Futures nailed our 4424 target overnight. Most will attribute it to Powell’s (completely unsurprising) resolve to support the economy the stock market. But, we know that the algos were spurred into action by VIX’s drop back into the falling channel from Mar 2020 and its dip below its 200-DMA.
Remember, it ain’t over till it’s over. Follow this headfake at your own peril.
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OPEC+ is expected to increase production by another 400,000 bpd in today’s meeting, another dagger in the heart of the stubborn oil/gas rally. Of course, at this juncture, CL can backtest its SMA200 without even making a lower low. So, perhaps a pullback will finally be allowed.
Given how important rising oil/gas prices have been to equity performance, stocks might just have a hard time digesting a significant pullback.
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If you liked yesterday, today is shaping up as more of the same. But, there are still a few warning signs tugging at the market’s sleeve.
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Futures are continuing their meltup in the pre-market on a 4% bounce in crude oil and the usual overnight slump in VIX.
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The correction is gathering steam, with ES off 40 points earlier this morning before getting a bounce. From a technical standpoint the culprit is VIX, which broke out of the falling channel which has guided stocks higher since March 2020. 
Our downside targets remain unchanged.
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July retail sales fell 1.1% versus -0.3% consensus, reflecting the impact of stimulus payments, Amazon’s Prime Day change, and the general apprehension surrounding the delta variant.
Yesterday’s bad news faded under heavy algo action, with VIX going into meltdown mode…
…the instant SPX reached its SMA10. 
The bears will get another shot today.
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The Fed detests gold and silver because, like higher interest rates, they are a stark reminder of the soaring inflation the Fed hopes we’ll ignore. Interest rates can be manipulated lower by buying up every bond in sight. The Fed has been doing this to the tune of $120 billion per month.
Gold and silver, on the other hand, can simply be shorted, which is exactly what has happened – once again breaking a significant long-term uptrend and dashing gold bugs’ hopes for a breakout.
Silver, having reached our next downside target, faces a particularly important test.
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I’ve recently discussed this very issue with several friends who are a little nervous about the sharp runup in prices…and very nervous about the prospect of a selloff.
Most of us remember how ugly things got during the Great Financial Crisis: the sharp rise and the much sharper plunge when the bubble burst. According to HUD, the median sales price of a home fell about 20% from $257,400 in Q1:2007 to $208,400 in Q1:2009. 
The fallout was both disastrous and widespread. Yet, years later, it appears modest compared to the subsequent reinflation. The median sales price reached $358,700 in Q4:2020. 
It’s the size and speed of the bubble’s reflation that has many worried – particularly given the Fed’s involvement. How so, you ask?
In the wake of the pandemic, the Fed cut short-term rates to zero and began large scale asset purchases which have been more than enough to purchase the entirety of Treasury’s monthly borrowings: $120 billion per month, including $40 billion in mortgages. The net effect was to drive interest rates to all-time lows and keep them there.
If you’re feeling pretty smart about all the money you’ve made in real estate over the past year, make sure you fire off a thank you note to Jerome Powell.
Most home buyers purchase as much house as their income will allow. That is, they focus more on the monthly payment than the purchase price. Lenders, likewise, use a formula to compare your monthly housing costs to your income.
These debt-to-income ratios vary. But, in this example, we’ll assume a 33% ratio – meaning the total house payment should be no more than 33% of your monthly gross income.
A home purchased for $1 million with a $200,000 down payment at the current jumbo mortgage rate of 2.6% would require a monthly payment of about $3,203. Toss in $1,000 per month for taxes and insurance, and you’d be looking at a total payment of $4,203. With a 33% ratio, the required annual income would be around $152,826.
If mortgage interest rates had been 6% instead of 2.6%, the monthly payment for that same $1 million house would have been much higher: about $5,796, requiring an income of $210,778 to qualify for an $800,000 mortgage.
And, there’s the rub. Cutting rates to all-time lows clearly reinflated real estate prices. People have been able to afford more and more expensive homes because the Fed kept cutting rates, keeping the payments super low even as the prices soared.
What happens if rates ever rise back to normal levels? The chart below shows the relationship between falling rates and rising prices. But, you can read it the other way around too. If rates rose, what would the price need to drop to in order to maintain the same monthly payment?
