In a bit of a delayed reaction to Treasury’s announcement of its $3 trillion borrowing needs in Q2, the 2s10s has pushed above the white TL connecting all-time lows – a clear warning, should it last, for equities.
Meanwhile, CL backtested its Feb 2016 lows and USDJPY broke down at about the same time that ADP announced another 20 million job losses (roughly in line with Friday’s NFP.) All of this came on the back of dismal earnings from market darling Disney.
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It’s a day we all knew was coming — over 1 million cases of coronavirus cases officially diagnosed in the US, over 3 million worldwide. Experts such as Scott Gottlieb, former head of the FDA, estimate that actual US cases are 10 to 20 times the reported figure. Deaths currently stand at 56,803 – about 30% of all closed cases.
Social distancing has slowed the rate at which new cases are being diagnosed. But, with many states reopening, a shortage of tests, no contact tracing, and no viable therapeutic or vaccine yet available, the number of cases and deaths seems likely to accelerate.
The market continues its oblivious ways with last night’s low-volume meltup good for about 1.5% so far as the Fed begins its two-day meeting.
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With May contracts in the rear view, we wondered whether oil markets would revert to some sense of normalcy. A steep contango continues, however, with June contracts assuming the role of the panic stricken expiration month.
Futures tested our initial downside target yesterday, the Fib 2.24 extension at 2728.79, and bounced overnight…
…as oil and gas prices bounced sharply off our downside targets…
…and VIX collapsed after tagging our backtest target.
The question, as is often the case, is whether the relief rally can continue once equities’ cash market reopens. And, will SPX ever get to test its own critical support?
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Many seasoned investors are surprised to see how positively correlated stock returns have been to oil prices. Energy stocks make up 8% of the overall market, so you’d expect them to have some influence. But, thanks to the increasing prominence of algorithms and quantitative trading, the impact has grown well beyond what 8% should contribute – with most of the market’s significant highs and lows perfectly aligned with oil’s over the years.
A 2017 study by JP Morgan estimated that only 10% of trading volume is by discretionary investors who focus on fundamentals. This means that 90% of all volume is driven by passive and quantitative techniques including everything from index funds and ETFs to high-frequency trading and corporate buybacks.
The tail that wags the quantitative dog is algorithmic trading, where hundreds or even thousands of factors are constantly monitored and provide instant input for trading decisions. While these factors include big picture economic data such as interest rates, inflation or employment figures, the Big Three that consistently drive big moves on a daily basis are VIX, the USDJPY and the price of oil – specifically WTI futures [CL.]
Oil is the only one of the Big Three which has an almost immediate and substantial impact on the US economy. So, when prices are manipulated higher or lower, we see a change in inflation data, interest rates and, of course, stock prices.
This is why we were able to call the top on October 3, 2018:
CL and RB…not only reached overhead resistance by our measure, but must deal with inflation that’s too high, bearish API data, another round of Trump tweeting, and a large build in EIA inventory. I think the time has finally come to revert to short…
CPI had recently reached almost 3%, dragging interest rates higher as well. The 10-YR reached 3.25% on Oct 5, threatening to break out of a channel dating back over 20 years at a time when debt was exploding higher.
Trump had been jawboning and tweeting his desire for lower oil prices. But, his entreaties had fallen on deaf ears until Oct 3, when journalist Jamal Khashoggi was brutally murdered and dismembered by agents of Saudi Arabia for criticizing Saudi Crown Prince Mohammad Bin Salman (MBS.)
As details emerged and MBS’ complicity became evident, Saudi Arabia suddenly needed friends in high places. Trump was happy to oblige, but had one condition: oil prices needed to decline immediately – which they did. CL plunged 45% over the next 11 weeks.
The YoY drop in oil and gas prices was immediately reflected in inflation. CPI dropped from 2.52% in October to 2.18% in November and a low of 1.52% by February 2019.
The 10-YR dropped from 3.25% in October 2018 to 2.36% by March 2019. Prices at the pump plunged as well, and Americans rejoiced at more affordable commuting costs.
Remember, oil is one of the Big Three drivers of stock prices. So stocks plunged as well – shedding about 20% by December, when Treasury Secretary Mnuchin convened the Plunge Protection Team to prop up the market – enabling stocks to reach new highs while CL merely enjoyed an extended bounce.
Saudi Arabia needed the bounce every bit as much as did stocks. The troubled Aramco share offering had been delayed time and again, and higher oil prices made a larger raise possible. The plunge resumed within a few weeks of the IPO.
