Few charting patterns receive as much attention as the death cross and the golden cross. In a death cross, the 50-day moving average falls below the 200-day moving average, suggesting lower prices ahead. In a golden cross, the 50-day moving average moves above the 200-day, portending higher prices.

As we marvel at the speed and distance of the market’s bounce since March 23 and question whether the Fed’s assistance somehow invalidates it, it’s worth noting that SPX is about to experience a golden cross.The last time a golden cross occurred was on Mar 29, 2019. SPX closed at 2834 that day and rallied nearly 20% to 3393 on Feb 20, 2020 before crashing 35% over the following month.  [Incidentally, the Mar 30 death cross was a head fake, as the bottom was already in and stocks barely paused.]

The previous instance came on Apr 25, 2016 when SPX closed at 2087. It went on to rally over 40% until topping out on Sep 21, 2018 and shedding 20% over the following three months. Looking at only these most recent instances, one might think a golden cross is a very bullish signal to throw caution to the wind – at least for a while.

On Dec 24 2015, however, a golden cross turned out to be one of the greatest headfakes in years.  SPX pushed slightly higher over the next two days, then plunged 13% in a matter of 14 sessions.The biggest question in the investment world these days is whether the 15-minute 35% crash in March was an isolated incident and we have clear sailing ahead or whether there’s a bigger storm up ahead.

To put it another way, has the massive central bank intervention really precluded any more downside?

continued for members…

From a trading standpoint, we can see that a golden cross isn’t at all a sure thing. But, it sure simplifies things. If the bearish 10/20 cross unwinds, as it is close to doing, SPX is back in a bullish condition with its SMA10 (the obvious stop) about 2% below.

If SPX should drop through its SMA10 and the 10/20 cross doesn’t unwind, then the bearish signal continues and we have an obvious target at the SMA200 – a nice 4.6% drop. A decline through the SMA200 (currently at 3024.53) would confirm (noting the headfakes) the downside move. ES is very much in the same condition and, like SPX, has had its share of headfake closes over the past month.Admittedly, these are the sort of margins that are more amenable to swing trading, but it’s good to have nearby support when the potential for a big drop is so obvious.

If you believe, as I do, that those manipulating stocks higher wanted to get SPX as high as possible without it running away to new highs, today’s high should hold and we have significant downside from here.

The fundamentals would also suggest significantly more downside. Major swaths of the country are undergoing huge spikes in coronavirus infections, sure to be followed by sharp increases in deaths. Whole industries are essentially shut down. Except for a handful of companies which benefit from the shutdown, YoY earnings reports will continue to be dismal. Bankruptcies are on the rise. Unemployment, while improving, is still historically very high. And, a vaccine – the only true antidote to any of this – is at least 5 months away (assuming a successful one comes at all.)

Since the Fed has played such an important role in the market’s recovery, it’s worth noting we have one more large ($6.025 billion) POMO purchase coming tomorrow, and then outright purchases should taper off.

But, as readers know, it’s not just the fundamentals or QE, it’s the algo-inspiring moves in VIX, USDJPY, oil and bonds. We’ll start with oil, where CL has closed the gap from March and, so far, refused to move much one way or the other. CL has recovered from negative values in April to over $40, with the bulk of the recovery happening in the first month……and a very slight gradual increase since then. We have to vertically “stretch” the chart just to see the oscillations which are about to finally tag the channel bottom.  For the record, RB has almost closed its gap (1.325 vs 1.384)……and has been performing the same levitating maneuver since its own bottom. It hasn’t yet backtested its SMA200, though it came within .02 on June 23.

The reason we care so much about oil and gas prices, of course, is that in addition to driving stock prices they determine inflation and, thus, interest rates.

June’s price data for gasoline will reflect a 12.9% monthly increase and a 23.2% annual decrease. According to our model, annualized June CPI (due out Jul 14) should come in higher than April’s 0.33% and May’s 0.12% – perhaps 0.6% or more. The monthly read should exceed 0.27% (after readings of -0.67% for April and 0.002% for May.)

