As I mentioned in yesterday's Chart Advisor newsletter, the British pound (GBP) has been surprisingly defensive lately. From a technical perspective, the GBP/USD exchange rate was forming a bullish inverted head and shoulders pattern, which was completed today. That pattern is surprising because of all the uncertainty Brexit is causing – it seems investors have already priced Brexit into the market.
As you can see in the following chart, the technical pattern I pointed out yesterday has completed a breakout with a provisional price target of 1.3685 based on a Fibonacci retracement of the pattern itself. This method is reasonable at estimating breakout targets; however, in this case, the unknowns around Brexit could make this more of a guess than an estimate.
The bullishness in the GBP is the result of news that the European Union may insist on a delay of two years or more if an agreement can't be reached. This announcement reduces the risk for a very "hard" or "no deal" Brexit where there is no agreement in place when the U.K. leaves the EU.
As major components of the global economy, both sides of Brexit would benefit from a smoother transition out of the EU (or even an increased potential for the U.K. remaining in the union). This is also a positive for U.S. stocks, which would otherwise suffer if growth in Europe and the U.K. were to decline further.
Unfortunately, the Brexit news did not help the S&P 500 make progress against resistance at 2,800 today. Investors may have been distracted by Fed Chair Jerome Powell's testimony to the House Financial Services Committee or President Trump's former attorney's testimony to the House Oversight Committee. The potential for anything earthshaking to emerge from either event was unlikely, but there weren't any other positive catalysts for a breakout today either.
Risk Indicators – Armed Conflict
With all the political news soaking up the headlines today, another issue facing the markets is heating up without very much coverage. Pakistan says it has shot down two Indian pilots over the disputed region of Kashmir after India had launched airstrikes on Pakistani territory yesterday. While this doesn't guarantee war between the two nuclear powers, it is a significant escalation of hostilities.
It should go without saying that the potential for armed conflict is almost always a source of risk for the markets. However, traders have been surprisingly sanguine about the news. Indian stocks like Infosys Limited (INFY), Tata Motors, Limited (TTM) and Dr. Reddy’s Laboratories, Limited (RDY) were a little mixed but didn't show any signs of panic selling or hedging.
Hopefully, the conflict will be cooled before more lives are lost, and this week's events won't have a lasting impact on the markets. However, keeping an eye on asset classes that move the most when investors fear an escalation may provide some advance notice for stock traders.
In my experience, gold and the Swiss franc (CHF) are the easiest safe-haven assets to track, and both rise in value quickly when investors start to discount or hedge against global risk events like the Pakistan/India conflict. Both assets retreated today, which is a good sign. If you don't have access to spot quotes or futures charts for the CHF or gold, you can use ETFs that hold those assets as a substitute.
For example, in the following chart, I have plotted the SPDR Gold Trust (GLD) and the CurrencyShares Swiss Franc ETF (FXF). As you can see, both funds retreated today as investors evaluated the risks of the incidents over the past two days. However, if both safe-haven assets start to rise dramatically, investors should be careful about their long-stock positions as well.
Bottom Line: Expectations
Besides the unexpected news of conflict between India and Pakistan, this week's schedule hasn't produced many surprises. Powell's testimony didn't contribute much to market volatility, and investors seem to be encouraged by the Brexit news. The last major remaining news event for this week is an advance GDP report for the fourth quarter that will be out before the market opens on Thursday. In my opinion, although resistance on the S&P 500 has been holding at 2,800, the risk of any major declines is continuing to recede.
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