A Fresh Crack in the Stock Market’s Complacency

A Fresh Crack from the Currency Market

At the time of writing, the Australian dollar versus the Japanese yen (AUD/JPY) is falling below its 50-day moving average (DMA) (the red line in the chart below) for the first time since last September. This move is the latest yellow, perhaps red, flag on the stock market rally. It represents a fresh crack in the stock market’s (previously) growing complacency. The likely warning is sufficient to turn my short-term trading call on the stock market from cautiously bullish to neutral.

AUD/JPY is cracking through its 50DMA support that held firm on two earlier tests.

The last time AUD/JPY cracked this important trendline as support, the S&P 500 (SPY) was already below its own 50DMA (September 21, 2020). Two days later, the S&P 500 made what turned out to be a sustained bottom. The index retested that low in October and never looked back. THIS time, the S&P 500 is just barely off its all-time high. So follow-through suggests the index should retest 50DMA support sooner than later. (As a reminder, check out “Why the Australian Dollar and Japanese Yen Matter for Stock Traders” to understand how to use AUD/JPY as a barometer of market and risk sentiment).

The S&P 500 (SPY) experienced two straight days of selling for the first time since late March.

AT40 (T2108)

My favorite technical indicator, AT40 (T2108), the percentage of stocks trading above their respective 40DMAs, plunged to 45.9% from 53.7%. The move is significant for two reasons. Firstly, AT40 confirmed my concerns about narrowing breadth in the stock market by failing at one of its downtrend lines (drawn in black below). Indeed, anyone with a diversified portfolio likely senses these dynamics as so many speculative and expensive stocks have suffered from the growth tantrum in March and other stocks have been weakening since February. Secondly, AT40 tested its lows from March. The first point is bearish. The second point is close to bullish. In other words, the window to go or stay bearish on the stock market could be narrow from this point forward.

AT40 (T2108) reconfirmed its downtrend for 2021.
AT40 (T2108) reconfirmed its downtrend for 2021.

The Trade

I found myself making increasingly bearish bets on Monday and Tuesday. As a result, my switch to neutral on the market makes sense from my trades. I also think it is fine to be outright bearish on the S&P 500 with a stop above the all-time high. My put options are positioned in anticipation of a test of 50DMA support by May expiration. I am not so interested in chasing beaten down stocks even further into the abyss. These stocks could be first to rebound sharply if T2108 drops close to or through the oversold threshold at 20%. Also note that the volatility index (VIX) touched and faded back from the 20 level that is the threshold for elevated risk. A close above 20 would be the final “permission slip” for getting bearish on the major indices.

Be careful out there!

Full disclosure: long SPY put options, long AUD/JPY (as a currency hedge)

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