The algos have been working overtime this holiday weekend. CL is threatening another breakout, VIX is back below the two-month old bullish (for stocks) channel, and USDJPY is potentially staging a comeback.

It was enough to prompt a 5-pt bump in the futures which, while not much, is enough to keep the trend alive…for now. The problem comes in when you consider the longer-term economic implications of the above: higher inflation, higher interest rates and mounting fiscal problems. But, those concerns are being set aside in order to pursue a critical breakout in equities.

continued for members…

By continuing to work lower, VIX continues to drive SPX/ES higher. Obviously, there’s a triangle setting up (the purple TL.) But, at this point, the falling white channel counts for more than the rising TL.Currencies have also been supporting equities. Note that the dollar’s break out, a function of actual and expected interest rate increases, continues……which has been supportive of the USDJPY and the yen carry trade.   The charts are practically mirror images.The net result for ES has been a sharp rally with hardly any backtests to speak of. Let’s examine, from a chart perspective, why it’s so important for TPTB to keep the rally going at this particular price and point in time. Here’s the daily ES chart going back to the crash.It’s clear that the channel broke down in early 2016, the result of a number of things including yen strength and CL weakness. The white arrow identifies the white channel break, and the yellow arrow identifies the point at which TPTB were able to arrest the slide.ES is obviously back in the rising channel and just broke out past the midline signal.  However, it’s now testing the top of a rising yellow channel / TL that connects the past years highs and lows pretty well.

It’s helpful to look at each of these relationships. CL had plunged from 112 a few years before. When it dropped through 39 in Dec 7, 2015 (the yellow arrow below), it represented the break down of a long-term rising channel and completion of a bearish H&S pattern. This was a disaster for oil and oil companies and had a direct impact on stocks (energy is 8% of the S&P 500.)

But, it was also a problem for the countries that rely on oil for the bulk of their income and power and, of course, the unhedged banks, insurance companies and brokers who had extended way too much credit to the sector. Note how ES (the purple line below) after bouncing 220 points off its September lows, came unhinged and plunged to new lows after oil broke down through this critical support.

It was only when CL bottomed out on Feb 11, 2016 that stocks finally rebounded. We wrote about it at the time, noting that it a rebound in both USDJPY and CL was critical to stocks recovering [see: USDJPY Finally Relents.]

USDJPY, which spiked higher in Aug 2014 (precisely when CL broke down,) reached an important level of overhead resistance at 120.11. It danced around it over a year, never quite breaking out even though it constantly threatened to.It finally broke down in Dec 2015, backtested 120.11 at the end of Jan 2016, and plunged again until Feb 11, at which point it got a nice two-month bounce that saw it go sideways. It dropped some more after the CL rally was underway — seemingly no longer needed. The effect of CL doubling over a period of only 4 months was that powerful. Then Brexit happened.Oil, which had reached overhead resistance, took a hit. It was up to USDJPY to prop up stocks. And, it did — rallying over 7% from Jun 24 to Jul 21 — which helped save stocks from melting down.

But, that was nothing compared to the 17% bounce that propped up ES following Trump’s election.In many ways, the falling white channel shown above isn’t a great fit. The red one below has a top and midline reversals that make more sense. But, I favor the white channel because it allows for a return to the .618 at 120.11. In fact, the channel top and fib intersect the rising white channel midline in the next 1-3 weeks.

I think this is significant.  Although oil and gas prices weren’t fully accounted for in the latest CPI data, they still bumped the headline number up past where will affect both household budgets and interest rates. I think this is the reason CL hasn’t broken out, despite the bullish spin being released daily.  According to this Zerohedge article citing Bloomberg and others, spec hedge fund longs have never been larger.

My gut tells me oil is overbought, and that a drop in oil prices and the value of the yen (rise in USDJPY ) will arrive during the next few weeks.  The only reason it hasn’t occurred yet is the channel top/TL of overhead resistance.  It can be seen on the ES chart, and it’s obvious on the SPX chart, too.Note that SPX just now cleared the purple .1.618.  They might want the index to get significantly higher than the 1.618 before backtesting it.

This, of course, raises the question of when and where the next major moves will come.  CL and USDJPY can rise in tandem, but it inflicts significant pain on Japan to have higher oil prices and a less valuable yen.  So, one scenario is that USDJPY rises back to 120.11 — breaking out of the more “obvious” red channel to boost stocks as CL backs off to a level that isn’t as problematic in the US (CPI, plus the rising rig count in the Permian Basin.)  Together, cheaper oil and a cheaper yen mean that the BoJ can continue to make the argument that inflation is too low for them to normalize rates.

Another (scarier) scenario is that central banks really are ready to unleash inflation.  CL continues rising, which alone will boost stock prices — along with CPI and interest rates.  I call this the scary scenario because our fiscal and deficit picture doesn’t permit a return to normalized rates  — probably ever.

They can continue to cycle VIX up and down and eek out more SPX points.  But, at the end of the day, they need something to keep momentum alive.  That means a rising CL, or a CL that rises off a lower low that is achieved whilst USDJPY is rallying up to 120 or above.

Either way, the path forward is fraught with danger.   Data analysis plays an increasingly important role in investment decisions.  Those crunching the numbers are no doubt coming up with the same results: CL, USDJPY and VIX are calling the shots.  It makes for a crowded trade, and the odds of a crack in the system increase.

Just today, Bloomberg ran an article saying much the same thing.  Hedge fund liquidity has dropped to a dangerous level.  And, more and more money is piling into the same few stocks.

So, we have a heretofore successful strategy of algo manipulation working against mostly bearish fundamental and technical indicators.  Tomorrow, PG&E willing, I’ll focus on the logical turning points for DX, USDJPY, CL, VIX and interest rates in the hope of discerning some timing for the showdown that’s likely to ensue.

GLTA.