The analog we’ve been following since Feb 6 [see: Analog Watch] has proven pretty accurate in terms of prices, but has been off by a day or two a few times.

Yesterday was another potentially important deviation.  SPX opened higher, but fell steadily throughout the day — retreating, as expected, to the channel midline where it remains.

VIX had a golden opportunity to reverse lower after tagging its SMA10, as it has countless times before.  But, it didn’t — at least not yet.USDJPY even broke down, dropping through the bottom of the rising channel that suggested a return to the bullish side of a trend line from Jan 7. Perhaps the most troubling development for the bulls, however, was the yield curve breaking down.  It wasn’t a lot, at least not yet.  But, it’s a breakdown.  And, as we’ve discussed several times [see: Does the Yield Curve Matter? A Closer Look], this doesn’t bode well for stocks.The big question, then, is whether the algos can be brought to heel.  Perhaps the VIX can still be crushed by 20%, yields can correct, and USDJPY will regain its uptrend.  But, if not, the higher highs suggested by our analog could be very, very difficult to achieve.

We’ll look back at our base period, and why this time could be different.

continued for members…

In September 2007 the markets were nervous.  It was apparent that real estate had peaked, and credit markets were clearly freezing up.  On Sep 18, the FOMC met to discuss an appropriate response.  The transcripts make for fascinating reading.

They ultimately decided on a 50 bps decrease in the Fed Funds rate.  This sent SPX, which had opened flat, soaring by 43 points that day and another 19 points the following day — a total of 4.2% in two sessions.

The yield curve, which had only recently returned to positive after 18 months of inversion, turned sharply higher.  TNX, which had recently completed a double top of its Jun/July 2006 highs, backtested the trend line it had broken below around Day 0.The first backtest (purple arrow) came on Day 22.  The second one came on Oct 12, Day 40 — the day after SPX peaked.  The fact that the curve kept steepening even as TNX resumed its plunge speaks volumes to the turmoil in the bond markets.  In short, the Fed was racing to stay ahead of a plummeting 10Y.

I have to run out for a meeting.  Will continue this thread around 1pm.