Are Risk Assets on the Verge of Melting Up?

Raymond Micaletti submits:

After a 56% rally in the S&P 500 (from the March lows to the August highs) and similar rallies across global equity markets, wondering whether risk assets are about to melt up now might be precisely the kind of (recency bias) sentiment that defines market tops. And, admittedly, only a day or two ago we would have thought such a question silly. But after Friday’s close, a cursory look at various charts spanning multiple asset classes strongly suggests that an intense rally in risk assets may be right around the corner–that is, if textbook chart patterns resolve in textbook ways (if not, then financial market are deviously setting us up with one extremely impressive head fake).

We’ll begin our tour of risk assets with the U.S. dollar–for no other reason than the fact that the direction of the dollar will likely drive the direction of all other asset classes, should recent market correlations continue to hold. With that in mind, taking a look at the chart of the dollar index, we see what appears to be a descending right triangle formed over the past several month, with support in the vicinity of 78 and successively lower highs:

Such a pattern suggests there is demand for the dollar index in the neighborhood of 78, but that supply is steadily coming online at lower and lower price levels after each successive bounce off 78. Because the successively lower highs indicate increased selling pressure, a descending right triangle generally indicates a bearish bias. Consequently, despite the relatively extreme bearish sentiment on the dollar (as delineated here), the chart pattern of the dollar index seems to indicate that the dollar could quite easily break below 78 and potentially below its interim low of 77.428 relatively soon. Of course, the dollar breaking to new lows would likely jumpstart risk assets worldwide and potentially cause panic buying in hard assets such as gold, silver, and crude oil.

If we’re being honest, the descending right triangle in the dollar index isn’t the cleanest of descending right triangles–and until recently one may have construed the chart as having formed a descending wedge–a pattern that has bullish implications. So perhaps our bearish interpretation of the dollar’s chart is flawed. One way to corroborate this interpretation is to look at additional assets that would benefit from a weaker dollar and see if their charts are unambiguously bullish. To that end we will look at gold, eur/usd, and crude oil–and it’s in these charts that we see the strong potential for a rally in risk assets.

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