The rally in stock markets has now produced a small series of top extensions in two US indices and the German DAX:
These extensions are at a daily-scale and come approximately at price levels where we expect resistance from older weekly-scale compressions, as we have recently pointed out. These compressions were widespread, after a prolonged period of sideways range-trading and led to drops of varying size depending on the index type, into the late August lows. Now, as a result of the varying strengths of the subsequent rallies in different indices, some have re-approached the level of the compressions, some have not. Examples from the US and Europe:
When this ‘approach back under an old compression’ occurs, we start to issue sell advice (as we did on Friday) and the best candidate indices to choose are usually those that have previously rallied least. If you have not yet sold any US instruments (we didn’t wait and chose the S&P) then the better candidates may be ETFs in: Homebuilding (XHB) Biotech (IBB) Retail (XRT) or Healthcare (XLV) all of which have rallied feebly since the late August lows.
Choices to sell short in Europe are: Spain, Italy and France, as usual when selecting short-sales in the Eurozone as these economies are still uncompetitive with Germany. This is less true for Spain than before but it remains on the ‘sale’ list. Conversely, when it is time to buy Europe we usually choose Germany or a German surrogate.
Timing these sales now is a result of three factors coming together – these new top extensions, resistance from these old compressions and lastly the turn that we expected on Friday (or perhaps today) as warned in the last turn schedule. One word of warning though – markets don’t usually rally into a turn day, make top extensions and then immediately fall. It can happen, especially when a return to an old compression is involved, but a more likely outcome is a period in which some kind of ‘top’ forms before weakness begins.
We watch closely,
More soon.
