On top of the world, with an adoring crowd gathered below and indifferent law enforcement milling about…there is a bit of a parallel between a famous rooftop concert and the current market.
As stocks slink into the end of Q1 amidst a bevy of perils, there’s a sense of calm before the storm. Then again, SPX closed yesterday above its 3.618 Fibonacci extension – though just barely this time. Can the algos keep the music playing?
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Members will recall that one critical component of our oil/gas decline scenario is USDJPY’s breakout from the falling channel from 2017 shown below. Guess what?
The yen carry trade is a tried and true method of goading the algos into buying equities – even overpriced ones. It works especially well as a counterweight to falling oil/gas prices as we first observed in 2015 [see: Did TPTB Crash Oil?]
So, it’s absolutely no surprise to see central banks pull it out of the playbook at a time when folks are suddenly curious about hidden, systemic risks and oil/gas prices are in the midst of a healthy reset.
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The massive Ever Given container ship has been freed from the Suez Canal’s mud just in time for the market’s open. While positive for global trade, stocks are arguably more focused on the ambit of the latest Wall Street scandal – this one involving the Reddit-style goings-on of Archegos Capital and the banks which apparently neglected to check on their collateral from time to time.
The failure of some of the biggest and most sophisticated banks in the world to recognize the Long-Term Capital Management doppelgänger on their books is emblematic of the frenzy with which institutions and individuals alike regard the equity market. Why bother analyzing exposure when central banks will never allow a significant decline anyway?
Futures are off about 20 points – just enough to put SPX’s 3.618 Fibonacci extension at 3956.64 to the test on the open.
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There’s a well-known scene at the end of the classic film Casablanca where Captain Renault (Claude Reins), having seen Rick (Humphrey Bogart) shoot a Nazi in order to enable Ilsa and Lazlo to escape, tells his men to “round up the usual suspects.” It saves Rick, Ilsa and Lazlo’s collective bacon (though I suspect it sucks for the usual suspects.)
So it is with the algos driving equities lately. With oil/gas prices on their back heels and VIX being bid up every day by nervous carbon-based investors, it falls to the the usual suspects in the currency markets to provide algos with the proper “motivation.”
Think of USDJPY’s breakout not so much as a bug, but a feature of the modern market — one of the many quiddities which allows futures to ramp higher on, say, disappointing economic news.
While it is sometimes difficult to know when stocks will get much-needed support, these tools have been fairly predictable and have provided excellent trading opportunities.
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We have multiple targets being reached this morning, and several more in the works. We’ll start with ES, which just tagged our SMA50 target in a backtest of the falling white channel from which it broke out two weeks ago.
The one we’ve been waiting on for what feels like forever, though, is silver. SI broke out of the falling white channel twice before it managed to tag our 30.35 target in January. But, as we discussed at the time [see: Hi Ho Silver]:
With the SMA200 crawling along toward current prices, we can’t discount the potential for a long overdue backtest.
We’re finally getting that backtest. But, given DXY’s breakout, we have to wonder whether SI’s backtest will hold.
We’ll update the prognosis for silver and gold and also sneak in a discussion of EURUSD, which officially reached our next downside target yesterday.
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I know what you’re thinking: it’s “don’t fight the Fed.” While that’s generally true, too, the Bank of Japan is the central bank which most conspicuously wears its balance sheet on its sleeve. When my charts are a farrago of bearish indicators, but the Nikkei pushes up through resistance? I’ve learned to ignore the indicators and become bullish.
Conversely, when the narrative is incredibly bullish but the NKD slips below important support, it’s time to short. For those who haven’t been paying attention, that’s where we are right now.
We’ve had a few hints over the past week or so, but the NKD suggests there’s more to come.
US stocks just haven’t gotten the message yet.
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Today we get the benefit of both Jerome Powell and Janet Yellen telling us that, despite how incredible the outlook is, things are so horrible that they need to keep pumping billions of dollars into the markets every day. For the little people. You know – unemployed folks who can really benefit from rapidly rising food, energy, and housing costs.
It’s now been a year since SPX bottomed out, 9 months since a test of its 200-DMA, and five months since a test of its 100-DMA. The algos have been working overtime. Corrections have been short and sweet, quickly extinguished by rallies in oil and USDJPY and sharp collapses in VIX.
From this point forward, expect them to come as a surprise to many investors.
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Oil and gas suffered their worst day in months, yields have backed off their highs, and the Nikkei has even broken down ever so slightly.
Will central bankers back off their insistence that rising inflation and interest rates are of no concern? Maybe they’ve finally tired of yields being the cynosure of the financial press.
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We finally saw the first big selloff of the tumble in oil and gas prices we forecast months ago [see: Jan 13 Update.] Though the technical damage isn’t that great yet, it’s only getting started. I’ll focus today on how the decline in oil/gas should play out over the next several months and how other sectors of the market should react.
