days to see whether this is a conclusive break. This chart has more touches than the one you have displayed. You can check it out on www.elliotwave.com. Normally you have to be a subscriber to access it but currently they are having a free week.

D. L. Bailey said...

Is it conceivable that, at the greatest remove, we might be seeing the breakdown of all the dollar-priced markets, with oil being the last to go?