While not earth-shattering, the increase should put additional pressure on interest rates at a time when the Fed is desperate to keep rates low thanks to the ballooning debt/deficit.  As we discussed last week, rates had to crater. As debt increases, they need to crater even further. There was and still is no alternative.

Had the average interest rate on federal debt remained at 6.63% since 2000, for example, interest expense in FY 2019 would have topped $1.5 trillion instead of only $574 billion, consuming 53% of government revenues and resulted in nearly $50 trillion in federal debt.

The chart below is a stark visual of the impact that failing to lower rates would have had; but, it only tells half the story. The reality would have been even worse as much greater interest expense would have generated larger annual deficits and greater accumulated debt which would have, in a vicious cycle, increased interest expense.

The BoJ and ECB have learned the hard way that there is no easy way out of such a debt spiral. The only alternatives to defaulting [some have suggested the US government default to the Fed] are to grow your way into budget surpluses – nice in theory, nearly impossible historically – or to continue borrowing at ever more affordable rates that compensate for the rising debt.

“Ever more affordable rates” of course is the gateway to negative interest rates.  As long as borrowing costs nothing or even brings in revenue the game can theoretically continue forever – a consequence-free means to a solvent end, with rising stock prices to boot.  At least, that’s the horse to which the Fed has hitched our wagon.

And, this is where it gets tricky. Fundamental analysis stipulates that lower interest rates boost stock valuations by increasing the present value of future cash flows. But, market crashes also produce falling interest rates. As capital flows out of stocks and into bonds, bond prices rise and yields fall.  Bottom line, falling rates can mean rising or falling stock prices. It boils down to why rates are falling.

As central banks have become increasingly active in equity markets, we’ve also seen interest rate policy driven by the anticipated effect on stock prices more so than considerations of stable prices and full employment.

In periods of high inflation and interest rates, when investors most fear the repercussions of rising debt, we’ve witnessed the Fed lower interest rates to alleviate fear and support stocks. During periods of low inflation and low interest rates, we’ve seen the Fed raise rates (or simply allow them to rise) in order to boost inflationary expectations.

It’s instructive to compare 10Y yields to the stock market over the years. First, note that 10Y yields have followed a well-defined falling channel for years and have bottomed on a fairly regular basis – about every 4.4 years. The bottoms (the vertical purple lines) in 1998, 2003, 2008 and 2012 were 1,715, 1,682 and 1,646 days apart – a variance of only 4%.

The 2008 line is a cheat, as the Jan 23 low held until Nov 20, 2008 when QE kicked in to save the stock market and yields plunged to the new, Dec 17 lows which fleshed out the falling yellow channel.  The cycle held for the Jul 25, 2012 lows, however – 1,646 days after Jan 23, 2008.

In July 2016, we saw the cycle shortened yet again. SPX had bounced off the important 1823 Fib level in February and made it back to the Nov 2015 highs. After three separate efforts to break out, the Fed released its June minutes on July 6, stating that they intended to put any additional rake hikes on hold. This made perfect sense, as annual CPI was hovering around 1% after averaging 0.12% during 2015. But, there was more to it.

The Brexit referendum had just been approved and stocks were retreating from resistance (the yellow line below), with SPX dropping and closing below its 200-day moving average again.  The 20 biggest banks had shed half a trillion in market value YTD.  Central banks were getting very nervous.The day after the referendum passed, the 10Y dropped from 1.75% to 1.53%. By the 6th, it had plunged to 1.34%. As discussed above, rates were plunging in response to a strong flow of funds out of stocks and into bonds. A signal was needed.

Despite moribund inflation, rates had to rise. Along with VIX being crushed back below its SMA200, a sharp USDJPY bounce, and timely Fed governor comments, the narrative was massaged into one of recovery and rising inflation.  By Dec 15, the 10Y was back to 2.62%.

We faced another shortened cycle this past March, when SPX’s 35% crash sent the 10Y tumbling to a cycle low of 0.398% after only 1,342 days. In this case, the 10Y topped first – tagging the top of the falling yellow channel at 3.25% when oil topped out in Oct 2018.