Then came the slowdown. Demand had already been ebbing and prices had been settling lower for weeks. But, after a very brief bounce, oil prices plunged when COVID-19 came onto the scene. Suddenly, fundamentals mattered again.
Prices plunged to the bottom of a falling channel from 2008 over 3 years ahead of schedule per the cycle study we first posted in March 2019 [see: Macro Cycles and Regime Shifts.]
This added fuel to the fire for stocks, which already had plenty of reason to plunge as global economic activity screeched to a halt. Algos, which might normally have been employed to prop up stocks, were pressuring them lower. At the same time, the USDJPY was falling as the Japanese yen rallied and VIX spiked higher on greatly increased volatility.
Note that long-term trends in gasoline prices were also in danger of breaking down.
Perhaps more alarming to Team Trump, the Dow had fallen to levels not seen since the 2016 election. 
The energy industry is vitally important to the US, with millions of jobs and billions in loans dependent on prices stabilizing. It’s no surprise that the federal government would support it as it has many other industries which have been decimated by the global pandemic. Many majors oppose price supports, perhaps hoping to scoop up highly-leveraged players at a bargain price when they failed.
However, instead of making low or no-interest loans available to tide the industry over as it has with every other affected industry, Trump has focused on artificially inflating prices — first with a series of Tweets and lately with a threat to impose tariffs on imported oil.
As a result, oil has spiked over 50% higher in a mere 4 sessions…
…facilitating a 24% bounce in the Dow.
While some are thrilled with the outcome, there are winners and losers. The biggest losers are those who can least afford it: consumers. Higher oil and gas prices are a regressive tax on those consumers who must still drive (disproportionately those less affluent) or buy heating oil or natural gas to keep their families warm during the waning days of cold weather.
It’s important to recognize that Trump’s insistence on higher oil prices might be partly about saving oil industry jobs, but it’s really about saving the stock market which has learned to take its cues from oil prices.
If Trump’s “friend” Mohammad Bin Salman — a “man of the people” — still owes any chits from 2018, oil prices could be well supported going forward. But, of course, it will require the assistance of Trump’s other friend, Vladimir Putin, whose willingness to cut back production involves slightly different priorities.
With COVID-19 deaths in the US topping 10,000, Putin’s response will be important in crafting the next headline-stealing development. But, most studies I’ve seen indicate that supply now exceeds demand by at least 25 million bpd. So, even the 10-15 million cut suggested by Trump would do nothing to erase the massive oversupply but would merely slow the rate at which the excess is building.
Rumor has it that Russia will play ball as long as every other oil producing nation is willing to share the pain – including US shale producers, many of were already on life support before COVID-19 (and expect a decent return on their political donations.)
If I sell you 100 barrels at $30 instead of 200 at $15, have I made any more money? Will I now be able to pay back that overdue loan? Will the market reward my stock? Unfortunately, it only works if the pain is borne by the other guys — which will likely boil down to good, old-fashioned horse trading. Trump’s opening ante is throwing down-and-out Americans under the bus. We’ll see if it’s enough.
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In our last dedicated update on the Dow [see: July 2019 Update], we noted the intersection of a number of overhead resistance features in its chart and offered some thoughts on its downside potential if it managed to reverse.
Note that our 18974 target represents a backtest of the red channel from which DJIA broke out and backtested between 2014-2016 as well as the white 1.618. A May 2020 bottom at 18974ish would align nicely with the SPX 2138 target indicated by our analog.
I posted my charts on July 29 (the yellow arrow) and was roundly cheered when he Dow cratered 7% over the next two weeks, even closing below its 200-DMA…
…and was loudly jeered when it made that up and went on to new all-time highs. I’ve seen this sort of thing so often from the Dow that I was pretty hot under the collar. I’m pretty sure an older (yes, there are a few) wiser colleague took me aside and muttered “Forget it, Pebble, it’s the Dow.”
So, I did. You see, when it comes to manipulation the Dow is the all-time champ: share price weighted, with the ability to kick out losers and slide in winners whenever you like? How is this even an index?
When the market reversed on cue in mid-February [see: A New Day, Same Old Nonsense] I don’t think I even checked to see where the Dow was (the blue arrow below.) I’ll admit I got curious when it closed below its 200-DMA on Feb 25. But, I didn’t inhale. I stayed focused on real indices, cratering oil prices and the bond market.
