Trading Europe: Buy The Rumor, Sell The News (SPY, EPV, SDS, SKF, TVIX)

David Gillie: A level of euphoria has set into US markets on European Debt Crisis “fix” rumors like we’ve never seen before. The media is more than happy to pump rumors as “news” because they’re in the business of selling ad space. A euphoric audience buys more stuff. It has gotten to the point of ridiculous of recycling old rumors that are weeks old. Some financial bloggers are even having countdowns to the daily rumor.

Mrs. Merkel has ‘saved the planet’ 19 times with the headline of “We have a plan” without any story underneath it. So I decided to dig a little deeper to find out what is “The Plan”. Here’s what I found:

Somehow $440 Billion magically becomes $2 Trillion. How? By repeating the same mistake that got the US banks in trouble by leveraging their assets to the hilt. In addition to that, Merkel and Sarkozy are in complete disagreement of how this plan functions. Sarkozy wants to turn the rescue assets into a bank; Merkel wants to turn the rescue assets into insurance. Furthermore, Merkel doesn’t have the backing of her own government and they have rejected her plan twice. So far, the only thing they got going is Hope and Delay.

Meanwhile,  Bernanke has discovered that buying Euros with US Dollars has double the Dollar destruction factor as buying Treasuries and Congress is clueless of his actions and he has no accountability. This pumps up the Euro stabilizing Europe while effectively creating 30% inflation at the grocery store (but we don’t count that in the inflation data). Essentially, US food shoppers are bailing out Greece, Italy and Spain (unknowingly).

Lets take a look at SPDR S&P 500 Chart (NYSE:SPY) (S&P500) Daily chart to see what all this means… (Analysis below)

From the top of the chart…

DI +/- Although we did see a crossover in the Directional Index, it was weak and declined without a definative breakout.

MACD The Moving Average Convergence/Divergence broke above the midpoint and would appear bullish. However, it is currently at it’s highest level in several months with a declining histogram – indicating weakness

RSI The Relative Strength is now hitting the overbought level for the third time. Usually it takes some “tracking space” to develop momentum to break out. More likely, we’re seeing a triple top which is usually an indication of the price topping out.

Stoc Stochastics maxed out quickly in this recent rally and have been in an overbought condition all this week. Markets can remain in an overbought condition for sustained periods.

MFI In my opinion, Money Flow is the ultimate indicator of market sentiment. The MFI hits it’s crescendo around 80. Once it his that level and begins it’s decline, it virtually never reverses until it get near the 20 level. The MFI gave is a Sell Signal on Wednesday.

Price We have been range-bound from 1100-1230 since the big sell-off in August. Technically, Friday’s close just above that could be considered a breakout.  However, we need more confirmation than just price. In this case we have declining volume which is a lack of conviction (as well as the other indicators being overbought). Another thing to look at it the candlestick patterns. A gap up at the top of the range is often a last gasp effort to shove the price above resistance (a hopeful maneuver for follow through). We see two previous gap up maneuvers that failed. This pattern is called an “Evening Star”. If Monday is a down day (that starts with a gap down) we’ll have an Evening Star pattern which is very bearish. The last thing to look at it the 200 Day Moving Average (purple line) – we are still below that. It’s said that “smart money” doesn’t come in under the 200 DMA. I would need to see a strong break above the 200 DMA to give the “All Clear” to get back in the pool.

Summary So far in Earnings Season, reports have generally met (low) expectations. The exception being Apple which was the first miss since 2004 but was quickly explained away. This weekend is round the clock summits in Europe with the big powwow on Wednesday. The market (well, at least the HFT Algo programs) has been driven by keywords out of Europe. Rating agencies are threatening a downgrade of France. This would be the first non-PIIGS downgrade in Europe. As I’m writing this on Sunday morning, the Futures Markets are closed, so I don’t know what to expect for an open on Monday. A lack of euphoric rumors on Sunday night could be taken as a bad sign. Without a Merkel Miracle on Wednesday, the market will be very disappointed. Even so, the old market adage says “Buy the rumor; sell the news”.

If you have any long position, this euphoria might be an excellent time to take profits (at the very minimum). For the most gutsy, a significant sell-off on Monday would be a signal to short Europe (NYSE:EPV), S&P500 (NYSE:SDS) and the Financials (NYSE:SKF). Another option would be to go long on 20+ year Treasuries (NYSE:TMF) or long on the Volatility Index (NYSE:TVIX).

Drop me a note if you have any questions: [email protected]

Written By David Gillie For The ETF Digest

ETF Digest writes a subscription newsletter focused on technical analysis of exchange-traded funds. ETF Digest was founded in 2001 and was among the very first to see the need for a publication that provided individual investors with information and advice on ETF investing.  Even if you’re not a fan of chart analysis, ETF Digest provides insight and commentary into which global markets are “working” and why.

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