Oil reached our next downside target range yesterday.  This completes a 40% decline for CL since our Oct 3 top call [see: VIX Takes the Plunge] and brings our YTD gains to 177%.

From our Nov 9 Update on Oil:

CL just reached our next downside target of 59.47 and, RB has reached our target range of 1.58-1.62. This is important support for both which, if broken, would portend much more downside.  If it fails, there are much lower targets that would come into play: the gray .382 at 57.47, the purple .618 at 55.36, the gray .500 at 51.47 and the purple .886 / white .236 / gray .618 at 46.02.

Yesterday’s tag:

While it’s always nice to nail a forecast target, the commentary which accompanied that post was at least as important:

Ultimately, oil and gas’ path forward will decide much about interest rates and broader markets.

CPI dropped from 2.95% in July to 2.18% in November, low enough to prompt many Fed watchers to call for a halt to further rate hikes — which is exactly what led us to call for a sharp decline in oil and gas prices in the first place.

The big question is whether it’s enough of a drop.  For the answer to that, we’ll have to wait for the FOMC’s statement this afternoon.

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Doves are harmless, right?  Suppressing interest rates and pumping markets full of cash for 10 years straight has obviously done wonders for stocks. What could go wrong?

Nothing, unless you consider the markets’ addiction to easy money a problem.  The mere hint of the Fed normalizing rates and “allowing” a business cycle to play out has the doves massing for an attack straight out of a Hitchcock movie.

Opinions are all over the map regarding tomorrow’s Fed decision.  I suspect the committee members, themselves, are somewhat bewildered. The US has taken on way too much debt and can’t afford higher interest rates.  Yet, until recently, inflation dictated that they tighten.

Will inflation’s recent decline stick, or will it bounce back toward 3% the moment Trump takes his boot off Saudi Arabia’s neck?  And, what about those sectors of the economy which have relied on low interest rates to do as well as they have?  Will the Fed knowingly nudge autos, housing and financials into a recession?

To hear our Dove-in-Chief tell it, more rate hikes will unravel all the wonderful things his economic policies have accomplished.  Can the Fed afford to appear subservient to the president, even if they did agree with him?

The charts don’t much care about all that.  Yesterday, major indices reached tipping points below which things could get really ugly.  Once such index we’ve focused on lately is the Nasdaq Composite (COMP.)  Yesterday, it reached our downside target from October [see: Plan B] and, after a great deal of consternation, put in a bounce.

Whether or not the bounce holds is critically important, as it represents a backtest of a breakout which began two years ago.  If the red trend line doesn’t hold, the index is susceptible to a drop of another 8-24%.Many other indices are in similar situations.  Perhaps this is why we’re getting mixed signals from the algo drivers which have been such reliable indicators of future direction.

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An important test lies just ahead.  With SPX and ES having closed below their Head & Shoulders necklines on Friday, the inference is that the bottom just dropped out.  The real test will come, however, if COMP drops more than 1.6% to below 6801.75.

This, our downside target since October 10 [see: Plan B] represents an important fork in the road.  Then:And, now:Not exactly a very straight line — but, it got here, and pretty much on time.

A bounce here and stocks can finish the year at least even.  A failure to bounce, and the bears have a clear path lower.

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The futures tumbled overnight on unscripted weakening economic data, particularly in China.  ES tagged our H&S neckline a second time before getting a nice 12-pt bounce courtesy of CL (which broke out of a completed H&S)…….as well as USDJPY and VIX, which tagged our next downside target yesterday.

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The graphic below, direct from the ECB, tells a fairly bleak story.  Rate hikes?  Don’t hold your breath.The EURUSD was virtually unmoved on Draghi’s press conference.  In other words, nothing he said surprised or even resonated with investors. It’s been a while since we devoted a post to the lowly euro, which has gone nowhere since reaching our 1.1281 target last month — for the second time.  But, that’s okay.  Prior to that, it was all over the map.  We targeted 1.1281 in June [see: June 14 Update on EURUSD] as the pair’s rising white channel appeared to be breaking down.

