The coming week may prove to be relatively quiet with the long Easter break dawning upon us.
As the earnings season moves into top gear however, we should get a good idea of developments in the US financial sector: indeed, after JPMorgan and Bank of America reported in the past week (Bank of America this afternoon), we will see a raft of financials reporting their Q1 earnings, including no less than Citigroup, Goldman, Wells Fargo, American Express and Morgan Stanley.
In Europe, we will keep watching developments in the PIIGS sovereign debt as Spain’s cost of debt goes north again and the Finns go to the polls on Sunday! One of the big questions concerning this issue is: what will the impact of an even partial debt rescheduling in Greece, Ireland and Portugal have on the rest of Europe's banks, especially in the U.K., Germany and France?
Another area of concern is the current relative underperformance of the Consumer Discretionary sector compared to the Consumer Staples sector in the U.S. The ratio of the two sectors ETFs is shown below from May 2010 to today.
This relative measure characterises to some extent the strength of the economy: indeed, one can intuitively understand that when growth is expected to be strong, consumer discretionary stocks are in higher demand than consumer staples stocks.
Here, one can see that the discretionary sector has strongly outperformed the Staples sector since summer 2010, thereby confounding the prophets of the U.S. double dip recession at the time. But since peaking in February, the market has taken a much more defensive approach and the outperformance of the Staples sector has in fact accelerated sharply since the beginning of April!
What’s even more interesting is that the “Growth” index and the S&P 500 seem to be highly correlated: over the past year, the S&P 500 index and the growth index have indeed had a correlation of 71%, showing that the relationship between the two series is relatively strong.
Chart 2: correlation between the “growth” index and the S&P 500 – source Bloomberg
We will therefore closely watch the trend of this “growth” index during the coming weeks.
With light traded volumes expected in the market due to the Easter break, combined with the concerns highlighted above, we go into next week with a rather cautious approach, making sure that we play the current market with the right position sizes and stop levels.
From a technical point of view, we expect a test of the round numbers on both sides of the Atlantic but we still prefer playing the market from the long side for now.
In Europe, we have seen the Euro Stoxx 50 index consolidate towards the bottom of our expected range 2,900 – 3,000. We will be interested in the index on any test of the 2,900 support down to 2,880 with a stop below 2,850. We will target the 2,950 area.
Chart 3: Euro Stoxx 50 - Daily chart - source Bloomberg
We still see the market meltdown created by the Japanese nuclear crisis as a strong support area to be broken only in case of a serious accident. We are not there yet.
Furthermore, the European benchmark still looks attractive on a fundamental basis as it trades on a 14.1 Graham & Dodd price earnings ratio (10-year CAPE) at current levels.
In the US, we are still looking at the 1,300 support as a major support level. With many stops no doubt positioned just under the round number, we would not be surprised to see the level broken but would look at initiating new longs in the 1,300 – 1,290 zone with stops at 1,274. We will target the 1,320 area.
Here, we are still favouring the reverse head & shoulders formation that we highlighted last week. Interestingly, the 1,300 – 1,290 area would form the second shoulder of the formation. It does also form the support zone for the longer term trend we highlighted last week.
We also look with interest at the build up of protection purchases by investors against a fall in the S&P 500, as crystallised in the Put/Call ratio for the stock index.
Graph 4: Put/Call ratio for the S&P 500 – source Bloomberg
This is generally a contrarian indicator: as a record protective position gets built, the market gets ready for a move higher. Hence we take some comfort from this development for our bullish stance.
Have a safe trading week!
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