Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Technical Analyst, Saxo Bank
Summary: After a few years with little interest, gold initiated a long uptrend in 2002. It lasted almost 10 years, topping out just below $2,000 per troy ounce.
After a few years with little interest in late 1990s and early 00s, gold initiated a long uptrend in 2002. It lasted almost 10 years, topping out just below $2,000 per troy ounce. The precious metal had then formed a bubble pattern that burst in 2011; this was followed by 5 years of bear market before buyers took control in 2016.
The rule of bubbles, and the implosion thereof, is that the instrument in question always comes down to at least the larger correction occurring during the uptrend, also called a pre-peak.
For gold this large correction—or pre-peak—occurred during the financial crisis in 2008-2009. Gold dropped to the peak of this correction/pre-peak level and the 0.50 Fibonacci retracement level (in other words, 50 percent of the bubble uptrend), just a few dollars above $1,000.
Slowly buyers came back to buy gold and made the precious metal form a rounded bottom, eventually taking it to new highs in 2020 when it peaked above the $2,000 mark. A short correction followed until the war in Ukraine resulted in renewed demand for gold with the shiny metal testing its all-time high. This got rejected but a new attempt seems likely.
Gold has formed what looks like a cup and handle pattern: B is the bottom of the cup and C is the handle.
The cup and handle pattern is confirmed if gold performs a daily close above peak A at $2,078. If this scenario plays out, we can then calculate possible targets. As a minimum gold should reach 1.618 projection of the handle height—in other words, a price target of around $2,328. Based on the full cup the price could potentially reach 1,618 projection of the distance between A and C—around $2,578. If demand deteriorates and gold breaks below $1,673 (the bottom of the handle), this cup and handle scenario is busted and a downtrend will unfold towards $1,500-1,350.
However, with the Relative Strength Index (RSI) showing no divergence and back above the 60 threshold, the bullish picture is supported.
Oil is in a bit of limbo these days after some panic moves higher followed by massive selling pressure.
Brent Crude oil broke above strong resistance at $126/brl shooting even higher to 1.382 Fibonacci extension of the third wave (that means when third wave is the length of 1, the fifth is the length of wave 3 x 1.382) in what looks like an exhaustive fifth wave.However, when wave 5 is extended as it seems to be, it often extends to 1.618 times the length of the third wave—i.e., to around $148/brl. The all-time high recorded back in 2008 was $147.50.
At the time of writing Brent oil is back below resistance levels and trading in the consolidation area from 2012-2014—between $100 and $115. It seems like the uptrend is exhausted, at least on the face of it, but buying could resume.
Technically there is no divergence on RSI indicating we could see higher levels, possibly testing the all-time high around $147.50. However, if Brent closes below this month’s low at $98.30 the selling pressure could push Brent lower towards 0.764 Fibonacci retracement of the fifth wave, at around $83/brl.
Going back 40+ years the stock market has experienced periods of longer-running bull markets followed by almost as many larger corrections and even a couple of market crashes.
Examining these historic uptrends and corrections a bit closer we can see that in the build-up to every single larger correction there have been warning signs in the form of divergence in the market. Divergence is an indication of an imbalance and can been read from technical indicators such as RSI, MACD and volume. If price is rising under falling traded volume it is a sign of weakness. Similarly, it is a sign of a weakening trend if prices keep rising but the RSI is falling; that is exactly what we have seen in the run-up to market peaks and corrections.
As can be seen from the Dow Jones Industrial Average Equal Weight Index chart there was divergence up until the 1987 crash where Dow Jones lost 40 percent. There was also divergence during the dot com and housing bubbles.
Divergence—or imbalance—can run for a long time but must eventually be “traded out”. That can be done when the RSI drops below the 40 threshold. When that occurs divergence is cancelled—or reset, so to speak. Over the past 2-3 years equity markets around the world have been building up massive divergences. Markets have been moving higher but RSI values have not achieved greater highs.
Granted we have seen larger corrections—most notably in 2020 when the Covid scare hit equities—but even that sell-off was not enough to push the monthly RSI below 40. The bull market that followed has just added to the imbalance in the market, building more divergence. However, now could be the time that divergence will be traded out. The FAANG/TINA (There IS No Alternative if you wanted a return on your money) bull run has run longer than the dot com bull market and has the longest-running divergence in the past 40 years.
The strong bounce on the back of the Covid scare sell-off and continued bull run has reached 1.618 projection (of the Covid scare sell-off mini-crash), and seems to have exhausted. The downtrend is confirmed on both daily and weekly periods, and a monthly close below 32,985 will confirm the longer-term uptrend to be over.
Dow Jones is currently testing 0.236 Fibonacci retracement of the uptrend since the Covid low. Support is not strong around these levels and the Dow Jones could drop to the 0.382 retracement which coincides with the market peak before the Covid scare hit markets, at around 30,000.
However, a drop to 30,000 is not likely to push the RSI below 40—in other words, it won’t unwind the divergence. And it will still be quite far away from its 55 Simple Moving Average (SMA). It is not unlikely the price and the SMA will catch up.
If the Dow Jones closes below the pre-Covid scare peak at 29,568, which is not unlikely, the bear trend could be further fuelled. If that scenario plays out the longer-term rising trend line could be tested with a drop to the 0.618 retracement at around 25,000.
For this likely scenario to be demolished and reversed, the Dow Jones needs to perform at new all-time highs.