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Stock indices - Correlation & Divergence


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Ok @Caseynotes let's try a thread on this as you suggested.  It will surely get boring if we try to post on this everyday so I will kick it off with what I see on the large time frame charts and look to update only when significant milestones are met.  This will obviously be from a technical perspective for me but also, crucially, from a long term fundamentals perspective.  It wont be about trade set ups (entry, exits, stops) but is more about the backdrop to considering such trades on shorter term time-frames, according to each traders methodology and preferences.  Having said that discussion in between key milestones on the macro economic cycle picture and correlations across markets would be interesting, especially if any significant events could impact assessments of whether we are seeing a trend change or are in a new trend on stock indices.

So as mentioned in the indices post on the Nikkei, I saw a break of a Triangle to the down side last night and this tied with my assessment that US large caps were due a retrace and were at key resistance levels.  This prompted me to look again at the 2 scenarios I had identified on the recent turn and rally across indices which are:

  1. Rally on up to a new all time high
  2. Retrace rally only to a significant resistance point to set up another, much longer, Bearish move

I will just show those on 1 index (Dow Jones) via the Monthly and Daily charts:

  • The Bull trend channel is still intact on the Monthly Chart of course, with some considerable room below into which it can retrace and still rally back up thus maintaining the Bull trend.  The channel could also be described as a triangle (different top line) and there is an additional very long term trend-line above.  All 3 lines intersected at the Pink 3 high, which caused several commentators to call the top of the market (also because they saw an overshoot of a shorter term trend-line) but I didn't see a Negative Momentum Divergence (NMD) so I wasn't convinced.
  • Now we know that the market dropped sharply and then recovered into another rally phase, which reached higher highs before falling sharply again during Sept/Oct 2018.  This time I did see NMD on all Long term charts but the Daily one was weak and when I saw the market bounce off solid support lines on the Daily and Weekly charts, with Positive Momentum Divergence (PMD) I was fairly sure we would get a rally, but what kind (one of the 2 scenarios above).
  • On the Daily chart there was a pin bar to kick off the Bearish move and another to stop it.  The move down could be described as either an A-B-C or a 1-5 so no help there.  However I don't see NMD on the Daily and that means another higher high is very much on.
  • The currently rally broke the down channel fast and rushed up to the Fib 76% just now and has been turned sharply back.  This is a very strong retrace, if the trend has changed but we might expect that of this Bull trend.  Looking at shorter term charts the current rally seems more like an A-B-C but it may not yet have ended and final rallies to market tops are different beasts than the norm so pretty much anything goes.
  • Summary: we cannot know which scenario is in play yet but can we at least say we are in end times for this Bull run?  Annoyingly any turn and rally we get on this Bear phase will likely fit both scenarios as well.  Trend followers might say no because the long term trend is still intact.  But are there any indicators that might help us to see a short term trend change and get positioned right?  Well Divergence between the various world stock indices could be one such indicator.

Before we go any further it would be useful perhaps to discuss the set ups we have so far to see if people think we are in end times and why OR there is still further to go on this Bull run (how far, how long and why?).




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That's probably a better idea @Mercury than the one I was thinking, I was thinking it might be useful to have side by side charts of the US indices to contrast and compare on a daily basis but realise now that they are much closer in step than I first thought, as per the pic below. I've used dxy bottom right as a space filler as Russell is not available on MT4.


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That's cool @Caseynotes, there is value is seeing the actual daily move evolution to assess if the various markets are at least tracking in an aligned way (even if on different strengths) or are actually moving in opposition.  I doubt they will diverge on tracking for very long as they are, I think, all governed by the same geopolitical and economic factors these days.  The divergence that I am testing for is in the quantum of the moves (e.g. Dax staying low and depressed on this recent rally vs Dow forging ahead).  I ask myself is this sustainable?  If not something has to give but will it be Dax charging to catch up or Dow falling back?

Additionally there is some market-lore that when normally aligned markets diverge, in the sense that only some make fresh all time highs and others fall short (typically the weaker ones) then the overall rally is done (the converse also works).  I will post some stuff on this once I have completed the analysis but in the meantime would love to heard forum members thoughts on identifying the end of the Stocks Bull, or is it over? 

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Not sure the article below constitutes a divergence (subject of this thread) but I have been noting a number of corporate actions in the major indices over the past few years, that is:

  • A sharp increase in M&A activity
  • Share buybacks
  • A focus on dividends (returns to shareholders) by CEOs

In the case of M&A market-lore suggests that excessive deal making occurs at the end on Bull markets on extreme Greed sentiment.  This may be true but for me, having worked in a few global companies in my time, I think it has as much or more to do with senior management desperately searching for growth and an associated story to hang share price appreciation on.  History tells us that most M&A deals are negative for shareholder value creation, due primarily to over paying.  That happens in spades at the top of the market.