The best targets are a backtest of the falling white channel top at 1.1281 or the red .618 at 1.1186.

It came within .002 of our initial target on Aug 15, then bounced up within .0001 of our upside/backtest target of 1.1734 on Aug 28.  We spent over a month wondering whether it might stretch for its SMA200 when it finally broke down on Sep 27 and plunged to within .0014 of our secondary downside target.

While it’s been an interesting trading vehicle, it’s hard to shake the impression that larger directional moves lie ahead.

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Last night, I attended a very enjoyable holiday get-together at which I was probably the only technical analyst among a hundred or so quants.  After solving the problems of nuclear proliferation and ensuring that the paintings in the room were perfectly level (who says finance guys don’t know how to party?) the discussion got down to forecasting.

I greatly admire quants’ ability to chuck billions of data points into the Veg-o-Matic and spit out statistical relationships that baffle those of us with normal-sized brains. Who knew sunspot frequency mattered so much?

But, we humble chartists do have one advantage: our emphasis on visual  perspective, which greatly facilitates pattern recognition and interpretation.

That’s a fancy way of saying we look at stuff and see patterns.  It helps enormously if you’re slightly Aspergerry, like yours truly.

Now, if you’re one of those folks who believe markets follow a random walk and are free from interference, price fixing, manipulation, etc…well, God bless.  Being a cynic, I look for explanations that go beyond the CNBC headlines.

So it was with our post this past April: Oil & Gas, Inflation and Interest Rates: A Delicate Balance or goal Seeking? In presenting dozens of tedious charts illustrating the historical relationships, I attempted to forecast the future path of, well, all that stuff.

Our basic premise was that oil and gas prices were rising, which made equity algos happy but goosed inflation to the point that interest rates were becoming problematic.  The 10Y had risen from a low of 1.34% in Jul 2016 to nearly 3%.  The 2Y had risen from 0.56% to 2.56%.  Interest-sensitive sectors were starting to feel the pain.  The 2s10s, which had peaked near 290 bps in 2011, was screaming toward a negative number — which tends to signal recessions.

I suspected oil and gas prices would be driven down, one way or another.  My suspicions were confirmed the very next day by Trump himself when he tweeted the first of his five missives on high oil prices.

The fastest and easiest way to bring interest rates back down would have been to ask the Fed to forget about that pesky inflation and put future rate hikes on hold.  Mr Trump tried this…to no avail.  After years of languishing below 2%, CPI was now pushing 3%.

The second fastest and easiest way was to bring inflation down.  As the chart below shows, the fastest way to do this was to crash gas prices.

I know, those of my fundamental analysts friends whose feathers just got ruffled, that’s not how markets work.  But, my friend Richard Fisher and I will just agree to disagree with you.  We think that’s exactly how “markets” work when central bankers have their backs against the wall.

What the Fed did, and I was part of that group, is we front-loaded a tremendous market rally starting in March 2009.  It was the Fed…the European Central Bank, the Japanese Central Bank…  all quantitative driven by central bank activity.  That’s not the way markets should be working… they were juiced up by central banks, including the Federal Reserve… I think you have to acknowledge reality.

Richard Fisher, former FOMC member

QE was an effective but expensive blunt instrument which saved stocks from ruin on many occasions.  Buying stocks directly is also effective, but can leave you in an equity trap – right BoJ?

Nudging currencies, commodities and derivatives, which can trigger equity algos to go on a buying spree, is downright brilliant.  It’s relatively cheap.  And, with only 10% of trading volume attributable to fundamental, discretionary investors, these algorithmic nudges ripple out through index and quasi-index funds, ETFs and quantitative funds of all stripes.

With the mid-terms fast approaching and interest rates on the rise, fast action was necessary. But, Trump’s tweets were working.  By October 3, oil prices had actually risen 10% since Trump’s first tweet.  OPEC, led by Saudi Arabia, wasn’t listening.

