Broadening Delusions: The Inconvenient Truth about European Equities

Broadening Delusions: The Inconvenient Truth about European Equities

By Joshua Enomoto, Founder of ContangoDown.com and CrushTheStreet.com contributor

In an economic landscape rife with debt, fraud, and derivatives, there is only one certainty: Something’s gotta give! That something could very well be a “deflationary shock,” a gift that no one wants to receive. This time, however, there will be no early morning rush to the local shopping mall for an exchange to a more desirable item. This gift comes with a clear “No Refund” policy and worst of all, there is an obligation of hegemony tied to it. You can choose to ignore it, but at some (desperate) point you will be coerced into acquiescence. Such is the irony of a fiat debt-based financial system that is rotten to the core yet convened by the masses.

The year 2013 promises to be an eventful one, if for all the wrong reasons. Perhaps the most significant economic issue in our global community is the reluctance of Washington policymakers to negotiate a deal to avoid the dreaded “fiscal cliff.” Although a speculative opinion, the likely outcome would be a song and a dance by Congress and the White House which, after a series of comedic darkness, a deal emerges: Middle-class Americans can continue buying flat-screen televisions and stuffing their faces with Big Macs! However, the artificial stimulus that a deal provides will be short lived. The equities sector will continue rising towards new highs but informed traders will notice with alarm the constricting range of the price action the various indexes are leaving behind. At some point, the “paper bulls” will lose confidence and a mass exodus will ensue. You can use your imagination to fill in the rest of the story.

You may ask, but what about the rest of the world? As economic experts from Puplava Financial Services have pointed out, the fiscal cliff is a pre-contrived issue; a hard deadline that was conveniently erased from the mainstream media’s calendar on their way to election season ratings. Now that that particular dust has cleared the fiscal cliff has been rebranded to divert eyes away from another crisis: Europe.

Let’s take a look at Germany’s main stock market index, the DAX:

From a cursory glance, it appears that the DAX is technically, if not fundamentally, strong: the faster 50 day moving average is well above the 200 DMA and the MAC-D indicator confirms positive momentum (black line above the red line, also called the “signal line,” with both lines above the zero mark). Directionally, mid-March of this year was significant since prices declined from a high of 7,200 to a low of roughly 5,900. By September, the DAX fully retraced that decline and the current price at 7,500 stands significantly above that prior high.

However, there is one pattern in the daily charts that should give Euro bulls pause and that is the broadening wedge or otherwise known as the broadening top formation. This pattern is one of the rarest in the field of technical analysis and it also is one of the most difficult to decipher. It features large and growing swings between the upper and lower range of the price action and it resembles a horizontally flipped triangle. Rather than the price action squeezing into an incrementally narrower range before breaking out (or down) at the focal point, the opposite is true for the broadening wedge: The price action starts at the focal point, and continued trading broadens the upper and lower boundaries until a directionally significant move breaks the pattern. Usually, this significant move is DOWN.

An important point to bring up here is that the broadening wedge has been in play since mid-September of this year, giving this pattern in the DAX a 3-month lifespan. Clearly, this is not a short-term, hourly development that would only be of concern to day traders and currency manipulators; no, there is definitely something deeper in the works in order for this pattern to register in a relatively lengthy time frame.

Here’s why I’m so alarmed: The last occurrence of a broadening wedge pattern in a major market index was in May of 2007, at a time when U.S. housing prices were starting to decline and a year before the biggest economic collapse in modern history.

Let’s review the Dow Jones Index, from 2007 to current:

Based on chart history, we know that the week of May 13th, 2007 was the epicenter of a decidedly bearish technical pattern that correctly (and unfortunately) predicted a major crash in the global financial sector. We also know that anyone who espoused “doom and gloom” scenarios based on a study of the technicals at that time would have been viewed as a tinfoil hat wearing conspiracy nut. However, we now realize through the prescience of hindsight that the broadening wedge was in fact the market’s incarnation of human psychology at its most gluttonous. The bulls were irresponsibly driving prices higher while the bears were desperately trying to find fair valuation, thus leading to huge discrepancies in range. This tug-of-war couldn’t last forever, and finally the bulls let go. This inevitably gave victory to the bears, but the sudden loss of tension between the two suddenly sent them sprawling to the floor. They got fair market valuation and then some!

Of course, lessons that should have been learnt were quickly brushed aside, leading to yet another ill-harboring technical formation, the bearish wedge. Again, from a cursory glance, it looks like we’ve made a recovery and that we’re on the verge of a new economic renaissance; as some in the mainstream media have called it. After all, who can argue with a rising trend? The problem is context. None of the massive bull runs over the past decade have been sustainable, thus suggesting that any positive move in European (or American) equities should be viewed with a healthy dose of suspicion.