MSCI world index is topping out

June 12, 2015

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On May 7th I tweeted on MSCI World Index saying that the bull market for stocks is over. I pointed out that MSCI World etf charts (weekly and monthly) indicate that the markets have entered to a volatile topping phase. This phase typically takes place after a long move higher and leads to a severe correction or a period of bear market. Monthly chart showed an increase in volatility and a bearish shooting star candle with the next candle moving well below the shooting star low. The weekly chart showed how this MSCI World index tracking etf had moved outside the up trending regression channel, a clear sign of increased volatility and weakness. Since my tweet price action has been exactly what you’d expect of a market that is topping out.

In this report I will take a closer look at some of the main stock market indices around the world and provide an updated view on the MSCI World index.

Over the last few years the financial media has been full of people trying to figure out when the global stock market rally might be ending. Most experts and commentators focus only on fundamentals and macroeconomics as they try to figure out the most likely future course of the markets while others take the view that central bank money printing (sometimes called funny money) makes fundamental analysis obsolete. There are high level examples of very skilled people misunderstanding and misinterpreting the impact of macroeconomic developments. Probably the most famous example is the Fed president Ben Bernanke failing to see subprime crisis impacting the economy. This was of course followed by a huge downward market in stocks that lasted until March 2009.

On May 28th Bloomberg TV highlighted a big sell off that took place in Shanghai listed shares. Shanghai Composite index fell by 6.5% on one single day. Another Chinese index, Hang Seng Composite Index finished the day down by almost 3.4%. Such moves often come as a surprise for those that don’t know how to read price action and focus solely on fundamentals. Fortunately technicals and market dynamics are quite revealing when it comes to spotting the early indications of developments that often lead to increased volatility. Let’s take a look at some of the world’s most followed stock market indices.

Strong rally in Chinese stock market started in March as traders and investors alike started focussing on central bank stimulus. Market participants started buying stocks not because the underlying economy was performing and economic growth accelerating but because there was hope of increased liquidity in the economy. In other words the underlying economy and the real value of Chinese companies did not go up but the expected future value money went down as it was likely to be diluted by the extra liquidity by the central bank. This is not a great basis for investments fundamentally but certainly can lift the markets higher (or push the value of money down) for a period of time.

Hang Seng Composite reached the topping formation from year 2007 and has been since facing severe challenges in trying to move higher. Week starting on April 27th created a doji candle (a sign that upside momentum was lacking) and has since failed to move to new highs. Index dived twice from the top of the range before dropping below the support area (3810 -3840). Roughly at the time of my tweet on MSCI World index etf it was also reported that institutions have significantly increased their stock liquidations in Chinese stocks. Increased volatility was supporting the report and now that Hang Seng index has topped we have the ultimate proof that validates the rumour. Price made a return move to resistance at 3812.50 while the nearest significant support level is at 3461.  A new lower high would mean further confirmation to this bearish technical picture.

Indian stock market had a solid run higher for the whole of the 2014. The rally started in August 2013 and made the 2015 high in March. Since March high of 9119 CNX Nifty drifted lower until it attracted buyers at 7997 support level in early May. Also, the 50 week SMA and lower Bollinger Bands coincide with this area adding to its significance. This area has been a support since but even though a couple of weekly pin bars were created the rally from this level was weak and index has returned to this level again. This is not encouraging and suggests that buyers are not in overwhelming majority at this support. Therefore, violation of this support on a weekly closing basis is now more likely. Daily chart shows how Nifty has been trending lower and making lower highs and lower lows. If the current support doesn’t hold it is likely that the recent volatility is indeed a new market top and a more severe correction is ahead in Indian stock market. The next significant weekly support level is at 6415.

