Charts-Markets are Overbought!

This week’s must read from UBS Technical Research Team. Of all the technical research we go through, these guys have been one of the most accurate….



US Trading: On the back of a strong rotation from overbought defensives into cyclicals and financials, the December rally has been extending in price and time. Nonetheless, on a short-term basis financials and cyclicals are increasingly overbought and we have seen significant reversals in defensives, which caps the upside where 1292 to 1304 remains a strong resistance area for the SPX. In our indicator work we are getting initial divergences and on the sentiment side we have seen a huge shift towards a more bullish sentiment in the last two weeks, which all in all still suggests the risk of a near-term setback.

The current bounce leg lasts longer than expected but our tactical view is unchanged. From a cyclical perspective we continue to see the risk of a 2- to 3-week lasting setback before moving higher into March. In one point we certainly have to adjust our view. Following the healthy rotation a potential setback is likely to get milder than the previously expected 10% move. Another consequence is that a setback could lead into deeper February before starting another bounce attempt. We still wouldn’t chase the market as on a 2- to 3-week basis the risk/return profile is negative. Given the whole set up we can’t rule out a test of 1304 early this week. A daily break below 1285 would be initially negative and indicate that a significant trading top is in place. Initial support is at 1250 and a break would call for 1200.

US Strategy: From the October 4th low we expected the SPX to start a corrective (a-b-c) countertrend rally that should unfold in a volatile sideways trading range into deeper Q1 before resuming the underlying bear market into the second half 2012. Given the US market’s continued outperformance it is likely that the whole pattern take a more complex form and that into March we could see a final overshooting as a sentiment climax. Our big picture view is unchanged. Following our cyclical models we continue to expect a second bar market leg starting from a March top down into late Q2/early Q3 and given the toppish picture of defensive mega caps we continue to see a negative surprise in large cap indices into summer.

European Trading: The DAX is still bullish biased on the back of the rally in chemicals and autos but the rest of European has been trading sideways for more than a week, so despite the huge rotation from defensives into cyclicals we actually have an unchanged situation on the index basis. Cyclical sectors are increasingly overbought and heading into stronger resistance and financials remain flat. A final spike early this week we can not rule out but we wouldn’t chase the markets or cyclical sectors since we continue to favour a pull back of 2 to 3 weeks before starting a final rally attempt into March. In this context we also wouldn’t follow a potential break of 2400 in the Euro Stoxx, as we think the risk is high to see a bull trap. On the downside 2279 represents a key support.

Inter Market Analysis: We have several times highlighted the strong outperformance of large caps versus small and mid caps. This effect we can see in the US, where a DJI strongly outperforms a Russell-2000 or a NYSE Composite and this is something we can also see in the relative picture of the US versus the rest of the world. The picture in Asia is beginning to improve from a relative picture, where the Shanghai Composite and the NIFTY are bouncing. However, the overall price structure of the October rebound pattern in global equities has not changed and the shape of the rebound in the MSCI World (EX US), the MSCI Emerging market or Europe we still see as corrective. So despite the fact that on a short-term basis the December bounce is extending in price and time, we always said that the whole October rebound should finally move into a March top before we see equities starting a second bear market leg. This call is unchanged!!