Monday, June 10, 2013

Head & Sholders suggest Credit Tightening!!

Emerging markets ETF declined another 1%+ today. This decline came on the heels of warning put out by Understand, Survive and Thrive few days ago about possible breakdown in the emerging markets. Persistent decline in the emerging markets has validated the Head and Shoulders pattern, which will in turn validate the argument that emerging markets are now in a pronounced downtrend.

Downtrend in the emerging markets is a dangerous omen for the global economy. Emerging markets are most sensitive to credit markets, and react first when there are possible problems on the horizon. At this point in time, it seems like these markets are foreseeing a tightening of global credit along with reduction in money printing spree of global central banks.

Tightening of money printing might result in lower demand for the bond market because Bonds were the primary purchase targets of U.S. and World central banks. This suggests that if Federal Reserve’s ginormous bond buying invisible hand vanishes from the scene, there will be very little demand left for the U.S. Bonds. Consequently, bond prices will start declining and yields will start creeping up.

Well, this has already started to take place. Looking at the following bond chart suggests that bonds are now in a free fall territory, at least in the near term. Like Emerging Markets Bond prices have also carved out a long-term Head & Shoulders pattern. This pattern seems complete and the market is now breaking down.

Long term Head and Shoulder pattern along with lack of appreciation of this pattern in the media is a very good indicator that a Head and Shoulders pattern has been completed. This pattern could result in sharp losses in the Bond Market.
As far as U.S. stock market is concerned, there can be far reaching consequences.
  1. U.S. Market is in a long-term Bull Run è Rising Yield = Improving Economy and Strong Market
  2. U.S. Market is about to Follow Bonds & Emerging Markets è Rising Yield = Poor Economy like Greece
Only time will tell the real story, but we will analyze these two scenarios further in the upcoming posts.

Please note that the IPM Model's Weekly Turn Date predicted this decline in the Emergig Markets.

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