A rise in rates from 2.6% to 3.6% equates to a price drop from $1 million to $880,000. A rise to 4.6% would mean a drop to $780,000 – enough to wipe out your equity and leave you owing money at the closing.*
The Fed has managed to hold interest rates low by buying up all the bonds it sees. The flood of QE required to suppress rates has bid up not just real estate but most other categories of goods and services as well, thereby amping up the pressure to raise rates.
The Fed could mitigate inflation by raising rates or suppressing oil prices, but either would do some damage to stocks – another overinflated market. So, instead, they keep insisting that everything’s just fine, even as they paint themselves into a corner.
Is it time to sell your home? If you’re planning on it any time soon, consider the above and keep a very close eye on the market and on interest rates. It won’t necessarily happen tomorrow. In fact, sales/prices typically increase in the short run when rates begin to rise because buyers fear even higher mortgage rates to come.
But, spoiler alert: it will happen by this time next year. The Fed is playing a dangerous game – not because they love taking enormous risks but because, having reinflated all these bubbles, they have no other choice.
We all remember what happened the last time inflation reached these levels. From the July 2008 FOMC statement to Congress, the only time in the past 30 years that CPI has topped last month’s 5.4%:
According to these projections, the economy is expected to expand slowly over the rest of this year. FOMC participants anticipate a gradual strengthening of economic growth over coming quarters as the lagged effects of past monetary policy actions, amid gradually improving financial market conditions, begin to provide additional lift to spending and as housing activity begins to stabilize.
Stocks crashed 50% over the next 8 months as the Great Financial Crisis decimated the economy.
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* the spreadsheet below shows the effect on price of a change in mortgage rates, while holding payment and qualifying income steady.
Stocks rarely drop over a 3-day weekend. This one was no exception. The miniscule decline we saw in the futures last night has been all but erased despite a conciliatory 5% bump in VIX to backtest its SMA10. No fuss, no muss.
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Under ordinary circumstances, a 2.3% MoM bump in Durable Goods orders would be very welcome – especially on the heels of last month’s -1.3% print. When inflation is a growing concern due to the Fed’s largesse, however, it complicates things. For instance, might it cause the Fed to take its foot off the gas?
Not to worry, VIX was hammered sharply lower for the fourth session in a row. 
It’s now off 35% since Monday’s highs and has reached levels last seen on Feb 14, 2020, a few days before the market crashed. Note that this is the target we first charted back in early April [see: Irrational Exuberance and You]…
…when we observed that VIX was repeating a pattern seen many times over the years.
It should come as no surprise that VIX did break down and SPX did, indeed, rise above 3956. Like all the other breakdowns, this one has the potential to keep the party going long past curfew.
This time, it went a step further – breaking below a falling trend line – especially bearish for VIX and bullish for stocks. It now has the opportunity to break below the trend line from 2017 — all the reassurance algos would need in order to bid stocks even higher.
Along the same lines, RBOB futures just topped their May 2018 highs (CPI was 2.8%) and are now 27% higher than their Feb 2020 (2.33% CPI) peak – even though total miles driven in April 2021 were 10% lower than April 2020 and 11% lower than in May 2018. RBOB hasn’t been higher than this since Oct 2014 when CPI, now 5%, was retreating from its recent 2.13% highs.
If this all seems a little overdone, you’re right. The economy has rebounded. But, few responsible economists would argue that things are better than in Feb 2020 when markets crashed as the pandemic roiled the global economy.
The obvious X-factor, of course, is the massive amount of money the Fed has thrown at markets. The less obvious factor is the ease with which the Fed can manipulate algos. The warning signs which used to cause correction-causing reversions to the mean — rapidly rising inflation and interest rates, rising volatility, etc. — are no longer legitimate concerns.
Why? Because the Fed has proven that stocks can keep rising even in the face of data that would otherwise be problematic. So what if inflation is out of control? Interest rates sure don’t reflect it. Below trend GDP? All the more reason for massive QE. 
They haven’t learned how to cure the patient, let alone prevent him from getting sick. But, they’ve rigged the thermometer, the blood pressure cuff, and the stethoscope to indicate that everything is just fine.
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