黑兔年

Black Tuesday

Black Monday

Year of the Black Rabbit

A different look at the HYG/TLT ratio. The candle forming is confirming at top.

Bond Ratio and Targets

The ratio of HYG and TLT looks to be finally reversing. There is a gap on HYG near $75. A trip back to the 2007 ratio high map to TLT at $101. A trip back to the next resistance line gives a $105 target. If HYG goes higher, there are yet higher targets possible. A 50 percent retrace of the TLT drop since June gives a possible target of $105. Given this context, I see a fairly high probability of TLT moving above $100 as long as the general move in bonds is higher. What interests me about bonds is that, as I had expected this summer, eventually inflation and the broader economy weaken enough for an extended bond rally. That could produce targets upwards of $120, with a backtest of TLT's former long-term support possible up around $130 in the event of a disinflationary or better (for TLT), deflationary recession.

HYG-TLT Ratio Breakout

New all-time high. The argument for a breakout is that we get a sovereign debt crisis that takes U.S. government bonds down more than corporate bonds, including junk. HYG also leading against investment grade bonds in LQD though. That only makes sense if the economy is much stronger than the data reflects. Place you bets.

With dividends stripped, the ratio also broke out.

A case can be made for HYG outperforming TLT in an inflationary environment that is also strong economically. The converse view is the oversold reading suggesting a reversal. HYG is sitting above long-term support, while TLT and LQD have broken down. As a ratio trade, I'd look for a reversal in the ratios. Whether that is more long TLT or short HYG I can't say for certain, but I'm buying puts on HYG.

Tight stops. I expect a downside move to be almost immediate.

High Yield Debt

One Path to a Market Crash: Credit Spreads

High yield credit is outperforming government debt as it did into the 2007 peak. What's amazing is credit has been deteriorating unlike in 2007. The low in 2007 was below the 1997 low, and it produces a peak in the HYG/TLT ratio. The current high is being made with credit risk sitting at the "get out of stocks now" line.

TLT isn't an appropriate comparison fund for HYG in most cases because there's a big duration mismatch, 20 years versus about 5 to 7 years. U use it because it is volatile and these two funds are sort of companion ETFs for income investors the past 13 years. You buy TLT in the corrections, and HYG at the lows. With that in mind, here's another way of expressing this relationship. The high-yield srpead divided by the 10-year and 5-year treasury yields. They're both approaching lows seen in September 2018.

Think of it this way. The decline in interest rates this year has taken companies up to the starting line of panic in the credit markets. Any follow through will trigger the type of fear normally associated with recessions and credit events. At that point, it doesn't matter if treasury yields fall except that falling yields will keep panic limited to corporate bonds.

High Yield Debt Still in Positive Divergence

Amazing that high-yield is diverging positively from investment grade bonds even as it has been moving lower. Positive divergence the past few days as well.

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.

DING DING DING What Does It Mean?

I updated the DING DING DING post, discussing the prior peaks and reversals. I see this stuff in the midst of the day's action and alarm bells go off, but fully digesting it takes time. To hammer home the implications, here are crude and stocks layered alongside this ratio.

It's always possible the ratio goes higher before turning. Or even going far higher than anyone anticipates. Yet the latter would mean the public has faith in junk bonds as it loses faith in the credit of the United States. That strikes me as unlikely at this juncture.

DING DING DING DING DING DING DING DING

Update: Charts don't really need an explanation, but I thought I'd give one now that I have time. The trade here is long TLT and short HYG, or straight short HYG given context. Or you use it solely as an indicator. However, here's some added context on the peaks in the chart.

The touches that form the trendline are are in June 2007 and February 2011. Lows in the stock market: March 2009 and September 2011.

Other peaks:

January 2014. Markets bottom in January 2016.

October 2018. Markets bottom in December 2018. I think this one might be most relevant here as it also saw QT and rate hikes. The ratio itself didn't bottom until March 2020 though.

Now.

I expect an imminent meltdown in the markets, but the history of this indicator also says the bear market low is well into the future.

Crash Line on HY Credit Approaches

Expect accelerated selling in stocks if this line breaks.