Well…guess where it landed today? Go ahead. I’ll wait.
You guessed it. Right where our July 2019 forecast said: the bottom of the falling red channel where it intersected with the top of the rising red channel and the 1.618 Fib extension at 18974. It’s a 33% drop from stem to stern. You can’t make this stuff up.
Knowing we have a global pandemic on our hands and a minimum of a quarter of negative GDP ahead of us, surely it’ll keep going, right? I mean, did you hear Bill Ackman today? Hell is coming! So, the Dow is positioned for a bounce. That’s right. IF oil and gas can continue bouncing, and IF USDJPY can pop up through its SMA200 and IF VIX breaks down and IF the 2s10s craters back below 48 bps, then DJIA will definitely probably bounce. At least a little.
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The futures are lock limit down again this morning, with ETFs trading in the after-hours indicating losses on the (eventual) open of up to 10%. This is probably not what the Fed had in mind when they unleashed the massive, emergency rate cut and $700 billion in new QE an hour before the futures opened on Sunday.
As before, the factors are all aligned bearishly, with the bond market failing to swing back to a bullish alignment yet despite the Fed’s desperation move. There are, however, some glimmers of hope.
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Two charts best define the day we had yesterday.
First, VIX tagged our next highest target: the intersection of the .786 Fibonacci retracement and the trend line connecting two previous highs.
The other one was the SPX arithmetic (as opposed to log) chart, which stopped on a dime at the channel bottom.
The bleeding continued well past the Fed’s ineffectual $1.5 trillion injection and had to wait until the low-volume aftermarket to be staunched. At that point, central bankers went to work – pumping oil and gas, the dollar, interest rates and currencies in order to restore confidence whip up the algos. It worked…at least so far.
I’ll have a separate post up later regarding COVID-19, including my latest projections for the US.
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It’s been a while since we took a big picture look at VIX. Since it reached levels not seen since the GFC yesterday, this seemed like as good a time as any.
VIX is an interesting instrument. Once a reliable measure of volatility in the market, it was used by many to hedge risk. As equity corrections became an endangered species, however, fewer investors bothered.
Eventually, VIX became a source of income for those willing to take a chance on selling vol. It might have seemed risky at times, but every one of the six times VIX exceeded 46 since 2010 was followed by a collapse to below 15. Actually, make that 5 out of six times.
On Feb 28, VIX shot up to 49.48, but it only dropped as low as 24.93 before bouncing up to yesterday’s high of 62.12. The price to which it rallied was significant.
Eagle-eyed members will note it’s been one of the higher targets on our charts for years – but, one we seldom mention as VIX is always smacked down upon reaching a lesser Fib level and a price between 46 and 54. From the post Market Timing, a Bad Thing? last October.
The 25.50ish target represents the intersection of the .382 Fib, two red TLs and the midline of the white channel seen below. If 25.50 should ever be broken, things could get very interesting very quickly.
The 62.12 high was very close to the .618 retracement (58.6) of the drop from 89.53 in 2008 to 8.56 in 2017.
Now, it was no surprise that VIX stopped rising once ES had dropped to our 2728 target. But, the breakout begs the question: What do the charts say about the even higher targets?
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After weeks of gathering clouds, the storm we’ve been watching has finally arrived. S&P futures are lock limit down just a few points above our next downside target.
Not surprisingly, all of our other targets across currencies, commodities and fixed income have either tagged or exceeded our next downside targets, with more to go once the cash market opens.
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Once upon a time, a few boys whose families owned the biggest lemon groves in town got together and opened up a lemonade stand. It was a very hot summer, so they sold an enormous amount of ice-cold lemonade. Since they controlled the supply of lemons, they were able to quickly raise prices from 10 cents per glass to as much as $1.50. Their customers didn’t mind as they could afford 1.50, it was excellent lemonade, and there were no alternatives. They like it so much, in fact, they invested $2 trillion in shares of the stand.
One day a freak storm hit town, and the temperature dropped from 95 to 25 degrees in a matter of hours. The weatherman said it could last for months. Not many people were interested in ice-cold lemonade, even though the boys frantically dropped their prices. They even tried cutting back on the amount of lemonade they made. For some reason, this had no effect on sales, and prices continued to drop. A few boys split away from the group and tried selling cheaper lemonade on their own, but this further depressed prices. Soon, the lemonade stand went out of business. The end.
And that, boys and girls, is how OPEC came to be in their current predicament.
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