Share buyback at the levels we have seen are a phenomena of the Central Bank Bull I think.  This is about financial engineering.  In an ultra low interest rate environment a company can take out a load and buy back shares thus simultaneously adjusting gearing levels (and average interest rate levels) and ramp share price by reducing the number of shares issued.  It would not surprise me if low interest loans were being used to fund cashflow for divided payments as well...  Such things one does not expect in a "normal" economic management environment.

The final one, the subject of the article below, is, for me, a strong signal of end times.  Is it market exuberance or desperation?  I think the latter as Boards ramp up dividends despite lukewarm growth or worse.  In a normal environment corporate suffering lackluster growth would be seeking to invest for growth, especially with such low interest rates, but that appears not to be happening at the levels it should be.  CEOs are focused on the above 3 corporate actions.  Not only has it been easier to do this but I believe CEOs are finding it difficult to find investment opportunity.  Indeed I know quite a few are actually selling off areas of their business, the low growth or stagnant ones, to focus, which improved their growth numbers...Smacks of desperation to me.


https://www.hl.co.uk/news/articles/stock-market-dividends-hit-record-high?cid=halDM46766&bid=201966768&e_cti=5513301&e_ct=T&utm_source=AdobeCampaign&utm_medium=email&utm_campaign=EOWSI_Weekly share insight_09.11.18&theSource=EOWSI&Override=1


Another article you may find interesting in the debate over where we are at or near the top of the Stocks Bull.  The general thrust is that the trend in key industrial output is down and in particular in China, which the analyst contends was the driver behind the bull phase from 2016 to now...

 https://app.hedgeye.com/e/7zK/a6jf0p/is-the-global-economy-heading-into-recession?utm_medium=email&utm_campaign=Weekend Reading Edition 1 11102018&utm_content=Weekend Reading Edition 1 11102018+CID_b3d200469bda54e69efff6c7c7980aaa&utm_source=campaignmonitor email&utm_term=PREMIUM MACRO Is The Global Economy Heading Into Recession

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So US large caps could go either way (All time high & market top yet to come OR already in and current turn down is a natural retrace into a longer bearish move) but what of other major world indices?  Are they correlating or indicating something different?

Looking at the Dax, which has seemingly been weaker of late, the case for the end of the Bull appears stronger than elsewhere.  On the Monthly chart the same basic set up as all of the others is apparent but the rally up from early 2016 shows a much cleaner 1-5 form and the subsequent drop is deeper than others, now approaching the long term supporting trend-line.  The interesting differentiating factor is more visible on the Weekly chart, a Head & Shoulders pattern.  There was NMD at the potential market top and recently a break through and retest of the potential Neckline.  The EWT count looks stronger too (looking at the Daily chart now) with a much clearer case for a 1-5 pattern on the recent bearish move off the top and an A-B-C retrace to the Fib 76/78% (blue 2) followed by another ST retrace (brown 2) and then an extended Bearish move to date.

With the LT supporting trend-line very close it will be interesting to watch the price action, especially in the context of the US large caps.  A rally off this support zone does not negate the Bearish set up outlined above as another test of the Neckline (or even a so-called hard retest, penetrating and falling below again) is eminently possible.  However on balance I think the most likely scenario on the Dax is that the Bull has already ended.



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European stock markets seem weaker than US ones.  If we have indeed seen market tops on all global indices then the Dax went first in January, then the FTSE in May and the US large caps and Nikkei not til Oct just gone.  Only a massive rally across all indices from here to fresh all time highs will bring these indices back into correlation.  Look also at the recent rally retrace levels, the US large caps went very long but Europeans didn't even make the Fib 38% area (at least not yet...).

Looking at the FTSE 100 the case for the market top already in is getting stronger.  The rally up to the May high was very strong, barely a retrace worth mentioning.  The drop down took longer to get going that on the US but once it did the market gave up all of the previous rally gains, stopped only by the important 6800 support zone.  There is a decent medium term supporting trend-line from 2016 that was broken on 8 Oct this year and recently retested and rejected.  We could see another test of this resistance zone or the actual trend line itself in the coming days/weeks and another rejection here should bring up a retest of the 6800 level. If this level goes then I believe the Bear is truly on.


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Today European markets took off strong off support levels BUT US large Cap and Nikkei out of hours did not, staying within key resistance zones.  Again we are seeing a divergence between the Geographies on stock indices, perhaps because the European indices have been weaker speculators saw more upside?  Dangerous game betting against the massive SP500, I waited until US opening and went Short again at key resistance levels.  The longer this US route goes on the more I am inclined to believe the Top of the market is in but let's see how correlation shapes up as we approach US key support areas...

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