Markets are creatures of habit. Traders rely on historical behaviors to forecast the future and educate trades. Dollar down, commodities up. Lower crude, lower economically sensitive base metals used in manufacturing. 99% of the time these relationships hold true; not with every tick, but predictably enough to embolden traders to bet on the relationships. What makes it tougher is the 1% of the time when these relationships fail. Internet stocks decouple from reality eventually resulting in a crash. The Thai Bhat, of all things, ruins Long Term Capital's algorithms, leading to a near collapse of the financial system in the late 1990's. When traditional relationships fail, markets and traders start heading for the sidelines. Bad and weird things start happening. That's a bad thing for market bulls.
According to Peter Lee, Chief Technical Analyst at UBS, the traditional relationships are showing signs of breaking down and the natives are getting restless. "Decoupling is taking place in the market," Lee says. The market "is in a state of flux; there's too much noise."
Take the commodity space. Lee believes the U.S. Dollar is heading lower as measured by the DXY, an index measuring the greenback against global currencies. In a flat or better economy, a weak dollar should lead to higher commodity prices. It takes more dollars to purchase each barrel of crude. In a weak economy the dollar and commodities should move lower together as the U.S. printing press kicks into gear but demand for oil and production metals is weak. Bonds and stocks should broadly move together. These are gross generalizations but the relationships broadly hold true.
Which brings us to where we are now. Crude is breaking lower while base metals like "Dr. Copper" is strong. Bond yields have been dropping since February while stocks have only been dropping since, well, about this time last week. Brent Crude has stopped moving in lock-step with WTI, its American cousin. The Euro and Dollar, the most liquid "grown-up" currencies in the world, both seem to want to move lower, messing up not just trader minds but also the "Dollar up/ Stocks down" trade so often discussed on Breakout.
I'm painting with broad strokes here but I'm sure you get my point. Lee says we're seeing "abnormal correlations" right here, right now. Bigger picture he thinks the bond market wins the debate on the economy, meaning stocks are going lower. He says the dollar is going to the lows it saw in 2008 during the Lehman crisis.
Lee's bottom lines for our purposes are these:
* Oil is going lower.
* The dollar is going lower.
* The economy is a getting worse.
* Correlations will eventually re-correlate and, for the most part, it's going to be the negative "tells" that win.
The picture is both scary and bad. It's an environment in ample supply from sellers meets no demand from buyers. Boiled down to its essence Lee is suggesting caution if not fear. Things are getting weird. Weird markets being bad for bulls may be the one correlation traders rely on in the most uncertain of times.
- Brent Crude
- base metals