The last Investing for Dummies worked out pretty well; so, here goes again.

There’s a lot of confusion out there about what matters or doesn’t matter at this juncture.  Allow me to simplify things…

SPX 2702 is the 2.24 Fib extension of the drop from 1576 to 666 between 2007-2009. If SPX backtests it and bounces tomorrow, the uptrend is intact. If it drops through, there’s plenty of downside potential. It’s a number worth watching very closely.

GLTA.

All good things come to those who wait.  Or, so the saying goes.  It’s not always easy.  The past few weeks have sorely tested bears’ patience.

For many weeks we’ve been wondering when the rising channels would break down.  It seemed inevitable, as oil and gas were causing inflation problems, USDJPY had reached a turning point, and VIX was threatening to break out.  The post from Sep 21 see: [Quad-Witching] is one example:

But, we’ll see what happens this weekend in Algeria.  CL and RB are long, long overdue for a correction.  Combined with USDJPY running out of steam and VIX due for a breakout, this would not bode well for stocks.

Yesterday, SPX’s red channel broke down and it made a beeline for the yellow neckline at 2780, closing just above it.  It was a long overdue backtest.  Interestingly, it leaves the 2.24 Fib extension at 2703.62 within striking distance.With CL off nearly 7% and RBOB off 8% over the past week, and USDJPY having reversed where expected, it appeared fairly likely.  Had VIX not reversed at our next upside target overnight, SPX might be tagging 2702 on the open this morning.Is this another question of “when” and not “if”?

CPI just came out.  One comment…  Gasoline’s 9.1% increase over September 2017 was greatly muted by last September’s huge spike.  October will not enjoy the same benefit.  If the Fed is looking for an excuse to pause rate hikes (without appearing to acquiesce to the Inflator-in-Chief) as I believe they are, gas prices must continue falling.

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Back on May 18 [see: Bonds and Value] I suggested the 10Y might be a good value at 118’105 (yield of 3.11%.) The 2s10s had just reached a trend line connecting previous lows.

Ten-year yields had recently reached the top of a channel connecting previous highs.

DXY had just reached the top of a falling channel.

And, 10Y price had just reached the bottom of a rising channel.

It was an important test, as we discussed at the time.

The 10-year is at an important inflection point, poised between a strong rebound and a significant selloff.  Its next moves are critical not only from an investment standpoint, but in terms of what to expect from the broader economy.

Now that yields have broken out and prices and spreads have broken down, we’re already beginning to see the effects on the market and the broader economy.  Bottom line, they aren’t good.

The Fed is bent on (1) creating more headroom for easing the next time it’s needed, and (2) dealing with an inflation problem that the official data don’t reveal but which is very real and getting worse.  They are also wary of allowing a 2s10s inversion because it would portend a recession.  Last, they are trying to prop up the USD because it helps stave off inflation that would pressure rates higher.

They can’t very well come out and say inflation is really pushing 6 or 10% without panicking the bond markets.  So, they’re talking yields up slowly and, more importantly, not pressuring them lower as has been the case for the past decade.

The repercussions, though, are already being felt domestically in the overinflated housing market, in the auto market, basically anything which relies on low interest rates for sales.  But, the most serious repercussions are in emerging markets, where huge amounts of dollar-based debt must be repaid with appreciating dollars.  The defaults could be catastrophic.

The critical question is how high rates might eventually go.  Here, the view is hopeful.  Members might recall we had two potential channels for ZN, the price of 10Y notes.  I never liked the white channel that much because the midline was all wrong.  The yellow channel worked perfectly except for the slight overshoot in 2012 – which was a year of heavy, heavy manipulation.

So, I’ve always been inclined to believe more in the yellow channel — which says that 10Y yields have now topped and ZN has bottomed.

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It’s been a long, slow decline for VIX.  It’s been locked in a falling channel ever since the Jan-Feb correction.  As we noted last week, a breakout could be troublesome for equities.SPX closed about 12 points above important support on Friday, but futures are currently off about 12 points.  In other words, today is a critical test for bulls.

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Well, that was fun.  Just when I was wondering if investors had abdicated all decision making to bullish algos, they woke up and decided that things are a little more complicated than market conditions have been indicating.

Powell says the economy is so great that rates can continue to rise.  This is clearly a double-edged sword, as the 10Y has aptly demonstrated.  Members will remember the flattening of the yield curve poses little threat to stocks.  It’s the rapid steepening that does the damage.It’s pretty obvious, therefore, that Powell is blowing smoke and that interest rates have topped out. Why? Whether of not he employs any chartists at the Fed, I think he’s fully capable of doing the math.

Those who took an economics class or two (or even elementary algebra) can see that a continuing increase in interest rates poses serious problems for this “wonderful” economy of ours.  The tiny increase we’ve seen to date (the black line below) has contributed to a massive increase in interest expense.

