Has bad news now turned bad?

So when does bad news become really bad instead of being good? Lately, the mounting bad news on the US economy has been good for stocks as investors’ belief in the bullish power of lower interest rates – and their touching faith in the ability of the Fed to keep them stable to lower – has trumped the obvious conclusion that company earnings are declining.

So has yesterday’s very weak PMI data provided the tipping point where now bad news really is bad? As stocks are now falling, that would be the conclusion that conventional pundits would invoke to ‘explain’ the decline.

But I have another reason stocks fell hard yesterday. And it has nothing to do with the Fed, interest rates, Brexit, inflation or the plethora of macro data many pundits use in their analysis.

For one thing, bullish sentiment has been running over. Latest DSI (Daily Sentiment Index) has been running at an extreme 90% or so for days on end. That is unstable and always leads to corrections – sometimes very large ones.

Then the flow of funds chart I showed recently:

I believe this is one of the most important charts you will see this year as it shows the funds who were bearish since Christmas are suddenly in thrall to the FOMO Effect. Remember, fear is a highly emotional state. So when the bears throw in the towel with gusto and suddenly turn highly bullish, that often marks a major high.

Why? Because when the bears buy back (cover) their shorts and go long – in effect buying shares twice over – they join the huge army of bulls who are already long. So who is left to do further buying? And that creates a buying vacuum, so prices inevitably fall. There need not be an outside ‘catalyst’ at all.

All market waves are created by internal changes of the market, not by external events.

And the speed of yesterday’s decline surely is proof that many bulls are now taking cover as they sense an important turn is at hand.

Recall the Equinox Effect I featured recently. That a major top was due this week if the reliable pattern was to be repeated. And with last week”s top, that makes it five out of five of the most recent equinoxes. Nice call!

Is the current yield inversion pointing to a major slowdown?

Last week, yields on the 3-month Treasury bill was higher than that on the 10-yr T-Bill. Let that sink in a while. An investor will get more yield buying a short-dated T-Bill – the equivalent of cash – than a longer-dated one. That is highly unusual since the longer-dated security will normally have higher yield to account for inflation which is the normal state of affairs.

But what if investors feel inflation will be low in the future? Say zero – or even negative? Hard to believe isn’t it as we are all accustomed to seeing prices rise for many everyday items (with beer being no exception!).

But with a negative expectation for inflation, yields on long dated securities may well fall to account for this, especially when demand for such securities is high (as it is). So if inflation expectations are negative, what does this say for the economy? With prices falling (dis-inflation), demand will be falling and that is a symptom of a weak economy. With falling demand, company earnings will fall and we enter a recession.

And that is why a growing number are now pricing in such a recession this year. And there is lots of history! Here is a chart going back to 1970 showing all six recessions since then have been flagged by a yield inversion (yellow bubbles)

The updated chart will show the blue yield differential curve is now below the zero line – and now predicting the seventh recession directly ahead.

Long time readers will recall I have been calling for a major Deflationary Depression starting this year – with major impacts on stock and most other asset markets. A recession will be the first step along this path.

So not only do we have a yield inversion in US Treasuries, but the amount of negative interest rate sovereign bonds globally is pushing upwards of $9 trillion. Amazingly, these bonds are finding buyers who will definitely lose money if held to maturity. They are instruments of confiscation! I still am unable to understand the motivation of buyers of these bonds. But the fact remains that the huge pile of these bonds out there is deflationary.

Crude oil retreats off my target

In Wednesday’s post I showed the chart of crude oil and set out my case the rally would likely run out of steam around the $61 high. I based that forecast on the position of the market close to a critical Fibonacci retrace level – plus the bearish configuration of the COT data the previous week. It shows hedge funds are mighty long on the rally.

Experience tell us that when the large specs are this lop-sided, nasty things can happen to them – and so it proved yesterday with a $1.50 swoon

But take a look at the latest COT data issued yesterday

The hedge funds are at it again! They massively increased their bullish bets even further just before reaching my target zone – and are a stunning 7:1 net long! That is an extreme lop-sided position by anyone’s reckoning – and is a classic setup for a swift reversal. As always, they love ’em at the high and hate ’em at the bottom. My first target is the $55 area with much lower potential.

