We’re crashing here

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This is the story of a capitulation day, and a rally that went bad. The shooting star formed near the bottom from the Nov. low, a good sign for the bulls. The next day the futures buyers opened the index much higher and they were met with enough selling to take it back to the previous days close. That’s a Bearish Counter Attack. It’s only one day, right? The futures buyers took another try and pinned the open right back where it was the day before, and they sold it out from under them again. Those black candlesticks indicate the close was lower than the open.

Weakness begat weakness. The long shadow on the shooting star is suddenly showing the market where it wants to go. The reversal is in trouble.S&P314

Here we are without all the distracting candlestick patterns, a simplified version of a bear flag, which is a continuation pattern. I took the liberty of reading a slight downslope into the range because that gives the breakdown on the right side a little wiggle room. The RSI looks supportive but it feels like it is rolling over. Back of the napkin the size of the range implies the downside, which is 15 Spyder points, or 150 S&P points, or 248, or 2480 in the main index. That’s another 5%, which hardly seems like much of a fuss.

Gold appears to rolling over but flight to safety buying could alter that outcome. The Oil sector is collapsing, that may be the most important industry in America, our main export. LIBOR took another step forward, the yield curve is inverted if not for the Feds jawboning of the short end. A full credit crisis is brewing, Europe, France, Brexit, Italy, a monetary stew.

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Robot Santa Claus Rally

SantaIf seems obvious we are all screwed at least until New Years. I suspect the Fed/Treasury has wasted a few (precious) taxpayer dollars trying to buy the overnight S&P Futures market, only to have the market turn around the next day.  After tax selling season is over, there might be some respite. The change of the calendar often has this effect. Here’s a few reasons why Robot Santa might turn into Robot Easter Bunny.

Europe is literally ablaze. Brexit isn’t moving fast enough, Macron’s policies are not working, yet. The Yellow Vests have taken to the streets. Eventually the people in these movements tire, the winter in France has been made worse by high fuel prices. Nobody wants to go home. Italy is quiet because the coalition is hoping the EU will buy more sovereign debt. The largest German bank is deep in scandal, and will probably collapse. The condition of the global banking industry is in decline.

The Fed has tried to jawbone the yield curve higher by calling for a pause in rate hikes, but LIBOR just kept going. Using their measure the 2yr/10yr has probably already inverted. Banks are under performing the S&P by a dramatic margin, and US Banks are considered the safest!

Oil services has broken down, the group is headed for bankruptcy (at which time you might want to buy them) . Lower interest rates fuel over supply drive prices lower, force more wells to shut down. Meanwhile the dollar continues higher suggesting to some Trump might opt for controlled devaluation, aka another Plaza Accord. I think anything might work in a normal environment. This is like the bonfire of the vanities when the townsfolk get carried away and burn everything!

The American middle class is being fitted for Yellow Vests. They are a small bitter bunch, and that makes them politically dangerous. When small demographics swing to an extreme they can pull an election, Obama won based on the black vote, period. He got all of it.

Things may magically change the first day of 2019, the problem is this problem is not just our problem, the NYSE drives higher on foreign investment. So keep an eye on Macron and May, and those so far reticent Italians, in case the EU puts coal in their stocking.  No mention here of China, and the arrest of the CFO of the largest Telecom. The news media is ignoring everything, a sure indicator that the fear index is off the charts. When they whistle past the graveyard they prefer dulcet tones.

None of this matters to be so much as what I see watching the S&P struggle with the selling, (and trying to make a few profitable trades) is that nothing right now is working. There was capitulation selling a few days ago and a rally that was met with more selling the next day. Whoever has been buying overnight futures has been taking a beating. This morning they opened higher but the volatility jumped out at you, with no fancy oscillators to announce that the buying was on shaky ground, volatility occurs more often at highs, rather than lows. And the character of the buying has been sporadic, while the selling is on less volume, but relentless like a tsunami wave only one foot high. How can it do so much damage?

I go on too long, the markets were on such elevated perches that the fall has not even registered by many measures of technical analysis. The potential on the downside therefore must seem to the bears to have unlimited potential, and it does. However first there is a short respite probably when valuations are shown to be improving, causing some rally, until of course future disappointments lower those valuations again, so valuations must descend in logarithmic reverse.