Then, Trump was presented a gift.  Saudi journalist and critic Jamal Khashoggi was butchered, apparently by Prince Mohammed bin Salman’s henchmen who flew in for the occasion from Saudi Arabia…as in leader of the OPEC pack Saudi Arabia.  The uproar created instant leverage for a certain politician who was, say, in a position to defend MBS.

Isn’t it fascinating that the very day these headlines hit the wires, oil and gas began a precipitous decline? As we illustrated in October in Coincidences and Consequences:, Khashoggi’s brutal murder top-ticked oil and gas prices and kicked off a 37% slide which hammered CPI, which had reached 2.95% in July, to November’s 2.18% announced today.

The drop in inflation will only serve to bolster Trump’s argument that additional rate hikes are unnecessary and give the FOMC cover should they decide to sit on their hands next week.

If higher interest rates are the problem for equities, are lower interest rates the solution?  There, things get a little tricky.

On Monday, SPX reached the neckline of a large Head & Shoulders pattern we’ve been watching for the past couple of months.  In the old days, when markets weren’t “juiced up by central banks,” completion of a H&S Pattern kicked off big declines.  So did death crosses, the passage of the 50-day moving average below the 200-day as occurred last Thursday.

These days, a death cross and an arrival at a H&S neckline is much more likely to mark an important bottom — hence the 100-pt bounce in the past two sessions.  But, can the US dollar continue to appreciate if the rate hike narrative crumbles?  And, if the dollar declines, how would that affect equities?  Time to hold on to your hat.

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SPX completed the H&S Pattern yesterday, and dipped to within 4 points of the white .886 retracement for good measure.  As we wrote yesterday, several things needed to happen in order for the H&S to play out:

For a breakdown, we’d want to see VIX break out and not retreat from the red TL.  We’d also want to see USDJPY reverse course and the dashed red TL break down. Ideally, we’d also see CL break down.

VIX did not break out, but got hammered at the same exact same trendline which has cut short the last four rallies.USDJPY bounced at the red TL and, for good measure, broke out above the latest TL of resistance.  And, CL didn’t break down. And, while SPX’s subsequent bounce ran out of juice at a point of overhead resistance at the close, the algo drivers have been at it again this morning.  Futures are up another 30 points.

The pols have thrown fuel on the fire by suggesting (yes, again) that the trade situation has improved.  But, this morning’s PPI report hints at lingering inflation and interest rate problems.  As expected, energy went a long way toward turning down the heat.  But, PPI still came in hot.As such, all the talk about fewer rate hikes in 2019 must be questioned.  Alternatively, oil needs to drop even further.  Neither option will get the bulls where they want to go.

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This has been one of the more satisfying years since I first began writing pebblewriter 7 1/2 years ago.  Yes, our forecasts have been accurate. But, it was even more gratifying that the themes we identified earlier in the year (oil’s collapse, interest rates topping out, CPI tumbling, etc.) played out as expected.  They were excellent guideposts to equities’ outcome.

In short, it’s been a trader’s market.  A buy-and-hold investor would have a 40-point loss (as of Friday’s close) to show for all her sleepless nights.  A trader who simply paid attention to the 200-DMA and the Fib extension, on the other hand, would have done much, much better.

By accurately anticipating the moves in currencies, oil and gas, interest rates and VIX, which are instrumental in driving the algos which determine so much of each session’s outcome, we have been on the right side of most of the moves – correctly identifying most of the major turning points.

Since futures reached our next downside target last night, we’re faced with another such opportunity.If SPX had simply held 2703 in October, or even tagged our 2579 target around the election as we forecast two months ago [see: All Good Things], it would have had a decent chance of continuing higher after a bounce to 2800.But it bounced prematurely, and in coming back to tag the right downside target is threatening to complete (ES already has) a large, bearish Head & Shoulders Pattern.  Here’s that same chart from Oct 11 with the interim price action filled in.

So, what’s it going to be?  The usual stick save, or a 380-pt plunge?

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