The battle is on – the Fed vs the virus

Boy, isn’t the air thin up here?  We’re gasping for breath! Just like magic, stocks continue their levitation into the value stratosphere – valuations only matched by the 1990s dotcom boom, which most now acknowledge was a full-blown mania based on hope and hype where the fantasy was that you can monetize eyeballs.  Hindsight is always 20/20.

But complacency today is at or near all-time highs, just as in 1999.  Daily DSI bullish reading at 92% was last seen in January 2018 when the Dow rose to its ATH at 26,700 – and them promptly reversed hard down.

But on the other hand, COT futures-and-options positioning shows that the e-mini S&P market is evenly spread between longs and shorts, so no imbalance there.  Evidently, the large number of calls are being balanced by the smaller number of short futures. Hmm.

However, S&P Put/Call ratios have plunged to their lowest levels in six years and last week, investors bought 22 million call options – an ATH record.  Investors are falling over themselves to get on board as they display extreme FOMO.  The QE4 magic is weaving its spell to lure investors into the mother of all bull traps.

But what’s this coming out of left field?

As I point out below, the crude oil market is taking the outbreak of the coronavirus in China very very seriously.  Whole cities are in lock-down and travel is being heavily restricted in this Chinese New Year period when families usually get together.  Energy demand is being hit and no end is yet in sight.

In fact, the virus is spreading around the world and so all sorts of apocalyptic scenarios are being suggested – to add the the massive current global warming scare.

Can stocks take this intensity of negative sentiment?  After all, the fundamental driver behind stock rallies is supreme confidence in the future.  And when investors start to lose that confidence, they start selling assets and especially stocks a fear spreads.

Suddenly, the Fed now has an opponent – the new virus scare.  Will this battle be enough to dent the confidence of the bulls?  The technical conditions are just right for a massive re-alignment now.

But we must open our minds to this much more bullish possibility:

This is an acceptable Elliott wave scenario that breaks no EW rules.  The key to this outcome is to push hard above the upper tramline in wave 5 – a solid line of resistance.  It is currently on that line.  Will it hold?  If so, this is the better Elliott wave picture:

and we have a possible overshoot (buying climax) last week – provided the market falls hard next week.  That is my litmus test – and I need to see a clear five down on the 30-min chart to confirm.  That way, we can abandon the bullish picture above, at least for now.

Over in the Nasdaq, here is an interesting feature:

I have a ‘five wave continuation’ pattern (arrow) – see my text pp 38 – 39, 144 – 145 – which is a pattern I have noted usually lies about half-way along a major wave (in this case wave 5).  And the market has reached that target already around the 9,250 region. Only a strong surge above it would cancel out this signal.

So we have definite price area in both the Dow and Nasdaq which would spell the rally ending if they fail to be penetrated.  If that is the case, I expect a decent correction very soon and a wave 4 down in the Dow (at least).

Maybe AEP was right after all

I may have to give a rare hat tip to my old adversary AEP – crude prices are indeed in decline- but not for the ‘green’ reasons (switch to renewables) he laid out.  The Chinese travel disruption is the more likely culprit. Before the virus hit the headlines, global oil consumption was rising at an annual rate of around 1.5% consistently. This is my outlook

The decline off the ‘e’ wave high at 65.50 on 7 January to the current 54 – a decline of an impressive $11 has only taken less than three weeks – and it has just broken below my lower tramline area.  If we are indeed in a third of a third, the decline will likely gather pace towards the old low at $40.

Here is the Dow chart again but in the last three weeks, shares have continued climbing while crude has fallen out of bed.

Note that the spike lows in both the Dow and Crude occurred on exactly the same day – at Christmas 2018 and both staged rally phases more or less in synch last year.  Obviously, higher crude prices did not put a crimp into investor’s perception of company earnings/stock prices.  Of course, energy companies make up a large part of the stock major indexes and these benefit from higher oil prices.

But also note the last few weeks’ action.  While shares have continued to climb rapidly, crude oil is in a sharp decline. A big divergence is opening up.  So how will it resolve?  We are suddenly getting the answer to that question in spades.

And now the incredible junk bond market is showing signs of stress – finally.  The US oil frackers have issued tons of these high yield bonds to fund their operations and with the collapse in crude prices, they are in great danger of default – and the market has suddenly woken up to this:

As yield spreads start to widen (US Treasury yields are in steep decline), stocks will take fright.  I expect fireworks – but not in China at the New Year – in our major markets.

Silver displays a lovely chart – as does Fresnillo

We have been trading silver (and Fresnillo for PRO SHARES) very successfully for some time and recently took major profits earlier this month on a spike high (wave 1).  Since then we sat on our profits and waited for the next opportunity, which came yesterday.  Here is the lovely chart

My wedge is textbook with very accurate touch points.  The surge off the wave 4 low in early December broke above the upper wedge line – and we caught that low precisely.  The momentum divergence gave the game away!

And over in Fresnillo, the picture is just as juicy:

Just as in the silver chart, we have a lovely wedge but the shares are much earlier in their recovery.

My best bet in silver is that we are starting wave 3 of 5 that should exceed the old wave 3 high of 19.60.  And if my bearish outlook for stocks is borne out, precious metals should rally hard in a flight to safety.  But this should be the final wave 5 of a bear market rally in a large C wave. 

Eventually, this rally will terminate and silver will decline with stocks and most other assets as global deflation takes hold.  But that is for another day – meanwhile, swing traders can ride the action.

Take a two week FREE TRIAL to my VIP TRADERS CLUB and/or a generous three week FREE TRIAL to my PRO SHARES service.