Next missive we might try to decipher the inverse leveraged bear ETFS which were reverse split adjusted lower since the bottom in 2008 and now when we look at those securities they represent 1000x times value potential. First I have to get someone who really knows their math to help me.

Panic Time

LIBOR124 This is what panic time looks like. The Fed pauses its rate hikes and LIBOR shoots up 1 1/2% for the day. Gold is catching a flight to safety bid, DTYS (ten year rates) might have been trying to put in a bottom, instead there is more follow through lower. With the drop in long rates the Yield curve collapsed, harbinger of a recession.

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Oil has dropped to fifty dollars a barrel, (even if gasoline is cheaper, all the lost jobs will hurt the economy) You do need to heat your home and Natural Gas is on a tear.  It’s going to be tough on consumers either way.

The stock market is cratering at this moment, having lost all the gains from the Rate Hike Pause, Tariff Cease Fire bump. We are much closer now to president 46 than we are to 45.  The partisan civil war begins in January. It seems to me that if you are a Congressman and someone lies to you in committee, and maybe you redacted that, that the public might want to know why? The repercussions go deep. I never believed that the Trump bump applied to the stock market and its robust gains since 2016, or that the Trump dump should necessarily bother investors. These things have their own reasons, and the planets are aligned for better or worse.

Is this what a real panic looks like? Not yet……..

 

 

Are Rates Basing?

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Those long shadows in the down trend are interesting. Are they just bad trades (too many for that I think) There is a powder keg underneath rates. Once the stock market gets going money gets off the flight to safety trade and rates explode. Maybe this downtrend in rates is something else? The Fed decided to PAUSE while real rates are still negative, (their rates minus inflation). Sounds to me like somebody is tired of being less accommodative.

(Enablers never really ever quit enabling)

This is where LIBOR comes in, you know a bunch of bankers fixing daily rates according to their business. LIBOR takes a clue from the Fed Rates, so will LIBOR pause as well? Will LIBOR-OIS send the signal that the signals are mixed. Meanwhile gold shares are providing some charts of their own, not all good, but then gold doesn’t like higher rates. Maybe the bottom is in for rates? Maybe 5% on the 10yr is the next stop?

I have an alternate scenario, and I will make the case as it develops. GDP is expected to surprise lower, but I think could be strong again. The economy could enter a recession but with GDP at these levels? Why GDP? Consumer spending is strong which has nothing to do with discretionary income, (C), business investment is strong because interest rates are still low relative to inflation, while GM retools for the new electric cars and thousands are without jobs (I) Government spending is predicted to increase, like always including people who live off assistance who need more, (G) and our main export now is energy, including LNG, which is actually catching a bid, while oil bottoms at fifty dollars (X-M). Not to mention the inflation rate is low because of the Feds onerous rate hike policy (which thank goodness they have seen the error of their ways). Business is already in recession mode, which hamstrings Fed policy. Who looks at GDP? They do. Letting off the rate hikes was a monumental mistake, and it will cause deflationary collapse. If rates don’t go up here, the system is broken. (you knew that)

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I changed to the Point and Figure, because the bar chart fell out of bed, and that means we need a wider lens. This is the 1/2 box, bonds and fixed income move pretty slowly. Notice the objective is Tentative, that means that for every O lower without a corresponding rally of three Xs that the objective remains OPEN. The ten year was around 1% in 2016, and 1.7 isn’t pushing any alarms. The 2016 drop in rates was conducive to gold stocks and gold (FYI).

The case for deflationary apocalypse remains. What is that exactly? I would say it would be a rapid decline in asset prices of all kinds and probably the dollar.  There are some smart guys who think a dollar devaluation is right around the corner, aka The Plaza Accord.  However with all the planets aligned they are just pushing the system farther into collapse. The Fed should never even have thought about easing back on the rate hikes. Any attempt to devalue the dollar will ruin the US credit rating and the Treasury will be reduced to selling a dollars worth of bonds next auction for six bits.

They always ring a bell at the top, don’t they? The speed of events in this next case might be astonishing. The futures markets were shut down sporadically on Tuesday, so we took a day off for a one term former president’s funeral, and then what looked like a capitulation rally, was all given back the next day. A Chinese woman is in jail in Canada for extradition to the US (no formal charges), she lives in Canada and has business there, and is the CFO of China’s largest telecom. She ostensibly violated US sanctions against Iran, some years ago. The DOJ was holding the warrants and arrested her in a routine traffic stop (if you believe that, note this, our current president did the same thing in Russia in 2016) S&P futures are currently down -50. Things are pretty bad and if I miss my guess the UST has already spent some capital trying to boost the market, through surreptitious buying of S&P futures and they may be short on cash, and guts.