Note the lovely wedge pattern that has accompanied the rally off the Christmas lows. Yesterday’s swoon took the market to test the lower line again. It should break through next week.

Is Dr Copper telling us something – and should we listen?

I confess trading this metal has not been easy of late – and that is why I have not done so since discretion being the better part of valour in my book. Normally. copper bull markets coincide with stock market advances, but as the Dow/S&P/Nasdaq have been approaching their ATHs in the post-Christmas surge, copper has lagged stocks badly. In fact, it has only reached a so-so Fibonacci 50% retrace of last year’s high

which area is massive chart resistance and yesterday, it fell very hard as stocks fell. Also note the grey zone – an area of potential support (connects the recent highs). That means the market may be trapped between these two zones for a while.

The alternative option is for the market to break past that support and head much lower – an option that would take centre stage if shares start their wave 3 of 3 down in earnest next week. I expect fireworks as Dr Copper seems to be leading markets in a southerly direction..

A major turn in Nasdaq yesterday?

I have been preparing VIP Traders Club members to expect a major top in the three major US indexes around the time of the Vernal Equinox (and Fed Day) last Wednesday. In fact, the Dow and S&P made their highs at 4 pm Tuesday. But not the Nasdaq – it kept the bullish flame alive a little longer by moving to its high in overseas trading Friday morning.

But it was downhill from there:

Here is the 2-hr chart of the run-up to the purple wave 2 high. The blue tramlines are drawn off the Christmas lows and I have a lovely small scale pink pair that describes the bulk of the rally. The standout feature is the sharp ‘overshoot’ on Friday in a buying frenzy that took the market briefly well above the upper tramline.

But buying exhaustion set in and when it fell back inside the trading channel at noon UK time yesterday, that confirmed the importance of the overshoot as a valid signal that the trend had changed to down. Late in the day, it also broke below the lower link tramline to increase the odds even further.

Note the very rapid plunge in the momentum indicator – a surefire indication that sentiment had done a 180 yesterday. When massively over-bought markets turn, they turn with a vengeance.

And as further evidence, here is VIX the ‘Fear Index’

I have an excellent tramline pair working and the market is about to surge above it. It had retreated to the 15 zone, which is long term support in a solid display of utter complacency as shares zoomed ever higher. But I believe that state of affairs is changing as reality starts to bite.

Some thoughts on the Equinox Effect

Many dismiss the whole idea that major market moves can be influenced by astronomical events. They may say it is akin to Astrology or tea leaf reading. I forecast such a major turn days before the recent Vernal Equinox. So was I tea leaf reading?

As a (now lapsed) scientist, I used the scientific method to discover truths about the way the universe works. Propose a theory – and pit it against experiment (experience). If the results agree with theory, it is deemed valid. But if the results disagree, the theory must be thrown out (although retained by die-hards). I use the same approach in my own technical analysis work.

So with major highs around the time of the previous five equinoxes (at least) – and confirmation that last week’s Dow/S&P/Nasdaq high fell right on the VE (see chart above), most would agree there is something there to this ‘coincidence’.

So really, how sure are we of our current understanding how markets work? How sure can conventional analysts be of the standard theory that the Fed controls interest rates, the economy and inflation (and the value of the dollar thrown in). Does theory match with experience? I say not.

Most recognise there are four seasons in the year – and each has been marked throughout history as marking significant changes in human behaviour. Spring started (in the Northern hemisphere) last Wednesday – and that is when the sap starts to rise – and emotions stir from winter’s hibernation. The current tumultuous Brexit battles here in the UK is testament to that.

Not only that, but there was also a Full Moon last week – always a time of heightened emotions. And this emotional spectacle was played out in spades in stock markets! Here is the Dow after the VE had passed:

A buying frenzy started on Thursday followed by a mad rush to sell on Friday in a titanic struggle. Was this the last throw of the dice for the Dip Buyers?