This is as good a time as any to point out that equities have become increasingly sensitive to changes in rates. As in 2016, algorithms cue off them in making buy/sell decisions, resulting in an environment where the Fed’s unspoken motives have become more important than the presumed economic impact of changes in interest rate policy.

The hitch? We know there is no way in hell that the US can afford for interest rates to normalize.  The Fed will continue to follow the Bank of Japan and the ECB down the rabbit hole of lower rates in the interest of both minimizing debt and deficits and maximizing equity returns.

Periodically, a steady increase in rates can drive stocks higher and stave off a market correction. But, given the huge increases in the deficit and debt, these increases will likely never be anything more than temporary bumps.

The Fed has painted itself into a corner much like the BoJ, where markets aren’t satisfied with low enough – they need lower. Always lower.  Under this theory, March’s lows weren’t low enough. We’re in for another leg down, a lower low.

If the next low comes 1,621 days (the average since 1998) after Jul 6, 2016, it would fall on Dec 13, 2020. If we throw out the shortened 4,443 day span between 2012 and 2016, our average rises to 1,681 days and our next low would arrive on Feb 11, 2021.

Either way, the upshot is that rates will continue to fall. Bonds will continue to increase in value. Our charts suggest that 10Y futures, ZN, will reach or exceed 144’195.

We’ve already seen the little white channel off the Mar 9 lows break down and backtest. The next step should be a decline to the 1.618 Fib at 0.154% or the falling yellow channel bottom around -0.165%. It could come as soon as July 24 (the falling red TL) or as late as Feb 2021.If 10Y yields do continue to fall, it would require that inflation remain under control, which would require that oil and gas prices remain under control. It would also potentially squeeze the 2s10s back below the white TL or the yellow TL, either of which our yield curve model shows is negative for stocks.

The 2s10 could theoretically remain aloft, but that would require that the 2Y decline below support at 17 bps – also bearish for stocks.

In other words, pick your poison. Either outcome is bearish for stocks.  The only alternative would be for the 2s10s to track the white TL, neither breaking down nor breaking out. Given the imperative that rates continue declining, I find this outcome extremely unlikely.

If rates continue to fall and oil and gas also fall, could currencies prop up stocks?  Perhaps. The USDJPY is the primary tool used for this purpose: a rise in the pair, which means a strengthening dollar and weakening yen.

The traditional limiting factor/argument against this outcome would be the inflation angle. Remember, Japan has had even worse debt and deficit problems than the US. Rates have needed to remain at or below zero for years so the BoJ can monetize ongoing deficits which would quickly spiral out of control if rates were to ever normalize.

Spiking levels of debt made lower interest rates necessary.Though inflation definitely had an impact on rates, particularly during the 2011-2014 and 2016-2020 rallies in oil and gas prices which drove inflation higher. Japan, which has no domestic production capacity, imports all of its oil and gas. Even though rates have been hammered, we can see the impact of inflation on interest rates – which have bumped back above zero as gas prices and inflation have recovered over the past several months.The discount rate has continued to decline, even (especially!) while inflation was rising.

continuing…

 

 

 

 

 

JULY 8, 2020 – DAILY UPDATE:  7:00 AM

Our beloved family cat has taken a turn for the worse and I need to run her over the local veterinary hospital. Below are the charts I prepared yesterday morning before starting the big picture post. Nothing has really changed other than the moving averages (the 50 and 200 are slightly closer), though I have more to post regarding the big picture upon my return.

UPDATE:  3:10 PM

I picked a good day to be out as not a whole lot is happening so far. SPX/ES have risen almost 1/2%……mostly on a small drop in VIX……and rise in CL/RB…

…even as USDJPY tanks. Note that both ES and SPX have seen a bullish 10/20 cross (about 1.5 points) which, with just a little selloff at the close, could quickly vanish.Since I only got about 2 hours of sleep last night, I’m going to hold off adding to the big picture post. Chances are it’ll make more sense after I’ve had a chance to catch up on my sleep.

GLTA