 

 

Energy

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This chart has been working up to this moment for a while. Breaking the range in technical terms implies a drop of the area of the range, which is ten points. Take 10 – 12.5 and you get 2 1/2. This is oil equipment, which means something like a deep recession would have to occur. This unfortunately confirms what is happening to WTIC, and by extension interest rates. By recent analogy the casual observer would have to guess that higher interest rates will constraint investment in new oil fields, and that will reduce supply and price will rebound (though it is hardly good for the equipment sector. One can postulate that a reduction in output in the oil shale industry will be met with increased production in offshore and conventional drilling efforts, hence equipment will rebound somewhat. The US is currently an exporter of oil so the political need to supply US consumers does not seem to be at risk.)

This will by extension hurt the trade deficit, and put pressure on the dollar. Should the Federal Reserve reverse itself on “neutral” rates, it could set off a deflationary crash, which will bring even more oil to market, and put further pressure on prices, (when the price of oil falls nations which depend on oil revenue must pump more of it to pay their debts). Dropping interest rates will have no positive effect on jobs in this industry, hence the Fed effect of implementing new QE (or lowering interest rates when the recession begins) never gets out of the starting gate and has the secondary effect of further crashing bond values, without any commensurate rise in rates.

What about the LIBOR-OIS spread?

This is pretty geeky, but with Investopedia we can get some sort of idea what it means and why it is important

LIBOROISHIS

The LIBOR-OIS spread blew out in 2007 well before the crash reached its full force. None of the Fed chiefs saw it coming? (Yellen was adamantly blase in her remarks at the time)

LIBOR-OIS is a spread on a spread if you will, mayonaisse on peanut butter. We know what LIBOR is, the LONDON INTERBANK OFFERED RATE It is the equivalent of the Feds overnight rate, only set by bankers according to business conditions on the ground. To a great degree LIBOR and FedFundsRate tend to correlate, but there are important differences. The Fed is considering implementing its own LIBOR rate which was done ostensibly to provide a better LIBOR (there have been rate fixing scandals in the past) However it also brings the Feds arbitrary, and politically motivated, system of setting rates into the twentieth century.

Next we will work on the Electoral College, as we struggle to abolish slavery (voter repression) for the second time in two hundred years. The American system is full of anachronisms which do not serve us well in the modern world. At the same moment we have lost the sense of grace and civility from that earlier time. We know how to tweet, we don’t know how to run a free market.

Defining the Two Rates
LIBOR (officially known as ICE LIBOR since February 2014) is the average interest rate that banks charge each other for short-term, unsecured loans. The rate for different lending durations – from overnight to one-year – are published daily. The interest charges on many mortgages, student loans, credit cards and other financial products are tied to one of these LIBOR rates.

LIBOR is designed to provide banks around the world with an accurate picture of how much it costs to borrow short term. Each day, several of the world’s leading banks report what it would cost them to borrow from other lenders on the London interbank market. LIBOR is the average of these responses. (For more, see “What Is ICE LIBOR And What Is It Used For?)

The OIS, meanwhile, represents a given country’s central bank rate over the course of certain period; in the U.S., that’s the Fed funds rate – the key interest rate controlled by the Federal Reserve If a commercial bank or a corporation wants to convert from variable interest to fixed interest payments – or vice versa – it could “swap” interest obligations with a counterparty. For example, a U.S. entity may decide to exchange a floating rate, the Fed Funds Effective Rate, for a fixed one, the OIS rate. In the last 10 years, there’s been a marked shift toward OIS for certain derivative transactions.

Because the parties in a basic interest rate swap don’t exchange principal, but rather the difference of the two interest streams, credit risk isn’t a major factor in determining the OIS rate. During normal economic times, it’s not a major influence on LIBOR, either. But we now know that this dynamic changes during times of turmoil, when different lenders begin to worry about each other’s solvency.