I think the writing is now officially on the wall: the Fed must tread very carefully, especially over the next 4-6 weeks. 
The good news is that there should be some excellent swing trading opportunities and there is still plenty of time to position for them.
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You didn’t have to read any further than the title of Freddie Mac’s latest quarterly market report to understand what’s happening in the housing market:
It made me wonder just how important lower rates have been to price appreciation. And, given the Fed’s purported insouciance toward rising rates, how alarmed should we be that rates are spiking higher?
Home buyers usually base purchase decisions on what they can afford (or what they can qualify for), and affordability comes down to purchase price and interest rates. So, it’s a fairly simple process to assess the effect of one on the other.
The National Association of Realtors (NAR) reported that January 2021’s median sales price for existing homes was $303,900 — 14.1% higher than in January 2020 ($266,300) and 21.9% higher than in January 2019 ($249,400.) If you owned a home during this time, congratulations!
If you don’t mind looking a gift horse in the mouth, you might be wondering why prices increased so much. As it turns out, a great deal of the appreciation was due to the historic drop in interest rates.
Let’s take a peek under the hood.
Freddie Mac reported that the average interest rate on a 30-year fixed conventional mortgage in late January 2021 was 2.73%. Assuming taxes and insurance at the nationwide average and a 20% down payment, the monthly payment (PITI) for a $303,900 home would have been $1,347. A buyer would have needed an annual income of about $57,730 to qualify.
Since median household income in the US is currently about $78,500, the median home price of $303,900 seems reasonable. [Of course, housing is not affordable in many cities — particularly in larger cities and on both coasts.]
One year ago, in January 2020, with rates at 3.51% and an income of $57,730, you could have purchased a $275,227 home. And, in January 2019 with rates at 4.46%, you could have purchased a $245,370 home. In other words, the drop in mortgage rates alone accounts for a 23.9% increase in value. 
Remember, the NAR reported an increase in the median sales price between January 2019 and January 2021 of 21.9%. So, all else being equal, the increase in value for the median existing home was entirely attributable to the drop in interest rates.
Imagine the effect of all that wealth created out of thin air, and it becomes easier to understand the Fed’s motivation in driving rates to all-time lows.
Of couse, the drop we’ve seen over the past 10 years is nothing compared to the drop over the past 40 years.
Thank you, Fed. All’s well that ends well, right?
Not so fast. If falling rates can result in a sharp increase in value, what about rising rates? As interest rates rise, the income required to qualify for a loan increases. This wouldn’t matter much if your income were stable and you planned on owning your home for, say, the rest of your life.
But, what if you want or need to sell your home in the next few years in the midst of a rising rate environment? If rates were increasing, the average buyer might be less willing or able to pay your asking price. You could hope that your buyer’s income rose enough over the years to compensate for the increase in payment.
But, “hope” isn’t really a strategy, is it? So, let’s do the numbers. Let’s assume rates rise over the next year to where they were one year ago, and that rates two years from now revert back to where they were two years ago.
Remember, the Fed’s policy of lowering rates to historic lows would have enriched you by $72,000 over the past two years – not bad, considering you made a down payment of only $61,000 and were able to write off the bulk of your monthly payments.
An increase, on the other hand, to 3.51% by 2022 would reduce the value of your $303,900 home to $275,227 – a 9.4% drop. If you were to sell at that price, you would net only $15,593 after paying a 6% commission and paying off your $243,120 mortgage. In other words, you would have lost 74% of your original down payment.
An increase to 4.46% by 2023 would further slash the value of your home to $245,370 – a 19.3% haircut from its original $303,900 value. After commissions and settling up with the bank, you would owe $12,472. Including the $60,780 down payment, you would have lost a total of $73,252 – 121% of your initial investment. Ouch.
Someone gleefully signing up for a $567,000 mortgage at a rate of 2.73% on a $709,500 house (the average) in Los Angeles because the $2,900 house payment is even lower than their rent payment would do well to consider the repercussions of rising rates.
If rates simply reverted to 2019’s 4.46% when they sold, they’d need to write a $29,000 check at closing – a bitter pill after waving goodbye to their $142,000 down payment.
Is such an outcome in the cards? I doubt it. As we’ve discussed countless times over the years, the Fed needs higher interest rates and inflation like a fish needs a bicycle. While inflation is set to spike much higher over the next 4-6 weeks due to sharply higher oil/gas prices…
…I have little doubt that oil/gas prices have already begun their collapse. It’s one of the very effective ways central bankers have been able to quickly bring inflation back under control in the past. Yes, we’ve seen this movie before.
Jay Powell insists the Fed’s not worried about higher inflation and higher interest rates. That makes them either liars or fools. And, I sure don’t take them for fools.
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