The Week Ahead: Profiting from a Weak Euro

09/12/2014 5:15 pm EST

Focus: MARKETS

Thomas Aspray

, Professional Trader & Analyst

Forex traders have been suffering because of the low volatility but that's returned to the currency markets with a vengeance, but MoneyShow's Tom Aspray thinks, due to the overly bearish sentiment on the euro, a rebound is likely before it moves lower.

It was a nervous week for the markets as September's history of weak stock performance kept some on the sidelines. The other main concern for the market (as overseas tensions subsided) was whether the FOMC may change its policy this week.

In last week's analysis Is the Junk Dump a Warning?, I noted the heavy selling in some of the high yield or junk bond ETFs ahead of the FOMC meeting.  If we do see a change in the wording of the FOMC announcement, as some are expecting, it could trigger a sharp-but I believe brief-market decline.

In a way, it would be a positive as it would remove one more concern from the investor's wall of worry. A decline would also serve to reduce the high level of bullish sentiment as-amongst the Wall Street firms-the bearish strategist camp was reduced further last week.

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The volatility has returned to the currency markets with a vengeance as forex traders have been suffering with the low volatility. The Japanese yen fell to a six-year low last week as their bond yields dropped into negative territory. Overseas yields are now much more attractive, especially with the potential of higher US rates in the next year.

The chart shows that the yen broke major support, line b, on December 12, 2012.  Since then, it has lost 22% of its value. The breakout (line 1) came one week before the NK225 broke through its downtrend, line a. The NK225 is up over 71% since the bottom formation was completed. I continue to think that the yen will get even weaker, which will be good for Japanese stocks.

The comments from Mario Draghi last month that the Eurozone should drop its austerity-based recovery plan was followed-up by an asset repurchase plan. Some countries, like Germany and France, are not in favor of this change in policy. He also suggested that the governments should guarantee some of the riskier assets.

The pressure of the low inflation and low growth needs drastic action, in my opinion, to avert a deflationary spiral. As I pointed out in October of 2012, Austerity Didn't Work in '37...What About Now?, the brief switch in 1937 to austerity by FDR almost pushed the country back into a depression.

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The action by the ECB has had a big impact on the euro as it has dropped almost 14% from the March highs. The euro has been forming lower highs since the spring (line b) and then violated its uptrend, line c, in the middle of July.

As I noted last week, sentiment on the euro is overly bearish so a rebound is likely before it moves even lower. For those interested in the forex markets, I will be doing a Webinar on September 23 discussing FX trading techniques (If you are interested, sign up here).

European stocks have been lagging this year, including Vanguard FTSE Europe (VGK), which is one of my dollar cost averaging picks I discussed last week. In addition to the 66% in developed European stocks, it also has 33% in the United Kingdom. The Scottish vote on independence has hurt the pound recently.

The chart of VGK shows that it has come back to support from the 2011 highs, line a, which is holding so far. I think the weaker euro will have a positive impact on their exports and their economies. I expect more widespread growth in the Eurozone by next spring.

Some of their economies are already recovering nicely as the beaten down Irish economy has staged a dramatic turnaround as they will repay part of their IMF loan early. Their composite purchasing mangers index recently hit the highest level since 2000.

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Though the economic calendar was light last week, the falling gasoline prices should translate to stronger consumer spending in the next few months. The chart shows the sharp drop in the gasoline futures since early in the year. A drop much below $2.50 (line a) would signal that prices can move even lower.

Lower gas prices may have helped push the University of Michigan's Consumer Sentiment higher as the mid-month reading came in at 84.6, up from the August reading of 82.5. The jump in expectations, a component of the index, says Econoday "does point to long-term confidence in the jobs and income outlooks."

NEXT PAGE: What to Watch

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Retail Sales were also out on Friday and-at 0.6%-it was not disappointing. One of the highlights was the 0.6% increase in food service and entertainment, indicating a higher level of discretionary spending.

The economic schedule is much heavier this week with the Empire Sate Manufacturing Survey and Industrial Production on Monday. The FOMC meeting begins Tuesday and the latest reading on the Producer Price Index is also released. Consumer Prices are out on Wednesday followed by the FOMC announcement and press conference in the afternoon.

Some new numbers on the housing market are out on Thursday as the Housing Starts data is released along with the Philadelphia Fed Survey. On Friday, we have the Leading Indicators as well as the quadruple expiration of futures and options.

What to Watch

The stock market was hit with heavier selling on Friday as the declining stocks led the advancing by a 5-to-1 margin. The selling was the heaviest in the Dow Utilities, which were down 1.5%. All the major averages did close the week lower.

The A/D analysis, including the S&P 1500 I featured Friday (see chart), did confirm the early September highs. This is consistent with an orderly pullback not a test of the August lows.

The monthly OBV analysis for the Spyder Trust (SPY) and the PowerShares QQQ Trust (QQQ) did make new highs in August and the weekly has also confirmed the recent highs. This is in contrast to the daily OBV analysis which has been diverging from prices.

The number of bullish investors, according to AAII, did decline last week to 40.38% from 44.67% the previous week. The bearish percentage at 26.6% is still quite low.

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The number of stocks above their 50-day MAs has dropped sharply from the early September highs. In blue, there is the % of Nasdaq 100 stocks, which has dropped from 59% at the end of August to just above the 40% level.

In green, we have the same plot of all US stocks, which was 75.5% on September 5 and is now at 61.6%. This suggests that we can see a further correction this week as we head into the all-important FOMC meeting.

The NYSE Composite (NYA) hit a high of 11,108 on September 4 after breaking its short-term downtrend, line a. It looks ready to close Friday just above the monthly pivot at 10,886 with the 50% support level at 10,816.

