With lots of central bank and political turmoil likely ahead, I thought it would be a good idea to review the big picture and identify the most likely outcomes for equities.

We’ll start with the weekly chart for SPX.  This is the pure, unadulterated version — showing just how insanely steep the slope is on the channels — both rising and falling.Note that the rising red channel from 2009 is contained within the .236 – .500 quarter of the rising white channel.  It’s no accident that it started below the .236 line.  And, it’s quite significant that SPX arrived back at the white channel midline and the yellow 1.618 Fib at the same time [see: The Last Big Butterfly.]

The index’s difficulty at busting out of the rising purple channel is evident in the mass of channels, Fib grids and assorted other chart features packed in the most recent peak.

continued for members…

Spreading it out a bit, we can see on the daily chart that the yellow 1.618 Fib (2138) has severely limited the red channel’s ability to guide prices any higher.  We’ve gone over this in great detail in past posts, so I won’t dwell on the importance of completing this huge butterfly pattern.Zooming in, we can see details of the major trends since SPX reached the white channel midline.  The rising purple channel kept things going higher for a while.  But, the falling yellow channel took over and the purple channel broke down in January with a 3rd and 4th tag of the 1.272 Fib at 1823.

This also completed a 2nd H&S Pattern (in yellow, the first being in purple) that, had it played out, targeted about SPX 1500.  Ouch.

Regular readers will remember Feb 11 as the day I insisted that TPTB needed to turn SPX around if they were ever going to [see: USDJPY Finally Relents.]

They not only turned it around (before it even tagged the falling purple channel bottom), but the subsequent rally busted the H&S Patterns, the falling yellow channel and — at least, temporarily — the falling purple channel.

This was accomplished primarily by algos driven by CL, which essentially doubled between Feb 11 and Jun 8.

Unfortunately for the bulls, CL ran out of upside in mid-May when it reached its .618 at 48.63.  TPTB managed to use it to goose stocks higher, anyway, but ramping it up during market hours (the light purple rectangles) and allowing it to reset overnight.

For whatever reason, TPTB stopped goosing CL higher last week.  Whether out of embarrassment, or just wanting it to appear at least somewhat legit, they let the air out.  And, SPX has been slipping ever since.

The timing was interesting, as SPX had just pushed above the falling purple channel top (from May 2015.)  Now, it’s back below, and has even fallen below the rising white channel (from Feb 11) bottom — a very bearish development.

The broken yellow channel top was already backtested — many times, in fact.  And, the latest white and yellow H&S Patterns were busted by last week’s push past 2111.  So, there are no great downside targets in the immediate vicinity except 2010-2017.

It would represent another backtest of the broken yellow channel, a backtest of the rising red channel midline, and a test of the yellow .618 Fib at 2010.72 (logical, as the .886 at 2097.71 didn’t hold.)  It would also limit the selloff to the top 1/4 of the falling purple channel.  And, best of all, it would allow SPX to tag both the SMA100 and SMA200.  Those are some of the things that are right about it as a downside target.

The thing wrong with it as a downside target is mostly harmonic.  It wouldn’t even reach the .382 Fib retracement of the rise from 1810 to 2120 (that’s at 2001.96.)  So, as selloffs go, it would be quite modest.  Too modest?

Well, let’s look at the fundamentals underlying tomorrow’s FOMC decision.  This is truly a back of the envelope analysis.  Nevertheless, a tin foil hat warning is warranted.

In my opinion, the US economy is stuck in a weird kind of stagflation.  The economy would already be in recession if not for various fudge factors and cheats that make it appear healthier than it is.

Thanks to the malinvestment forced by ZIRP/NIRP, cash has flowed into places that don’t justify it: stock buybacks, residential and commercial real estate, certain commodities, bonds, etc., preserving an image of economic health that isn’t justified.

Ask anyone who buys gas or groceries or pays rent in the US and they’ll tell you there is very obvious inflation.  We may have defined it into oblivion, but it’s real.  Real income, on the other hand, isn’t keeping up — not even close.

So the Fed, which has presided over a huge increase in money supply and debt over the past 8 years, has a serious problem.  It can deal with the lack of growth, or it can deal with the increasingly obvious inflation.

And, all the while, it must deal with its most important mandate: preserving the value of stocks and bonds.  The bond side is obvious.  With $19 trillion in nominal national debt, we simply can’t afford for rates to rise.  Period.

An increase back to historically normal 6.5% 10-yr treasury yields would increase interest annual interest expense to about $1.3 trillion — more than we currently spend on any other category in the federal budget.  Clearly, higher interest rates would do a lot of damage.

On the other hand, lower interest rates can also do a lot of damage.  The yen carry trade, which was the primary driver of higher stock prices between 2011-2015, relies on an ever-cheaper yen.  But, the flip side is an ever-more-valuable US dollar.  And, the US dollar’s value depends largely on (relatively) higher interest rates.

If US rates don’t increase, or at least maintain their margin, the USDJPY will fall and take stocks with it.

I know what you’re thinking: what about the CL algos?  Well, yes, that’s the big caveat, right?  The CL v ES chart up above makes a very compelling point.  All that’s necessary to keep stock prices rising is to keep oil prices rising.

But, of course, there’s a problem with that equation.  Higher oil prices = higher inflation.  At some point, those higher gas prices will not only hurt consumers and (non-oil company) businesses; they’ll also make inflation obvious enough that the Fed will have no choice but to raise rates.  And, around and around we go.

Tomorrow, I expect the Fed to punt.  I expect the dollar to try and sell off, but be propped up by central banks when the yen carry trade unwinds a little more.  And, I expect oil to rise to compensate.  There’s an upside target at 54.76 with Janet Yellen’s name all over it.

If I’m wrong, and I hope I am, then it’ll be because the BoJ takes the lead and deflates the yen some more to compensate for a sinking dollar.  It’ll be another tax on the Japanese people, just like higher oil prices would be on the American.  Either way, the central bankers can go on looking really, really smart just a little longer.

As always, I don’t recommend trading on Fed announcement days.  But, if SPX sells off, and if you’re very careful not to get whipsawed, I’d look for opportunities to short SPX, possibly down to 2017 or even 2000.  And, I’d watch for CL or USDJPY to break out in order to keep stocks from dropping any lower.

GLTA.