Last Thursday we noted that WTI was approaching an important line in the sand, the neckline of a Head & Shoulders Pattern that could spell real trouble for oil prices.  From Oil’s Dangerous Game:

So, it’s no surprise that equities are panicking just a little this morning, as CL is pennies away from completing a Head and Shoulders Pattern which targets 31.55.  I understand why it’s necessary.  But, equities are not happy – not one bit.

Last night, CL dropped through that neckline in the midst of a 2.5% dip.  We’ll look at what this means for oil and for stocks.

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With the FOMC, BoJ and ECB actions behind us, this seems like a good time to review the big picture.  This morning’s USDJPY, VIX and CL moves are, perhaps, the perfect reminder for how we got here, and where we’re going.

Note the strong correlation between USDJPY and ES broke down on May 24 when the dollar ran into trouble.  It was a dicey time for stocks, as oil had reached our upside target (yellow arrow) and was heading south.What enabled stocks to break out then, and maintain a floor afterwards?  VIX, which had spiked from 10.50 to 16.30 between May 16-18 — a rare trip back above the long-term yellow channel bottom — was hammered back to single digits on the 24th.And, so, the cycle continues.  When one algo driver falters, another takes its place.  How long can this go on?  Will it always work?  We’ll look at the mechanism, and the repercussions for traders in today’s big picture.  We might even delve into some underlying economics.

But, first a shout out to members J.H. and T.M. for posing some great questions this past week.  I’m convinced the pebblewriter readership is the smartest, most thoughtful group of investment professionals out there.  These two gentlemen are real students of the markets, and do a great job of keeping me on my toes.

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Things went very much according to plan, yesterday, with SPX plunging to our third support level before beginning the predictable meltup.  And, there’s no mystery as to what was driving it.With equities just short of a breakout (again), is the drama already over?

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Oil prices move equity prices, plain and simple.  When oil gets the sniffles, equities catch a cold.  When oil drops through major support, equities just plain panic.

So, it’s no surprise that equities are panicking just a little this morning, as CL is pennies away from completing a Head and Shoulders Pattern which targets 31.55.  I understand why it’s necessary.  But, equities are not happy one bit. The futures are currently off 14, which should land SPX right at our secondary downside target.

Our first was overshot by 2 points yesterday before a sharp snapback rally that probably left most people long overnight.  We remain short.

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It’s been a long, lonely slog since we first forecast the very contrarian view that plunging inflation would prevent the FOMC from raising rates in June.  The last time I checked, Goldman had the probability of a hike at 95%.

But, as we discussed in The Big Picture, May 3 the drop in oil prices was likely to push CPI below 2%. We reiterated this view the following week [see: Bye-Bye Rate Hikes.]

Guess what the BLS just reported?

The Fed might or might not hike rates anyway.  They still have five hours to mull things over.  But, the currency targets we laid out over these past couple of months look very likely to be tagged today. And, every single one is screaming “no rate hike!”

We listed the major ones yesterday:

I continue to think the real opportunity tomorrow lies with currencies and oil.  Here’s a quick summary:

– DX, currently at 97.05, going to 96.07-96.14
– EURUSD, currently at 1.1199, going to 1.1470
– USDJPY, currently at 110.05, going to 108.82

Whether or not we get the full follow through will depend on how things go starting at 2pm.  But, we’re off to a very nice start.

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Friday started off like so many other sessions, with algos working overtime to counteract the effects of the British election.  Our first upside target at 2438.44 was quickly dispensed with.  So, it was with some trepidation that I suggested another turning point an hour later at 2444.83.

Here’s the next opportunity for SPX to top out if it’s going to.   Note that ES has also reached a key Fib. I believe it’s worth taking a shot at a short with tight stops.

SPX slipped a couple of points higher before the rug was pulled out, prompting a 30.5-pt plunge that exceeded our downside target by 4 points.  Follow that up with a 16-pt rally into the close, and a return to some semblance of normalcy by VIX……and it’s no wonder that traders are a little rattled.  In reality, things went pretty much as they should have; it just took a little patience.

BTW, for those who missed it earlier, we gained some nifty insights into the Plunge Protection Team from our recent NDX update.  Check it out.

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Last year at about this time we noted that NDX had completed a golden cross — where the SMA50 crosses above the SMA200 — normally a strong buy signal.  But, as we also discussed, such signals had been head fakes the past several times in a row.

The 50-day recently crossed above the 200-day — a golden cross.  However, this has been a head-fake several times in a row:

–  the Sep 30, 2015 death cross marked a bottom instead of a top
–  the Nov 17 golden cross preceded the high by only two weeks
–  the Feb 5, 2016 death cross was followed by a bottom the very next session

On the other hand, NDX had also reached potentially significant resistance: two channel tops and a key Fibonacci level.

If the golden cross was to be believed, we’d see a strong breakout.  If it was another head fake, NDX was due for a tumble.  Unlike the Dow and the S&P 500, NDX had yet to even recover to its Mar 2000 highs.

It was a head fake.  NDX went sideways for a week before plunging nearly 8% in just 15 sessions.  The bulk of the drop (6.4%) occurred on just three days: Jun 23, 24 and 27. Clearly things were accelerating.On the 27th, the SMA50 actually dropped below the SMA200 — the dreaded death cross — on an intraday basis.  As bad as things had been, were they about to get even worse?

Readers might remember the Jul 2008 death cross which preceded a 46% drop, and the Sep 2000 cross which resulted in a 79% crash.  In other words, death crosses are not usually very healthy for stocks.

But, wait, did I mention that NDX experiences frequent head fakes?  On Jun 28th, when the death cross officially occurred, NDX gapped higher.  And, then it kept going. In three weeks, it gained a total of 16% (136% on an annualized basis!) and reached new, all-time highs — not bad for a bearish signal.Since QE started in late 2008, every single NDX death cross except one has signaled a bottom — usually the same day but within, at most, the next two sessions. The one exception, in Dec 2012, took 12 sessions.

If this doesn’t make you a believer in the Plunge Protection Team, I don’t know what will.  And, considering how critical NDX’s top stocks are to the market’s overall direction, it’s understandable.

NDX broke above its all-time high on Aug 16, but then spent almost 4 months trying to break out before finally doing so on Dec 7.  Since then, it has been a fairly straightforward meltup.  The only hitch, now, is that NDX has reached a key Fib level that could prove problematic.

With the NDX providing much of the market’s leadership, is this something to be concerned about?

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Just a quick update on VIX, which moments ago pushed below its Dec 15, 2006 lows of 9.39 — the lowest VIX had been in the lead up to the 2007-2009 market crash.The only time VIX has ever been lower was on Dec 22, 1993, when it fell as low as 9.31 shortly after its creation.For implications and forecasts, please refer to our last major update on VIX in How Broken is the Market?