I have been poring over my charts for the last few days and have noticed some large divergences opening up in our markets. The ASX 200 is underperforming the US markets massively at the moment. I find this fact quite intriguing when you consider that the Australian Dollar has been rallying strongly on the back of strong commodity prices caused by the threat of QE2.
Something is not adding up.
Have a look above at this chart of the ASX 200 vs. the S+P 500. You can see quite clearly that a very high correlation from the past year has broken down sharply in the last month. The ASX 200 closed at 4661 on the 15th of September and is trading at 4640 today. By comparison the S+P 500 is nearly 5% higher than it was on the 15th of September. What gives?
If we look at the Aussie Dollar the situation is even stranger.
It is quite clear from this chart that the Australian Dollar has continued to rally over the past month. But the high correlation between the strength in the Aussie and the strength in the stock market has also broken down. If all of these offshore investors are piling into Australia en masse in an effort to gain commodity exposure before Bernanke starts printing, why is our stock market refusing to budge?
Also, if the stock market is refusing to budge in the face of large offshore investor demand, then which direction do you think the stock market will go once the offshore buying stops?
There are already stories that offshore fund managers are becoming less willing to take on the currency risk present by buying stocks now with the AUD near parity. There will also be other fund managers who have made a killing on the stock market and the currency appreciation who will be looking to lock in gains.
I believe the large divergence in our market is sending a bearish signal. The Australian Dollar is now a very crowded trade and a quick glance at a weekly chart shows the chance that we could be looking at a multi-year double top being formed. Even if the AUD does end up trading to higher levels on the back of US money printing we could still see a short and sharp clear out of positions that could take the Aussie back to the low 90’s.
Another bearish sign is that the overall market breadth is falling. Have a look at the chart above of four different indices on the ASX 200. It is obvious from this chart that we have a two tier market. The financials and Consumer discretionary are looking very weak and have actually been selling off over the past month. The Resources are continuing to power ahead on the back of the large offshore demand but it is also apparent that the steam has been coming out of the Resources in the past week or so.
The market internals are not looking that great to me and I would expect to see the slow consolidation of the past month break to the downside before long.
Editor, Slipstream Trader
for The Daily Reckoning Australia