In considering central bankers’ “assistance” to markets, I’m reminded of the old fable about the scorpion and the turtle:

A turtle was happily swimming along a river when a scorpion hailed it from the shore.

The scorpion, being a very poor swimmer, asked the turtle to carry him on his back across a river. “Are you mad?” exclaimed the turtle. “You’ll sting me while I’m swimming and I’ll drown.”

“My dear turtle,” laughed the scorpion, “if I were to sting you, you would drown and I would go down with you, and drown as well. Now where is the logic in that?”

The turtle thought this over, and saw the logic of the scorpion’s statement. “You’re right!” cried the turtle. “Hop on!”

The scorpion climbed aboard and halfway across the river the scorpion gave the turtle a mighty sting. As they both sank to the bottom, the turtle resignedly said:

“Do you mind if I ask you something? You said there’d be no logic in your stinging me. Why did you do it?”

“It has nothing to do with logic,” the drowning scorpion sadly replied. “It’s just my nature.”

Forget their statutory mandates.  FOMC members lay awake at night worrying about three things:

(1) keeping interest rates low enough to prevent devastating deficits, but high enough to keep “animal spirits” alive;
(2) keeping inflation low enough to facilitate low interest rates, but high enough to not choke off investment;
(3) keeping equity prices on the rise, in hopes of eliciting a “wealth effect” or, more importantly, avoiding another meltdown.

They have many tools with which to accomplish the above, of course.  But, in general, QE dominated between 2008-2011.  The yen carry trade took over between 2011 and 2015.  Oil’s recovery came to the rescue for most of 2016.  And, VIX has been the tool of choice since December 2016.

Each of the last three is still active from time to time, with VIX being the most effective lately.  We had a reminder, just yesterday, of how well it works.  SPX was able to break out of a falling channel……simply because VIX was crushed by nearly 20%, dipping below the support of two key SMAs and the bottom of a long-term channel (shown below in yellow.)  In fact, it’s pretty clear that SPX’s recent slide occurred entirely while VIX managed to pop up above the yellow channel bottom.Algorithms, mindlessly searching for clues as to direction, eat this stuff up.  Just last week, Fed chair Yellen admitted that algorithms’ influence is increasing.

Yet, she characterized the rising influence as worrisome.  And, she and several other FOMC members have expressed concerns that equity valuations are too high.  If that’s the case, why do they continue to manipulate currencies, oil prices and VIX?

Like the scorpion, it’s their nature.  Interest rates and inflation are pretty well under control most of the time [in the case of inflation, it’s mostly a matter of defining it properly.]  And, when they’re not, they can be fine tuned or bludgeoned into place as need be.  The stock market is a little trickier — hence the combination and alternating of different techniques.

And, stocks are arguably more closely watched than interest rates and inflation, imparting a daily, almost instant, impact on the country’s financial mood and appetite for risk.

So, although the Fed might like to make it to the other side of the river (with moderate growth, moderate inflation and normalized interest rates) it’s more important to keep stocks on the rise — even if it means inflating bubbles that will ultimately sink us all.

With that in mind, let’s take a fresh look at VIX.  The chart below, which we’ve examined many times, shows a rising yellow channel.  Every year or so, VIX drops down to the channel bottom — corresponding with a rally in stocks which is characterized by general complacency.  The tags are marked by yellow arrows.Note that each tag is followed by a spike in VIX which corresponds with a sharp drop in stock prices (the thin purple line.)

Everything changed following the US election last November.  The historic sell-off which occurred that night (-5.4% in S&P futures) was completely erased by early the next morning after USDJPY and CL made spectacular reversals.  But, the manipulation of oil prices and FX leaves a mark.  It has real and immediate consequences.

VIX, on the other hand, can be hammered into oblivion without inflicting any damage — other than to unsuspecting bears.  And, that’s exactly what happened.  Of the 168 sessions so far in 2017, VIX has tagged or dipped below the yellow channel line 108 times.VIX has been so reliable since the beginning of the year that I have come to regard it as a veritable “toggle switch” for equities.  The big yellow channel bottom nearly always comes into play with any significant rally by SPX.

And, when it doesn’t, it’s only because a lesser trend line or some other surrogate has broken down, instead.  Note that there doesn’t even need to be a break down.  Simply approaching the channel bottom, threatening to drop below it, can be enough to boost equities.Admittedly, we’ve covered this same ground many times over the past 8 months.  Why rehash it now?  Yesterday, VIX crossed a line that should make a difference in whether the bears will finally get their day in the sun.

continued for members…VIX’s falling white channel has been relentless.  Tags on its top have been increasingly insignificant, as even those who don’t believe in chart patterns have learned that they’re a buying signal.The bottom of this channel has been a little more haggard, initially as VIX approached the yellow channel bottom and, lately, as VIX approached its all-time lows.

I have no way of knowing whether or not the 8.84 lows will hold.  But, it’s certainly not hard to imagine the bottom of the white channel — currently just under 7 — being tagged sometime in the near future.  Even if it isn’t, there seems to be plenty of empty air below current price levels.

So, I pay particular attention when breakouts in SPX are accompanied by breakdowns in VIX as occurred yesterday and is continuing today.  The rising purple channel has broken down, and the falling white channel midline is just below at around 10.50.  If this fails, too, then we could soon see VIX testing its former lows — meaning new highs for stocks.ES is currently backtesting its rising red channel midline.  If it can’t make it back above (2469ish) then the target down around the SMA200 (2338-2347) remains in focus (optimally, 2338 on Friday, Oct 13.) Otherwise, we’re likely to rack up incrementally new highs for the foreseeable future.I’m enough of a cynic that I’d short here at 2469 (SPX 2470) and take a chance on a reversal.  But, keep a very close eye on VIX and that potential breakdown and be ready to switch sides.

Aside from VIX’s breakdown, SPX rejoined the red channel this morning.  It was supposed to backtest it, but the backtest extended past the red channel bottom & TL (the yellow arrow) which is a very bullish sign if it holds.The red channel… …which dates back to the start of the year.  Of course, if we ignore the red channel and look at the white instead, we just bounced off the white midline to the white .786, which often serves as a reversal indicator as well. Stay tuned.