The Euro is on an Island

For months now I’ve been watching two charts very closely on my ticker screen -- the Euro exchange traded fund (FXE) and the S&P 500 (SPY). It’s been amazing to see how movements in the FXE have correlated to SPY (approximately 84% since September). This may be not be much of a surprise since the market has been taken hostage by the European debt crises, to the point where every rumor coming from Europe seems to create a short term market move.

Today I want to point out a technical pattern currently found in the FXE. At the moment the FXE is in the middle of an island reversal pattern (see chart below). Island reversals get their name from the appearance of the chart, where there's a price gap up, and then a gap back down, forming what looks like an island. The key here is that when the pattern forms and the gap is not quickly filled, it's usually a bearish omen for that asset. If the FXE declines and current correlations hold, this won’t bode well for the S&P 500, unless the U.S. is about to decouple from problems in Europe. While I don’t have room to get into my views on decoupling right now, I will say that the last time we heard about it was when people believed that the emerging markets could decouple versus developed markets. That was in 2008, and the theory didn’t work out so well. Those who believe it will work this time may get caught on an island with the FXE.