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The monthly projected pivot support is at 10,717 with the longer-term uptrend, line b, at 10,650. This is approximately 2.3% below Friday's close.

The daily NYSE Advance/Decline has made higher highs, line c, before it dropped below its WMA. It is already close to support from the late July high.

The McClellan Oscillator looks ready to close around -165, which is at moderately oversold levels. It dropped to -278 at the august lows.

The flattening 20-day EMA is now at 10,962 with further resistance in the 11,000 area.

NEXT PAGE: Stocks

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S&P 500
The Spyder Trust (SPY) looks ready to close the week on its lows. The week of September 5, SPY formed a doji so a final print on the SPY below $199.42 will trigger a low close doji sell signal.

The monthly pivot and the daily starc- band are in the $197.56 area. There is further support in the $195.50-$196 area. The weekly starc- band is at $191.17 with longer-term uptrend, line b, just a bit lower. The support from the early 2014 high is at $188.

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The weekly on-balance volume (OBV) did make new highs two weeks ago but has not turned lower. It is still well above its rising WMA and support at line c. The daily OBV has been below its WMA for most of September.

The S&P 500 A/D (not shown) looks ready to close the week below its flattening WMA.

Dow Industrials
The SPDR Dow Industrials (DIA), after a new high in early September, has closed below its 20-day EMA at $169.37. The 20-week EMA is at $167.57, which is just above the 50% Fibonacci support level at $167.12. The quarterly pivot is at $164.98.

The Dow Industrials A/D line (not shown) did confirm the recent highs but may close just below its WMA on Friday.

The weekly relative performance has been below its WMA since it broke down in the summer of 2013 (see arrow). This was an indication that it was starting to lag the S&P 500.

The weekly OBV did make a new high this week with support at its WMA and then the recent lows, line h. The daily OBV did not make a new high with prices.

Nasdaq 100
The PowerShares QQQ Trust (QQQ) continues to hold up the best with the 20-day EMA now at $99. The daily starc- band is at $98.31.

The monthly pivot is at $97.86 with the monthly projected pivot support at the $95.81 area.

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The September high for QQQ is at $100.46 with the daily starc+ band at $101.24 and the weekly is just slightly higher.

The technical studies still look the best on the QQQ. The weekly relative performance closed at a new high last week as it broke through resistance, line c, in late July.

The Nasdaq 100 A/D line, after making a new high, has traded in a narrow range but looks likely to close above its WMA. A drop below the late August lows would be more negative.

Russell 2000
The iShares Russell 2000 Index (IWM) is trying to close barely above its 20-week EMA and the quarterly pivot at $114.61. A close below the $113 level would be more negative. There is still major support, line d, in the $107 area.

The weekly RS line is now testing its steep downtrend, line e, but is still below its WMA.

The weekly OBV has turned down and is very close to dropping below its WMA. The daily OBV is holding above its still rising WMA.

There is initial resistance now at $117-$118 with more important in the $119-$120 area.

NEXT PAGE: Sector Focus, Commodities, and Tom's Outlook

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Sector Focus
The iShares Dow Jones Transportation (IYT) made another new high Monday at $154.37 but then closed the week lower. The 20-day EMA and first support is at $151.74 with the monthly pivot at $148.44.

The daily relative performance made another new high last week and the OBV is holding up. The weekly studies did confirm the recent highs.

The Spyder Trust (SPY) and the PowerShares QQQ Trust (QQQ) both gave up some of their gains, though the 13.5% for the QQQ is still quite impressive.

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The SPDR Dow Industrials (DIA) is now only up 2.7% while the iShares Russell 2000 Index (IWM) is flat for the year.

After the iShares Dow Jones Transportation (IYT) gain of 16.5%, the Select Sector Health Care (XLV) is next as it is still up over 15%.

The Select Sector Utilities (XLU) lost 1.75% on Friday and is now up just 11.5%.

The Select Sector Financials (XLF) held up pretty well last week while the Select SPDR Energy (XLE) was hit harder.

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Interest Rates
The yield on the 10-Year Treasury Note rose sharply last week as it closed over 2.6%. I wondered last Thursday in Is the Junk Dump a Warning if that was a warning of an FOMC change this week.

The daily chart shows that the close was at the daily starc+ band as the yield rose 6% on the week. The MACD has formed a series of bullish divergences (line b) that were confirmed by the break through the downtrend, line a. The weekly analysis has not yet turned positive.

Crude Oil
The November crude oil contract dropped below the $90 level during the week but closed just above $92. The weekly OBV has moved further into the sell mode.

Precious Metals
The Market Vectors Gold Miners ETF (GDX) and SPDR Gold Trust (GLD) have dropped sharply. As I discussed several weeks ago, the continuation patterns have not been complete, which was consistent with the OBV analysis.

The Week Ahead
After Friday's decline, we should see some follow-through early this week but some of the short-term A/D indicators are quickly approaching oversold levels. Therefore, I still expect that this will create a buying opportunity in the next week or so.

The new weekly and daily highs in the NYSE A/D lines continue to favor the bullish case as it has in the past. If we are going to see a more severe correction then it should take more time for the top to develop.

I adjusted the stops in the Charts in Play portfolio last week and gave a level where I would be adding to the long position in the PowerShares QQQ Trust (QQQ).

For those on the sidelines, the Vanguard Total World Stock Index (VT) is getting closer now to the initial level where those out of the market could start a dollar cost averaging strategy.

Don't forget to read Tom's latest Trading Lesson, Avoiding High Risk Entries.

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