Market Surges on QE3 Suggestion

Today Fed Chairman Ben Bernanke indicated that fiscal stimulus programs would be available in the future as needed, ala QE3. The SPY spiked sharply on this news as the US dollar dropped.

The Bernanke Effect

This should come as no surprise and is clearly the cause of yesterday's short-lived spike on the SPY at around 2pm ET. From my perspective, there is no way Ben Bernanke would ever say something the markets could interpret negatively. Fiscal stimulus comes in the form of soothing words just as often as it's monetary, and it's an area where the Fed has unlimited ammunition.

Prolonging the Fed's quantitative easing program means a weakened US dollar, and that will inflate the markets--just what we're seeing on the SPY intraday. It's unclear if this rally will hold, but a continually devalued US dollar will continue to push the markets up.

Despite all this seemingly bullish news, it's important to remember that Europe is still in trouble and those issues will not go away overnight. Any developments on this front (downgrades, defaults, etc...) will hit the Euro hard and therefore the markets.

In the event of a falling Euro and a rising US dollar, Ben Bernanke and his team at the Fed will have almost insurmountable task ahead of them in supporting this market. But until then, it's up up and away (for equities and commodities)!

Finding the Key to the Market

In any given market there is an over-arching concept or chart that can sway it one way or the other. For example, in a market driven by FX, the breakdown or breakout of a particular currency will have a direct, lockstep effect on stock and commodity prices.

Earlier this week I spoke about what I called the "FX-factor", or the affect of the Euro/US dollar coupling on the US stock market. The charts I posted showed clearly that the dollar would bounce and the Euro would fall, and that's exactly what happened. However, the market didn't react as it normally would. The USD and the SPY essentially rallied together.

There are an infinite number of reasons why this may have been the case. In my opinion, the combination of low volume and a market consumed with fundamentals like European debt and US jobs data let the major stock indices float as if in a vacuum.

The question now is what sort of catalyst will cause the markets to finally correct to a sustainable price in the short term. The S&P 500 is very close to a double top on the daily chart, but that's still another 30 points away. It's possible that we get there, but it's increasingly unlikely without first pulling back to consolidate.

SPX still far away from 1370 double top

While I was watching this chart today, I was reminded of early June when we were wondering where the market would bottom. If you followed me on Twitter then, you'll remember that we were looking for either a hit of the 200 daily MA or the pivot low just below it. Due to the precipitous fall we were experiencing at the time, I chose to wait for the pivot low as it had a higher risk/reward ratio of playing out in my favour.

SPX bounces sharply before hitting key pivot

Of course you'll also remember the SPX just barely hit the 200MA and never hit the bottom pivot before sharply reversing to the upside. The Nasdaq was a different story; it broke its 200MA and went all the way to the pivot below it. After hitting this level, the SPX, Dow, etc. all bounced sharply to the upside and the rest is history.

Nasdaq gets huge bounce from key pivot

With this in mind consider that we're in a similar situation right now. The SPX has just broken a major pivot level and seems to be on its way further up to the double top at 1370. The Nasdaq on the other hand is very close to its double top from early May and it will only take a slight push up for it to reach this level. Following the logic that the Nasdaq led the markets up, it stands to reason that it could lead the retrace back down. This could suggest that the SPX retraces before hitting 1370.

Nasdaq double top is extremely close

Right now, this is all just a theory based on an observation. We'll have to wait and see how the market reacts to this level either tomorrow or the next day before concluding that it's the key to the market. I may take an additional short should the Nasdaq hit the double top target, but if we close above it I'll most likely cover the entire position and wait on the sidelines for the next trading signal.

Check back here for updates on this topic and follow me on twitter for my latest thoughts on the market.

FXE and UUP: The FX-factor

Last week I posted about how the US dollar and the Euro are key to understanding the market. I explained that I was suspicious of the big S&P 500 rally on Friday because the major currencies did not follow. This week, as stocks continue to float up, my position remains the same.

The Euro typically trades inverse to the US dollar and in synchronicity with the stock market. If you look at the chart below, you'll see that the Euro (FXE) did not participate in Friday's rally nor has it moved up since. Also notice that it has not moved above the key blue trend-line. The pivot high at 144.86 and this trend-line remains strong resistance. These levels roughly correspond with inverted support levels on the US dollar charts.

Unless FXE can trade and close above these levels, I have to be suspicious as the stock market continues to float. I'll continue to stake out good short entries further up in charts and maintain stops on my current positions. If the FXE does breakout, I'll expect the market to trade back up to 2011 highs. If it doesn't, look out below.

USD and the Euro--Keys to the Market

It's no secret that currencies play a huge role in setting the direction of the market, or at least it shouldn't be to anyone who reads this blog. Currency fluctuations are a powerful force. They exert an inflationary pressure on stocks and give us a clue to the market's overall appetite for risk at any given time.

Considering this, have a look at the charts below. One is of the the Euro and the other is the US dollar. If you compare them to the market indices, you'll notice that something is amiss. The markets rallied on Friday with an unrelenting fury, while the world's two major currencies hardly budged. When I'm faced with an incongruity like this I rely on whichever side I believe has the most credibility. Currency markets remain active and liquid even when equity markets do not, so I trust what they tell me.

The Euro generally trades inverse to the USD so we would expect it to mirror the markets--this was certainly not the case on Friday. FXE (the Euro) ended the day positive by just 0.18%, far under-performing the S&P's rally. The blue down sloping trend-line will remain resistance, at least for the short term. The series of lower highs since early May is also a bearish sign. For me to have faith in a continued S&P rally, the FXE will need to get above the blue trend-line and these previous pivot highs.

The US dollar had a similar Friday to the Euro with UUP closing down just 0.09%. UUP will have support at the as-of-yet untouched up sloping blue trend-line. Any bounce in the UUP will put pressure on stocks and stock indices like the S&P. Bulls should be discouraged by the fact that the US dollar showed little signs of breaking down in spite of a huge rally in stocks.

Irregardless of how currencies perform we need to respect price action, so I won't just discount Friday's stock rally out of hand. What I will say though is that the prospect of a continued rally next week is tentative at best without the support of major currencies. I'll be watching both the US dollar and the Euro closely before trading resumes next week as they will be the key to the markets. Check back here and follow me on twitter for my latest thoughts.