Bear Rally Over? Yield Curve and VIX Turn Higher

It has been a long and winding road in this bear market. Yes, I still believe a bear markert is underway until new highs are made. I haven't been tactically bearish on the market over the preceding months, onyl taking some small swings when setups looked good. Until those old highs are taken out, my bear market call from November 2021 remains intact.

First, the classic bubble chart pattern hasn't been violated:

A double-top is a valid expression of the "return to normal" phase. Bullish sentiment and speculative behavior return to near peak levels, propelling the major indexes or stocks into double-tops. Anecdotal, but cryptocurrency speculators believe a new bull market is underway. Bitcoin BTC has a pattern that is consistent with the classic top though:

Tesla, Google, Amazon and Meta all sport the classic pattern with no hint of an imminent double-top. The paradox stocks are Apple and Microsoft. Both have achieved new all-time highs. Their massive weight in the S&P 500 technology sector (nearing 50 percent at times) propelled that sector to a new all-time high in July. If I'm correct in my assessment, this will turn into an overthrow of a double-top pattern and not an extension of the bull market.

Industrials also achieved new all-time highs this year. Energy and materials made new highs in the second-quarter of 2022 and remain within striking distance of new highs.

I'll digress here and give the bullish argument over the longer-term. Assume for a moment the U.S. was primed for a recession around the time the coronavirus hit. The government then wrecked the economy and then flooded it with far too much stimulus. Even though there's no official recession in 2023, the U.S. government is running deficits on par with the fallout from 2008:

There's nothing bullish about that chart long-term. Growing deficits will increase inflationary pressure. Falling deficits could trigger deflationary pressure. Since stocks are priced for perfection, deviation out of the Goldilocks Zone will trigger price declines in all sectors at least for a time, barring an explosive move higher in energy as we saw in early 2022.

I don't want to belabor the valuation topic, but here is the price-to-earnings ratio divided by the growth rate (PEG) and the spread between investment grade corporate bonds and the Federal funds rate.

Going back the to the bull thesis: what if the government front-loaded stimulus and the bear market/recession doesn't materialize? In that case, either an extension of the bull unfolds or the transition occurs without the bear move. Both EFA and EEM, the developed and emerging market ETFs, bottomed in October 2022, with EEM having a little overthrow this year:

To wrap up the bull case: the government flooded the economy with stimulus, triggering a temporary inflation surge. Inflation settles back into the Goldilocks Zone, as does GDP growth, sub-2 percent for both. In the short-term bull scenario, stocks enjoy an extension with tech and other speculative assets resuming leadership. In the longer-term scenario, the transition to new leadership such as industrials, energy, commodities and foreign markets takes place without a major bear.

Back to the bear scenario, one of the strongest signals for a recession has been the inverted yield curve. It doesn't indicate an imminent recession, rather it signals the pre-recesesionary stage. The actual recession comes when the yield curve steepens. Going back the past four decades, this has always occurred when the Federal Reserve slashed rates. Right now, the yield curve is steepening because long-term bond yields are rising faster than short-term yields. It is a small move at the moment, but the spread has made a higher low, indicating the final low might be in.

The 10-year treasury yield has a bullish formation that may or may not complete. If it completes, then higher long-term rates will sink financial asset valuation and could indicate a stagflationary recession. The 30-year mortgage would be on its way towards 10 percent, a level that would almost assuredly kill home prices too. On the flip side, a traditional steepening via Fed rate cuts would be another bear market and recession like we've seen in 2000 and 2008.

The decline in the VIX has been a hallmark of this bull market. The VIX has fallen below the level reached at the November 2021 peak, indicating fear is gone. Here's the VIX overlaid with the 2s10s spread:

VIX isn't a great indicator in that it tends to be coincident with the 2s10s, but a rising VIX indicates rising fear, likely because there's bearish action in parts of the market ahead of the full-blown bear. Here's a look at when the VIX bottomed ahed of prior bearish periods:

There will be bearish trades emerging very soon if the yield curve has finished inverting and moved into steepening. Ditto if the VIX follows it higher. With September and October coming up, the calendar supports a market top scenario here. New highs on the major indexes will invalidate the bear scenario, as will a falling VIX. If the 2s10s inverts further or moves sideways, it will indicate no imminent economic pressure. If the 10-year yield fails a breakout for instance, the yield curve might invert further while the broader stock market interprets the falling yield as disinflationary and therefore bullish.

SPY-EFA Ratio Threatening Breakdown

If this rolls over and drops, it's a major signal for the markets. U.S. stock market leadership is over and it is either the start or end of the bear market.

What do you think? A new bull market is starting along with a new U.S. dollar bear market, led by non-US developed markets or a major top in the U.S. markets is about to pick up downside steam? SPY has way more tech exposure than developed markets, so if bearish, it hints at a resumption of Nasdaq leading the markets lower. If you notice the stochastics below as well, SPX-EAFE ratio bottomed in February 2000 and peaked again in October 2000. This time it peaked in December 2021 and bottomed in February 2023.

Here is EFA versus EEM for comparison. Looks like a massive base in favor of developed markets.

BTC, Apple and Emerging Markets

BTC and Apple are the two most important chart junctures for the bear market right now. Not more important assets than the U.S. dollar or bonds, but they are sitting right near major support lines and both are core assets for the speculator and investor classes. If these charts break their support lines, it's a big bearish signal. Conversely, with the maket going on nearly one-month of a rally, failure to break lower here would provide a new bullish catalyst.

