Technical Analysis – This Week's Trading Opportunities – Indices

Dutch AEX Ascending Triangle Pattern 1-Hour Chart

Euro Area indices have been on a tear higher as the introduction of quantitative easing and weakening of the Euro have made regional stock benchmarks more attractive. Boasting one of the region’s highest credit ratings, the economy of the Netherlands continues to be one of the last bastions of growth and safety in the monetary union. The recent kickoff of European Central Bank President Mario Draghi’s asset purchase program has broadly lifted stocks across the monetary union. 

The intention of monetary easing is to push down longer-term borrowing rates and stimulate bank lending by freeing up cash through asset purchases.  However, Draghi’s program faces two major hurdles. The first hurdle is the shortage of quality collateral across the Eurozone, making it difficult for him to accomplish his bond buying target. Second, instead of lending the cash freed up from quantitative easing, banks are purchasing stocks. The incentive for banks to lend at record low interest rates amid soaring nonperforming loans on balance sheets is not attractive, hence the move towards riskier assets.

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Quantitative easing has seen the German DAX rise to record highs with other major benchmark stock indices following the momentum higher. The Dutch AEX is presently trading at the highest valuation since 2008 as that nation’s modest growth and stable outlook make it an attractive place for investors to park cash amid all the uncertainty. The ascending triangle formation setting up in the index has a bullish bias, with further upside expected as quantitative easing kicks into a higher gear. Resistance at 500.10 and a multi-week uptrend form the triangle as the index presently consolidates between the two levels. Any breakout above resistance will see increased momentum and volatility. Reward should be set to approximately 60-75% of the distance between the beginning of the uptrend line and the resistance line.  Any move below the uptrend should be treated as a reversal and breakdown in the ascending triangle pattern.

Australia ASX 200 Double Top Formation

The Australian economy continues to suffer from weak commodity pricing as global demand for raw commodities shrinks. China, which serves as one of Australia’s main trading partners, has slowed imports for input commodities amidst a glut on the mainland China which is keeping the Australian economy under pressure. The mining sector specifically has seen layoffs mount as capacity excesses plague the industry on a backdrop of weak global demand. The Reserve Bank of Australia under the stewardship of Central Banker Glenn Stevens has been highly accommodative in the last years, cutting interest rates several times to stimulate the economy. His efforts have seen the Australian dollar retrace some of the tremendous strength witnessed after the last financial crisis, making the local currency more competitive for exports.

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The dovish policy measures have been notably effective at helping the Australian dollar depreciate against peers while also making Australian equities cheaper on a relative basis, adding to their attractiveness. However, with complacency high in global stocks and valuations “stretched” according to many statements from global central bankers, the propensity for a swift correction downwards is high. The double top technical formation in the Australian ASX is indicative of downside for the index as a confluence of factors contribute to the bearish bias. The US dollar is rapidly turning from recent momentum despite the prospect of higher interest rates as the US seeks to make the currency more competitive. The Australian dollar rebounding from multi-year lows will add pressure on stocks, denting equity valuations. The key level to watch is resistance at 5997 with downside support sitting at 5863 and 5744. A break above resistance should be viewed as an upside reversal.

Shanghai Composite Equidistant Channel 15-Minute Chart

Chinese stocks have seen momentum higher renewed after the recording one of the best performance in all of 2014. The recent move by the Chinese Government to pare back growth targets for 2015 to 7.00% from 7.50% in 2014 might be one factor that reduces momentum in stocks, however, monetary policy conditions remain supportive of further upside. A combination of lower interest rates, ample cash on the sidelines from trust products, and a cheaper Yuan have all been a part of the most recent rally to the upside. There are numerous risks to the outlook including diminished inflation, slowing trade, and headwinds as the Government seeks to root out corruption. These factors coupled with weak external growth in Asia, Europe, and North America will also drag on the economy, forcing more stimulus from the People’s Bank of China. These will initially come as interest rate cuts and reserve ratio requirements being lowered for banks. 

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In the short-to-medium term, there is strong likelihood that the People’s Bank of China will ease monetary policy further to combat the external factors hurting the economy. This will likely push the Yuan further to the downside, making the Shanghai Composite relatively cheaper and adding to its appeal. The most recent break to new highs on the upside is reflective of the loosening in monetary policy with the Shanghai Composite trending in an equidistant channel for the past two weeks. The idea strategy in this case is to continue following the trend with positions taken at the bottom of the channel and closed out at the top of the channel. Fighting the channel with short positions worsens risk-reward characteristics and should be avoided.  A move outside the channel lines should be treated as a breakout to be accompanied by further price momentum and volatility.