With the FOMC, BoJ and ECB actions behind us, this seems like a good time to review the big picture.  This morning’s USDJPY, VIX and CL moves are, perhaps, the perfect reminder for how we got here, and where we’re going.

Note the strong correlation between USDJPY and ES broke down on May 24 when the dollar ran into trouble.  It was a dicey time for stocks, as oil had reached our upside target (yellow arrow) and was heading south.What enabled stocks to break out then, and maintain a floor afterwards?  VIX, which had spiked from 10.50 to 16.30 between May 16-18 — a rare trip back above the long-term yellow channel bottom — was hammered back to single digits on the 24th.And, so, the cycle continues.  When one algo driver falters, another takes its place.  How long can this go on?  Will it always work?  We’ll look at the mechanism, and the repercussions for traders in today’s big picture.  We might even delve into some underlying economics.

But, first a shout out to members J.H. and T.M. for posing some great questions this past week.  I’m convinced the pebblewriter readership is the smartest, most thoughtful group of investment professionals out there.  These two gentlemen are real students of the markets, and do a great job of keeping me on my toes.

continued for members…

To answer the questions above…yes, I think this sort of algo-driven manipulation can go on for a long time.

There have been three distinct phases of stock market manipulation:

(1) QE: it began in earnest in late 2008.  It was big, clumsy and expensive.  The effects were far from immediate, and it led to the massive central bank balance sheets we have today.  It’s not over, by the way.

(2) USDJPY and OIL: In the wake of Fukushima, the BoJ began aggressively devaluing the yen, and the yen carry trade became the go to tool for driving stocks higher.  The rise in SPX and USDJPY beginning in 2011 were very highly correlated, with USDJPY “breaking out” every time SPX ran into resistance. The yen’s demise was acceptable to the BoJ because oil was crashed at the same time.  When the yen ran out of room for further devaluation, oil’s rebound began to prop up and drive stocks higher.

(3) VIX: beginning in Dec 2016, VIX has increasingly been used to drive stocks higher by “breaking down” below recently constructed straw man trend lines and channels on a regular basis.  A major channel bottom dating back to 2014 is now a ceiling of sort.  VIX has spent 62 of the 111 sessions since January below the previous floor.

Just now, VIX tested the bottom of the latest rising channel — setting up a potential turning point for SPX, which just broke out to new all-time highs thanks to VIX’s 2.7% plunge.One might legitimately assume that SPX is due for a reversal, now, as VIX probably won’t test its all-time lows simply in order to drive SPX even higher.  It’s already broken all the bearish Fib patterns and produced new, all-time highs.  What would be the point?

If TPTB intend to keep this rally alive, they could simply extend CL’s breakout.  The two previous ones were head fakes.  But, as we discussed last week, a drop below 44.15 or so would complete a H&S Pattern targeting 31ish.  I don’t  think markets could stomach a 30% drop in oil prices.  The 20% since Feb 21 has been difficult enough.

The other alternative is to simply run USDJPY up a little higher.  The top of the falling white channel is around 111.60, and the SMA100 is at 111.85.  There’s no other real resistance.  And, all we’re talking about is extending the USD’s bounce a day or two.

Bottom line, they can keep playing this game of taking turns with CL and USDJPY bounces, and using short-term VIX moves to reinforce, for as long as they like.  The only issues that might unravel it are those which are too big for the algos to contain.  And, so far, the ones that looked likely to be a problem have been overcome quite easily (Brexit, US election, rate hikes, etc.)

We can also speculate as to what sort of event would be a real problem: a shooting war between US and Russia in Libya, an interruption of oil production in the Middle East, a big bank like Deutsche Bank failing, another US downgrade, etc.  But, the bar is pretty high.  I doubt even an impeachment would do much damage.

A concerted effort was made in the wake of the US election to break SPX out of the flat, white channel it had been in since Feb 2014.Had that not occurred, SPX would likely have fallen back below the rising purple channel midline and fleshed out the purple channel.  At the time, the bottom was around 1600 — 35% below the prices at the time.Importantly, it also allowed SPX to break through the 1.618 Fib extension which had (justifiably) been so problematic.I think it’s fair to say that if CL hadn’t bottomed, USDJPY hadn’t bottomed and VIX hadn’t broken down, we might actually have seen SPX’s H&S Pattern play out after it completed in Jan 2016 (instead of the IH&S Pattern.)

Note the purple channel bottom crossed the 2007 high (1576) in July 2016.  It would have been a perfectly legit backtest.   But, the folks pulling the levers saw the writing on the wall and made damn sure it didn’t happen.The great majority of SPX’s gains since the Dec breakout has been a result of VIX suppression, as can be seen from this very familiar VIX chart.Zooming in, we can see the struggle, over the past 3 weeks, to top and hold the IH&S target.  In the end, VIX didn’t even need to set new lows, USDJPY didn’t need to set new highs, and CL was able to remain low enough to send the message that inflation was low enough to justify maintaining extraordinarily low interest rates everywhere, and expanded QE by the ECB. So, we know why, when and how they got SPX to current levels. We know that they should be able to maintain it — unless something more difficult to diffuse occurs.  And, we know that whatever that thing might be, it will probably be unforeseeable (remember the S&P downgrade?)

Where does that leave investors/traders?

As has been the case for the past six months, shorting should be done very judiciously, and only when important support, moving averages, channel lines are broken.  If you’re a buy and hold type, this will mean different things to you than if you’re a swing or day trader.

We’ve seen so many instances of gaps higher overnight like today’s.  This is very difficult to guard against, as they are relatively arbitrary.  But, there are some signals, such as SPX sitting at a point of overhead resistance going into the close, leading up to a weekend, etc.

In general, it means embracing both the meltups and the oscillations.  As we’ve seen, there is a general preference for establishing a downward sloping TL or neckline and then gapping above it on the opening bell.

I will continue to work on developing better short-term signals so we’re not so susceptible to head fakes that go nowhere throughout the day.  I know I hate chop, and I’m sure most of our members do, too.

At the same time, I’ll amp up my focus on the algo-drivers themselves in order to identify trading opportunities.  As I’ve said for the past year, it’s become much easier to forecast the algo-drivers than it is the equity indices that they drive.

EOD:  4:30 PM