Japanese stock market has been moving higher ever since 2012 driven up by the QE programs driving the value of JPY down. This has taken Nikkei close to a year 2000 highs at 20833. The proximity of this resistance has made this market a little hesitant but at the same time hope of additional stimulus has caused the bulls to bid after the dips. Normally I would say that because Japanese stock market is trading near the upper end of the regression channel and close to a major resistance, upside is getting limited. However, in the world of seemingly endless supply of central bank funny money only seeing equates to believing and we don’t yet have signs of weakness in the daily timeframe chart. Therefore this market could well push through the year 2000 high. The nearest significant weekly support level is between 18030 and 18300.

German DAX has been trending higher ever since the low of 2009 but in October 2014 this market started a strong rally that extended outside the trend channel this year in February. This accelerated rally failed in April and the German index moved outside the rising regression channel. DAX made a daily closing high of 12374 on April 10thand has since had a good sized correction all the way to the 38.2% Fibonacci retracement level. The 12374 high and the correction that followed coincide with EURUSD creating a higher weekly low. This indicates that traders had been buying German shares based on the idea that EURUSD moving lower will increase competitive advantage of European companies. Now that EURUSD has rallied and created a higher low the pair is less likely to move below the March support. This has made the investors and traders more careful and they have been taking money off German shares.

Some months ago EURUSD was the easiest game around with the result that investors poured money in German shares. However, now that EURUSD has stabilised due to more careful views on when the US Fed might raise interest rates and the IMF has suggested Japan should introduce more QE to achieve the 2% inflation target the USDJPY has become more interesting playground than EURUSD. At first this meant sideways movement and consolidation in DAX index which then created a lower high in the region of 50 day moving average and has been moving below this average for over a month now. This hasn’t happened since October last year.

Four days ago DAX found support from 38.2% Fibonacci level that coincided with the lower Bollinger Bands.  DAX rallied from this support and is now trading just below the 23.6% Fibonacci level that has provided support on a closing basis (weekly chart) in April and May. Major weekly support and resistance levels are at 10050 and 11920. Yesterday market reacted lower from the same level. This suggests further weakness to come in DAX.

While German DAX is more exposed to currency fluctuations and represents the strongest economy in Eurozone the EuroStoxx 50 index represents a wider take on European countries. France has a 34.6% weight, while Germany’s weight is 30.82% and Spain’s 12.58%. Italy, Netherlands, Belgium and Finland all have a lower than 8 percent weighting in the index. This index has not had the extraordinary performance that German DAX has over the last 12 months but has still corrected lower with it. EuroStoxx found support from levels near 38.2% Fibonacci level from which it has rallied strongly higher over the last three days. Nearest significant weekly support is at 3325.50 (coincides with a 50% Fibonacci level) while the pivot from May 27th at 3691.40 is the nearest major weekly resistance. This market is closer to support levels than DAX and therefore not so vulnerable to major corrections. After two days of rallying higher index met resistance at previous but now penetrated support level and has reacted slightly lower today. I expect further weakness in this index as well.

While DAX and Nikkei have been rallying strongly due to central bank money printing the S&P 500 index has been one of the most boring stock markets for both investors and traders alike. Market has been range bound for the best part of the year. Against the backdrop of what’s happening in German and Japanese markets this suggests that those moving the markets have forgotten this sandbox and are trading where the real action is.

Technology stocks have the highest weighting in S&P 500 index and the fact that Nasdaq is trading at year 2000 peak is slowing the index down. Banking stocks has been another sector causing sluggish performance lately.  Finance sector etf (XLF) has been moving sideways since February and is only now challenging the highs from December last year.

When global stock markets start to sell off it is usually the US market that will be the last to resist moves lower. Fund managers see less liquid and therefore more volatile markets (such as Hong Kong) more risky and therefore off load them before they start selling more defensive US positions. In the US the last 100 days’ positioning has been favouring cyclicals, technology, health care and financials while two safe play sectors, utilities and consumer staples, have not been in the favour. This hints that the US positioning this year has been slightly on the bullish side when the sector performance comparison is made against the S&P 500 index.

