ZN broke down from its rising red channel back on the 6th. Since then, it has found support in a falling channel – from which it is now threatening to break down.
This is a moment of truth for bonds and the many correlated assets such as GC, shown above. Stocks might not be amused.
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Lots of calls and emails yesterday from folks wondering how the hell the market could be up so strongly in the face of the violent unrest in D.C.
When the capitol was breached, shortly after 2pm, the S&P 500 was already up 55 points on the day. This came on the heels of a sharp 22-point plunge on the open. Altogether, the S&P 500 rallied 78 points from the daily lows before finally topping out.
We know why this happened. As is so often the case, the algos were directed to erase any signs of dissatisfaction with the events of the day: an abysmal ADP employment reading, FOMC minutes, a brewing constitutional crisis, etc.
Note the slight breakdown of the futures around the time ADP employment (-123K vs prior month +304K and +120K consensus) was released at 8:15. Now, see if you can tell when Fed minutes, which the Fed obviously knew reflected a less than rosy assessment of the economy, were released.
I’ve marked it in case it’s not obvious. Note that it didn’t stop until ES had made a new all-time high (by 1.5 points at 2:15.)
Now, here’s what happened to VIX as the market opened and the day progressed. The breakdown of a falling red channel and the 10-day moving average are pretty common and effective algo signals. I’ve marked the release of the Fed minutes with a yellow arrow. As fate would have it
Sure, there’s too much liquidity in the markets thanks to central banks’ obvious agenda to prop up stocks. But, the cash on the sidelines we always hear so much about didn’t suddenly materialize yesterday at 9:30.
Let’s be honest about what’s really moving markets like this: the systematic and deliberate crushing of volatility which, in turn, signals the machines to buy anything that isn’t nailed down. It happens over and over – and especially when the market’s protectors fear a potential downturn.
As I wrote yesterday…
Either this is the start of a chart-busting rally, or things are about to get very ugly right as ES’ 50-day SMA has reached its Dec 21 lows.
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Maybe Warren Buffett can get through to Congress. In a CNBC interview aired this morning:
“It’s so important that small businesses, which have become collateral damage in a war that our country needed to fight, but we, in effect, voluntarily had an induced shut down of parts of the economy, and it hit many types of small businesses very, very hard… We made some provision for that in March in terms of the CARES Act, but then nobody really knew how long this self-inflicted recession would last with this particular effect on small businesses, so we need another injection to complete the job.”
Congress, the Treasury and the Fed have done a terrific job of “saving” corporations that already had access to plenty of cheap capital and whose stock prices could then vouch for the strong recovery from the pandemic. The rest of the economy? Not so much.
For all the independent restaurants, mom and pop stores, non-big box retailers, things are dismal. And, to all the unemployed folks barely hanging on to their house or their apartment, it will get much worse if Congress doesn’t act in the next few days to prevent them from being evicted during the depths of winter in the midst of a pandemic.
Naturally, futures are up 25 points.
According to VIX, it probably won’t last.
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One of my favorite market indicators is our yield curve model. It has warned us several times in advance of significant correctionsthis year.
Warnings over the past few years have included:
July 16, 2018: The Yield Curve Update – We were a little early. SPX closed at 2798 that day, rose to 2940 before crashing 20% by Dec 26. The final 13% was signaled on Dec 5: The Yield Curve’s Warning.]
April 25, 2019: The Yield Curve Model Warns Again – SPX gained 21 points over the next four sessions before quickly shedding 226 points.
February 20, 2020: Buckle Up – SPX (which had topped out the day before) crashed by over 35% over the next month.
August 25, 2020: Update on AAPL – We were about a week early, but the model signaled a correction which saw SPX fall 11%, followed by another 9% the next month.
The recent breakout of the 2s10s is clearly a bearish signal – though it hasn’t yet paid off. Is the model still working? 
First, a little history. Among other things, the model holds that breakouts above significant resistance are bearish for equities.
If we plot the 2Y and 10Y together, we can see that significant sell-offs in stocks were marked by more rapid declines in 2Y yields than in 10Y yields (i.e., a widening of the spread between the two.)
The shaded areas below illustrate the period during which stocks experienced their most significant corrections between 2000-2013. Though the 2Y and 10Y both declined during these periods, the 2Y yields clearly fell faster.
But, as we saw in 2015-2016 and again in late 2019, not all corrections involved a steepening. These selloffs occurred without the yield curve model signal being triggered. 
Did the model stop working? Hardly. The decline earlier this year was a stark reminder of its predictive power. 
What made these corrections different? More importantly, what is the model signaling now, and how likely is it to play out?
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We noted back on July 9 [see: Moment of Truth] that GC had reached our long-held 1823.60 target well ahead of schedule.
From a charting standpoint, it should reverse here at its .886 Fib retracement. From a fundamental standpoint, of course, the fiscal picture suggests plenty of additional upside. Remember, it broke out of two different rising channels in order to reach this price level well ahead of schedule. We have to wonder whether a reversal in GC would, as would normally be the case, result in a rally in the long-suffering DXY.
