Whew! BOJ Saved The Rally…For Now 01-30-16

BOJ COMES TO THE RESCUE

This week reminded me of the recent AFC Championship game as the Denver Broncos defeated the New England Patriots in the final seconds of the game by foiling the 2-point conversion attempt. The market, like the Patriots, struggled all week with any ground gained one day, lost the next.

Fortunately, for investors, instead of the final play of the game being an interception sending the Patriots into defeat, it was the BOJ completing the conversion and sending the “Bulls” on a rampage on Friday.

However, the announcement by the Bank of Japan (BOJ) to implement negative interest rates in a desperate last attempt to boost economic growth in Japan was only the catalyst that ignited the bulls. The “fuel” for the buying came from the end of the month portfolio buying by fund managers. As I wrote Thursday evening:

“But where could that lift come from? The first is month-end window dressing by fund managers after a brutal start to the new year. After much liquidation, fund managers will need to rebalance holdings.

The second is the potential for Central Banks to intervene which could embolden the bulls as further support could temporarily delay the onset of a bear market and recession. Note: I said temporarily. Pulling forward future consumption is not a long-term solution to organic economic growth. 

Not to be disappointed, the BOJ announced a move into NEGATIVE interest rate territory to try and boost economic growth in Japan. (Interestingly, however, was the lack of increase in QE.) The announcement was a shock to the markets as the BOJ had just stated last week that negative interest rates were not being considered.”

Importantly, the rally pushed the major averages out of the consolidation pattern that had me worrying on Wednesday about the possibility of a technical breakdown. To wit:

“Over the last few weeks, I have suggested the markets would likely provide a reflexive rally to allow investors to reduce equity risk in portfolios. This was due to the oversold condition that previously existed which would provide the “fuel” for a reflexive rally to sell into.

I traced out the potential for such a reflexive rally two weeks ago as shown in the chart below.”

(Chart updated through Friday’s close)

The most important parts of the chart above are the overbought / oversold indicators at the top and bottom. The oversold condition that once existed has been completely exhausted due to the gyrations in the markets over the last couple of weeks. This leaves little ability for a significant rally from this point which makes a push above overhead resistance unlikely.

“Just as an oversold condition provides the necessary “fuel” for an advance, the opposite is also true.”