However, according to Bloomberg Goldman Sachs research note in May the US stock market is quite overvalued at the moment. According to GS dividends and buybacks will be responsible for supporting a market where the median stock in the Standard & Poor’s 500 Index is trading at 18.2 times earnings, putting it in the 99th percentile of historical valuation. This means that the future long term upside is likely to be limited and investors are therefore cautious. However, with extremely low interest rates it is the equities market that is still more attractive option when compared to fixed income investments. Therefore, it seems that with QE from the Fed now out of the equation the US stock market can rise modestly if the Fed decides to keep the interest rates low. This should be a worry to long term investors in stocks.

Until October last year this etf tracking the most widely followed stock market index globally (MSCI World Index) was trending higher in a steady upward movement. However, since then it has rocketed higher which is never a sign of a lasting and steady up market. If a market moves too far too fast it is bound to have a sizeable correction (or even enter a bear market) at some stage. This correction usually takes place after a sideways movement and could lead to a bear market, which is what happened in 2000 and 2007. This time however, virtually all the central banks around the world are involved in funny money printing. It seems that people don’t care if the value of their money is diluted by the central banks that have an unlimited licence to just keep on printing. After six years of QE it has almost become a norm. Unless things get really ugly for reasons we don’t see at the moment, this might lead to buyers stepping in earlier than in these two earlier occasions (2000 and 2007).

The monthly shooting star candle in April pointed to lower prices and since then upside momentum has been missing from most of the global stock markets. Weekly chart reveals that the index ETF has made a lower high and has since then moved back to the support at 32.73, which once more bounced IQQW higher. This is very bearish and the peak of the lower high is a clear sell area should the market still manage to rally up there. After a weekly lower high it is probable that this market is now on sell the rallies mode but this sideways or a topping movement can last for several months before it is resolved. There are some minor weekly support levels at higher levels but the nearest major level where at least two technical factors roughly coincide is the area from 25.70 (2007 high) to 26.67 (38.2% Fibonacci level). This is some 20% below the current prices and could well be the extent of the downmarket.

Conclusion

It has been claimed by analysts that fundamentally global economies are still in an inflationary stage. But this view was shared by many analysts in 2007 as well. As we know global equity markets discount the future and the new macro trends are notoriously difficult to spot. The challenge lies in recognising those trends from macro data and news flow. In retrospect many things in economies are evident but often at the time of market tops the majority of analysts and commentators are still focussing on the current economic trends, not on the factors potentially changing the trend. And to be fair spotting those changes ahead of time is extremely challenging. Therefore after seeing two major market tops in my career (2000 and 2007) I am convinced that the collective opinion of market participants’ as it is displayed in different markets is be the best indicator of things to come. Therefore, a lack of momentum after a multiyear run higher is a sign that we need to pay attention to. The message from the MSCI World index is that we have a strongly increased chance of global stock markets topping and then rolling over.

There will always be markets that react differently and depending on central bank activity there might even be markets that don’t correct that much. However, this far (since my tweet on MSCI world index etf) market action in this etf has been exactly what I suggested it would be. MSCI World Index tracking etf has been moving sideways in a way that is typical for a market that is topping. This development is a good reason to steer clear from long term stock investments and concentrate these funds on forex trading where we can choose when to have market exposure and when to stay in the sidelines. This is highlighted by the fact that the US stock market valuation (still the most important stock market globally) is firmly on the high side.

The cautiousness I have on stock markets is legitimate in the light of price action but I would like to remind the readers that we do live in a world where easy QE money has become almost a norm. The negative stock market development could therefore be reversed for instance by a concentrated central bank effort. A strong liquidity increase would kick the famous can further down the road and if the liquidity boost was strong enough it would send the stock markets into new highs. According to some analysts co-ordination among central bankers is at the time of writing still as strong as at the time of financial crisis even though no such crisis exists. This either tells about them seeing the world economies much more fragile than we are lead to believe, or simply that this club of bankers is enjoying the global power they have managed to gain.

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