Emerging markets are also sending a bullish signal. However, they sent a false signal in 2008. Not for themselves; they didn't make a new low after bottoming in the autumn of 2008. Their low signaled the coming change in leadership, but U.S. markets wouldn't make a low until March 2009.

The Korean won is rallying and the South Korea ETF is nearing its former long-term support. If emerging markets have legs, it looks like South Korea is the leader. If this rally is going to give way, South Korea is also reaching a spot where a reveral is likely.

Emerging Markets and Gold

I expended on the prior post showing real rates and gold, along with a discussion of EEM, as two current ideas. Both are at important levels and their short-term performance will give an important signal for the broader markets. The Bull and Bear Case for Two Important Assets

Confuson Growing

We've entered the part of the bear market where confusion begins creeping in. Did the Bank of Japan intervene again or was that the market? Are central banks secretly intervening as the did in 2016? True or not, this signals the market now belongs to the central bankers. If the yen rallies, the BoJ rises in stature. If the yen falls, the BoJ has failed. Some bears are now wondering if central banks will destroy them again as in prior bottoming attempts and bulls must now worry that the yen starts trading more like the Thai Baht in 1997 than a G7 currency.

My advice: it's a binary event. Either it happens or not and there's nothing we can do about it. The market is already down a large amount this year so pressing shorts isn't advisable. Conversely, the bounce we have seen since the bounce from 3500 is a good spot for opening new shorts. I am stalking energy again, gold, and looking at individual targets such as DPZ.

USDCNY moved to a new high today and is tracking with the yen. USDCNH is up 1.2 percent, gold failed at resistance, U.S. long bonds are following through on their bounce from last week and Hong Kong cratered 6 percent overnight.

With Chinese yuan pounded and Hong Kong down overnight, iShares MSCI Emerging Markets (EEM) is down more than 3 percent in premarket and below it's long-term support line.

Better Off Red

ZB is heading for the measured move target of 121. TLT is in free fall. I do not know if 121 will hold or not. I'm agnostic here. As I've said before, I think ZB can bounce as stocks crater and it can bounce with a bull rally. If it is falling, then stock are probably going lower. ZB is at a new 52-week low. Don't over think it.

Gold, copper and oil are all below important horizontals that mark topping patterns. All three have collapse analogs. The Federal Reserve is doing what they did when commodities collapsed over the past decade. The charts are rolling over into h-like patterns. I have a simple two-part thesis. One, I think these charts are going lower. Two, if these charts go lower, they complete setups that forecast plunging prices. If they go lower, they go way lower. So I buy OTM puts. Since gold has lower expected volatility, I went with that one. I have November $150 strike puts on GLD.

Stocks say hold your horses. I can't ignore the counter-signal from the market because it can be a predictor. For now that's all it is, a prediction. Everything else says stocks are experiencing an internal technical move that will lose steam. Stock will recouple with commodities and bonds, and sink.

You know what didn't rally? Energy. I closed weekly puts I opened yesterday. I may or may not open them again. I am still holding some OTM COP puts for November. I also closed my USO puts that expire Friday yesterday. I may or may not reopen that position because as I posted yesterday, I think it's time for XLE to underperform USO. If oil goes higher, that is probably bad news for stocks and bonds.

I can see outlines of a dollar top in the euro, maybe even the Korean won, but not in the Japanese yen. Not the Chinese yuan. Currency crisis only needs one player. I view this as a high stakes situation because DXY is advising some caution that will be warranted if USDJPY tops out. The flipside is China could be forced into letting the yuan drop and last time that happened, stocks went almost straight down 10 percent in much better macro conditions. I'm playing the possibility of this with OTM puts on EEM for November. There's no support if emerging markets break lower and China is their lodestone.

Finally, BTC. It ain't screaming sell everything yet, but it also ain't rallying.

These aren't my only trades listed above, only ones relevant to these charts. My first thought will be to add more BigTech, energy and consumer staples shorts if the market turns lower. I did jump into some Apple November puts yesterday. Earnings season makes single-stock options trades pricier, but I might put some on in special cases or post-earnings.

Hottest CPI Since August 1982

That'll do it.

Here's BTC on the verge of collapse. I think it gets going sub-$18,000. Holding on right now along with stocks. I'm always paranoid about rallies and one could come in the morning, but I think the market will be busted from here into the tradable low that could be days away.

I'm keeping an eye out for all the stocks sitting on major support lines such as Boeing, FedEx and so on.

EEM lost final support in premarket. I drew a line just in case that cuts through the $32 area, but after that the only thing I see is the March 2020 low that is 16 percent lower. That isn't really support, but it could prove to be considering that's about the max decline I expect for the market here.

New 52-Week Low for Emerging Markets

Here we have yet another chart with bounce or freefall potential. Only this isn't an overvalued company, but emerging markets with China being the largest component.

Great Buy or Bombs Away

Why not both? If EEM holds major support and USD weakens in the ensuing rally, it will probably do well on the upside. Conversely, if EEM loses the $34 area that marks long-term support, we could see some incredible losses over the next few days and weeks, in which case it'll be an even better buy. I have puts. As I wrote on the weekend, I'm not doing anything except closing positions from here. I have puts on EEM and I'm still holding them.

All My Positions

I have short positions of varying size on all of these. In terms of number of options, XLP is by far the largest position. By dollar size, CME, APPL, MCD, SHW are relatively large. If I group together all my energy positions XLE, COP and USO, that would be larger than everything, but some of these are weekly puts that I may take off early next week if crude doesn't dip quickly. XLP puts are cheaper though, and thus I anticipate they could be my largest position at the conclusion.

Update: I forgot to list BITI calls, a short position on BTC.