When the LIBOR-OIS blows out the Feds targeted rates are out of sync with actual business conditions. A lagging indicator is really not much use. You can see the spread widened in September of 2007, but the Fed had barely eased up on interest rates. FEDRATES2007-9

Markets had not reacted at all. S&P2007-9

OIS spread has yet to widen to what are dangerous levels, and there are mitigating circumstances, the effect of tax policies, T-Bill issuance, and stock market performance. A large move in stocks either way could prompt a crisis in the credit markets.

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The 60 point widening does mirror the first move in the 2007 event, which did not show up in changes in Fed policy, or correlate to market instability until much later. We are already deep into our second stock market correction of the year. April marked the bottom of the early year selloff, but you see that despite new highs in the S&P the LIBOR-OIS did not return to previous levels synonymous with a healthy credit environment. Should the spread widen to a full point it could be game on, however we (the Fed and Central Bankers) have much less time to correct the situation before it turns into a full market shutdown. Things are happening much faster.

Market Poised? It Depends…

The inverse H&S in the S&P has fallen apart, it is still a double bottom of sorts and volume has shown some signs of returning on the side of buyers. SPY1127

The rally in early November failed to test the 50ma, which is not good, and the downside gap has not filled. It remains an issue of liquidity, or cash, how much of it is coming into the market, and how serious are the sellers. We might resolve to the upside here but it could be a long slow grind.

GS1127

Sure most of you remember Goldman’s role in the 2008 crash. I will do some backtracking later. The myth that the “banks” are okay this time, we stress test, we require larger reserves, none of these things change the business and the banking business is changing. More on what shadow banking really means to the industry and do you really believe we aren’t in a housing bubble? Check your housing value on Zillow, mine is higher than it was in 2007.

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The experts are having trouble explaining the price weakness in oil, relative to the fundamentals. The most obvious problem is that higher interest rates should be putting upward pressure on oil prices, as lower interest rates allow oil extraction through hydraulic fracking and exploration companies find it easy to borrow money and bring more oil out of the ground. I consider those lost jobs at GM are nothing compared to what is happening in this industry.

That situation led to the halving of oil prices two years ago, now rates are going higher, cheap money has suddenly become dear, and supply should be constrained. Yet oil prices are falling? Yes the Fed got itself in a box where lowering interest rates caused deflationary pressures and they had to raise rates to keep inflation on their 2% target (they believe they are tamping down inflation by raising rates while there is a solid correlation throughout all of economic history between higher interest rates and higher inflation.) Meanwhile

UNG1127

New York Thanksgiving was the coldest day on record for that holiday. Natural gas prices are strong while oil prices are weak. On the macroside the case for higher consumer inflation is starting to take shape. The lost jobs in the energy sector, (as well as the auto sector) could dovetail into an inflationary recession. (Remember the 1970s) . And yet???

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The TIP bond ETF tends to react to higher interest rates. Inflation expectations have actually been falling. Here is what I call the Fear Trade Setup, its not scientific. When a commodity or stock rises steadily and with little volatility for a time, investors tend to assume the gradual rise reflects further gains ahead, but then something happens. The price falters, and tries to rebound, and then investors pre-panic and a somewhat larger one day event signals the stampede lower. (The Fear Trade Setup took a marked reversal yesterday, perhaps it was support on the 50ma, but it might also be “panic” buying of Gold. I will followup on this, the TIP fund took a lift as well, so something is in the air, and it might be the fear of inflation. That could be another subject, since I consider deflation to be the immediate worry, but to some anyway, gold and inflation securities are “deflation” plays. We will see..)

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In sum: What drives markets is the flow of liquidity, much of it from outside the US, where  central bank policy is still loose. Trillions of extra dollars were printed, that now find their way into investments. The US market is the best, and most desirable destination for foreign investors. However that flow of credit will slow and perhaps even stop and (gasp) possibly even reverse. That does not necessarily mean that money will disappear, the real question for investors right now, are we better off with bonds, or gold, or stocks?

Everything crashed in 2008 including West Texas Intermediate. The parallels are setting up, (it is almost as though we have entered the crash without warning signs or systemic events) while the flow of funds is still favorable. LIBOR is the European version of the Feds overnight lending rate, and much more honest, the rate is set by bankers (not politicians) and it’s done every day. It approached 5% in 2008, before the system crashed, it is still only about half way there.

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The thought that the Fed controls interest rates is interesting.