We were still bearish on DXY, so the potential for a reversal in GC seemed limited.
As it turned out, the fundamental picture won out. Though it took it about 9 sessions, it finally pushed above its .886 retracement, and then its former all-time highs – breaking out of rising channels in an explosion up to 2089.20.
We got a (quite violent) backtest of 1823 as expected, followed by six weeks of sideways consolidation while pretty much everybody waited for Congress to approve another round of stimulus. Unfortunately for GC, the stimulus never came.
Since then, GC has been settling lower in a falling channel which pointed to a rendezvous with the 200-DMA – which was breached on Friday. This is a significant breakdown which implies a troubled path forward. But, there are other factors at work.
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After being stuck in a textbook triangle pattern for almost six months, XLF finally broke out last week.
We noted its having reached overhead resistance a few weeks ago [see: Yield Curve Model – Correction Imminent.] At the time, the 2s10s was threatening a breakout which, per our model, suggested a downturn for equities in general and XLF in particular.
The 10Y did, in fact, reverse as expected and XLF dutifully tumbled – but, to a higher low. By Oct 30, a triangle was very well established and we were again facing a break out vs break down decision. Note that XLF had dropped through its SMA200 and was in a bearish SMA10/20 alignment. 
Had interest rates continued falling, I have no doubt that the triangle would have broken down and XLF would have reached the .618 Fib at 21.06. Instead, the 10Y popped back above its SMA200 (the yellow arrow)…
…and XLF got a much-needed bounce back to the top of the triangle. Yes, again. This time, however, TPTB were ready. After bumping into the top of the triangle on Nov 5 and 6, XLF received a fabulous gift.
The 10Y gapped sharply higher, again breaking above the SMA200 it had fallen below and even above the top of the rising white channel. It was a massive move from 74.8 bps to 97.5 bps (point 6 in the chart above) in just two sessions thanks to the announcement of a vaccine from Pfizer and better than expected employment data [see: Vaccine!]
As a result, the 2s10s broke above overhead resistance. 
A steeper yield curve is theoretically the solution to the banks’ woes. Though, historically, major breakouts in the 2s10s have led to equity crashes. 
Even for XLF. 
We’ll see if this time is any different.
In the meantime, XLF has backtested the midline of the rising white channel from its 2009 lows…
…following its very obvious failure to break out to new highs in February which resulted in its 44% crash. Note that a failure to push above the midline means at least a backtest of the triangle top around 25.26. Much will depend on some very fancy footwork by the Fed.
The Fed’s exercise in ZIRP, which served as a lifeline to many sectors of the economy – not to mention the stock market, is a weight around the neck of the financial sector.
Rising rates and a steeper yield curve might be okay with $7-8 trillion in debt. But, at $28 trillion, it’s a tad scary.
Can the Fed find a way out of the corner into which they’ve painted themselves? Can they maintain the disconnect between the S&P 500 and the pandemic-stricken real world in which 30% of Americans are expected to be infected and another 200K are expected to die?
“We’ll spend the next three months probably infecting another 15% and get to 30%, maybe more,” [former FDA Commissioner Scott] Gottlieb, now a CNBC contributor, said on “Squawk Box.” “Thirty percent assumes the current run rate if things don’t get any worse.”
Stay tuned.
Sometimes I cringe when I place a target on a chart. Such was the case yesterday when ES reached our IH&S target at 3425. If it kept going, it was sure to backtest the intersection of the broken rising white channel at the falling channel top. Was that likely in the midst of election and pandemic turmoil?
Apparently so, because that’s exactly where ES ended up overnight.
Although I tire of saying it, this is an important threshhold for the overall market – which has benefited smartly from a rescue maneuver that wasn’t even really necessary.
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Futures were all over the map last night, with ES’ 113-pt range dictated almost entirely by factors as opposed to election results – which, contrary to Trump’s declaration, are still AWOL. Note that ES tagged our IH&S neckline (also the former H&S neckline) target where it is currently running out of gas.
As expected, the most important factor was VIX which collapsed over 18% from its overnight highs – slicing through channel midline and the 10, 200 and 20-day moving averages.
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CPI rose 0.2% MoM in September, half the August rate. It rose 1.4% YoY, slightly higher than September’s 1.3%. Without the outsized gains in used cars and the minor gains in energy (conflicting with the official EIA data), MoM CPI would likely have been negative.
This is hardly supportive of the reflation narrative driving equity prices lately. This should be the last straw for the 10Y’s bounce, with the resulting breakdown a significant headwind for stocks.
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Futures ramped higher overnight, continuing to dance to the tune of VIX’s smackdown and ongoing rumors of a fiscal stimulus deal…
…and ignoring troubling pandemic facts.
But, we’re finally into October and Q4. And, as we discussed yesterday, things are about to get very interesting.
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