Something has to give. And, by “something” I mean interest rates.SPX reached our initial target with ease yesterday, bounced for an hour or so, then tumbled to within 12 points of our next downside target before the obligatory last-minute recovery.This is where things get interesting.  Because, while a tag of the SMA50 and backtest of the January highs would make perfect chart sense, it would mean VIX breaking out of the falling channel it’s been in for months.

While I was wondering whether TPTB would allow such a thing, the employment figures came out and we got one of those trademark VIX plunges we’ve all come to expect.  The message of such a shot across the bow is clear: it can go lower, a lot lower.  Be bullish! Was yesterday’s plunge in equities close enough, in which case the more aggressive channel is in play?  Or, should we expect more fireworks today?  Not to worry. Once VIX breaks out, things will get much uglier.

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10Y rates broke out above a 30-year channel top yesterday, finally settling the argument as to the Fed’s priorities.We selected 28.56 as the upside target 9 months ago as it represented a significant enough Fib level and the top of the falling white channel.  From Jan 10’s China – It’s Not Me, It’s You:

Our view was seemingly confirmed on Feb 2 when TNX reached 28.56 and ZN reached the bottom of a long-term price channel.  It was strange, though, that the 10Y spurted up to 28.56 on the same day that SPX’s acceleration channel from Nov 9 broke down and SPX fell 59 points.

The following day, SPX fell 114 points.  And, it didn’t stop falling until Feb 9, 340 points off the January highs.  Bond prices, which normally move inversely to stocks, fell right along with SPX — and kept falling even after SPX bottomed out.  The chart below shows SPX vs ZN: 10Y prices.

Looking at it another way, we can see how 10Y yields continued marching higher as stocks plummeted, topping 28.56.  The rising red trend line from July 2016 wasn’t steep enough.  A new, steeper TL (below, in purple) took over in Sep 2017 and kept guiding yields higher until May 17.  

Fine-tuning the falling white channel, I was able to connect this peak with the previous highs from 2000 and 2007.  Like many, I noted that these previous TNX peaks had aligned with SPX peaks.  In other words, if yields fell hard as they had those previous times, stocks were quite vulnerable.

The charts suggested a drop in yields; and, so did common sense.  With $22 trillion in debt and a budget deficit topping $1 trillion, rising interest rates were unthinkable.  Or, so I thought.

I had assumed the FOMC would be able to read the writing on the wall and would take action to prevent rates from breaking out.

I don’t really think they want a breakout.  But, inflation being what it is, they’ve painted themselves into a corner.  USDJPY reached our next upside target last night, so the yen probably won’t be much help.And, oil and gas are very long overdue for a tumble — that inflation problem, again, not to mention a slew of chart patterns that spell a reversal. Note that CL has reached our 76.50 target from January.

So, here we are, this morning, with ES off 12 points, but having narrowly avoided (again) tagging its SMA20.  Usually, when this happens day after day, it’s because there’s a rising channel bottom or moving average which would make for a bullish backtest.  

This time, it smells of a failure – meaning the 10Y’s breakout is a head fake.

With VIX poised for a breakout…

…stocks might be in real trouble here.

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Another day, another after-hours meltup.  Put it all on black and give it another spin, right?  At least, that’s the message VIX is sending.

But, there are a few important caveats that suggest the message might well be a head fake.

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VIX has dipped back below the yellow channel bottom.  As long as it continues slipping lower, SPX and ES’ upside targets are presumably intact — unless oil and gas spoil the party. The hitch remains CL and RB, which not only reached overhead resistance by our measure, but must deal with inflation that’s too high, bearish API data, another round of Trump tweeting, and a large build in EIA inventory.  I think the time has finally come to revert to short, but with relatively tight stops in case this is another head fake. Then, there’s USDJPY which, as we’ve discussed, has reached channel backtest resistance.

Together with EURUSD and a resilient TNX, the pair is keeping the DXY on the rise. If it falters here at what is also very obvious horizontal resistance, stocks will come under considerable pressure. Bottom line, keep a very close on eye on VIX, USDJPY and CL. If, as I suspect, CL and USDJPY have topped out and VIX breaks out, SPX’s breakout will fail and we can look forward to sub-2500 prices.

GLTA.

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The market is quite healthy, or so goes the narrative.  Yet, day after day, we see signs of it “breaking” in the after-hours – only to be “fixed” in a V-shaped recovery the next day.

The usual “fixers,” oil, VIX and USDJPY, have limitations.  Oil can only rally so much before generating worrisome inflation headlines.  The yen can only sink so low before it starts to hurt Japanese consumers and corporations.  VIX can usually be counted on to decline when necessary.  But, there are lines in the sand that have a history of mattering.

With USDJPY and CL approaching important overhead resistance, is it now up to VIX?  Can it manage to inspire new highs or is that too much to hope for?

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