What's Next for Markets

Many traders are looking for a low around the 3500. Some are short-term oriented, but others have that as a long-term target. The 3500 level is only 5 percent away. I will ride a position down to 3500 and might take very short-term trades, but overall I wouldn't be looking to short here if I thought 3500 would be the final low. There would be more to be made by buying at 3500 and riding the subsequent rally.

Above is Elliot Wave. It is fractal, such that wave 2 can develop like the ABC pattern at the top, because within Wave 1 there are five waves. I don't use Elliot Wave for trading, but it does describe market psychology well, tends to work better in bear markets for that reason and makes it easier to put the market in context.

The first scenario is Wave 1 ended in June. (Note that everything is inverted because this is a bear market.) That low will hold until next year or the dip to 3500 on the S&P 500 is a bear trap for anyone not covering there. A new low at 3500, followed by a big rally, means wave b of the a-b-c of wave 2, completed. Wave c will be the rally into late this year or early 2023. 

Not making a new low is the same as making a slightly lower low, as long as the next move is a big rally. The 4400 level discussed before could be where this goes, a 25 percent rally. Since the market (measured by the S&P 500) would be down close to 30 percent at 3500, if that were only wave 1 it would open up a final bear market low in the low or even sub-2000s level because there are two more bear waves coming. This could easily touch the bottom of the megaphone made by the 2018 and 2020 lows. (I'm using VOO because it is less marked up than other charts.)

The second scenario is Wave 3. The market tumbles as it did in 2008 after sliding down most of the year. Most likely down to 3000-3300 area. An middle ground in this scenario would be the Feb 2020 level of 3400. Closer to 3000 it is more of a crash and would strengthen the Wave 3 thesis. Jan-Jun is Wave 1, Jun-Aug Wave 2, Aug-Oct Wave 3, Oct-Jan? Wave 4, and then the final low next year either breaking the March 2020 low or close enough to be called a test. More than 40 percent down from the top, more than 50 percent on Nasdaq. The final low might come in March to May. 

A crash should be triggered by a huge event. Catalysts could be currencies (yuan deval would be high on my list) or bonds (I posted high yield yesterday, right at long-term support and the ex-dividend portfolio trading like they did in 2008 and 2020). Perhaps a key earnings miss or warning from a company such as Apple (AAPL). Geopolitical events such as Russia-Ukraine escalating into a regional war or with use of unconventional weapons. This might be a best case scenario for bulls (without the war escalation) and for bears if they have positioned for a big drop.

Leaving speculation aside, a move lower will absolutely require major breakdowns in key charts. One is high yields bonds. HYG broke and recovered a line from the 2008 and 2020 lows. JNK broke that line clean, but there's a second line formed by post-2008 corrections still ahead. HYG is the better signal here. A plunge through support will be a huge event.

CNYJPY probably doesn't need watching, but it sums up the yuan depreciation thesis. China is struggling as export competitor currencies crash. If the yen continues falling, the yuan will eventually break sharply lower as it catches down to the yen, won and euro.

Many charts, including HYG above, are where a bounce looks likely. Charts such as USDKRW also make it clear that this move has to be terminating because charts don't go vertical for very long.

Moreover, a chart such as USDKRW will reverse explosively. The only scenarios for this chart are accelerated continuation or reversal. The 1997 peak was in December after a 3-month panic, but global financial markets didn't bottom out until September 1998. The "2008" peak was in March 2009 with some choppy months. It is 13 percent back to the 2009 peak and 30 percent to the 1997 peak.

As I speculated on August 19 in Won Enters Crash Zone, the prior two breaks above the horizontal led to huge moves. We are in this move now. It ends when it ends, but this has major implications for all markets because this chart isn't moving in isolation.

I wish there were a way to be more confident, but these situations are always opaque on the inside. In hindsight, they are obvious. They're unknowable because crashes break everything. Candles, technical indicators, sentiment and so on can all scream buy buy buy and the very fact that the market doesn't bounce, or reverses after a short bounce, is what induces panic from the professional trader down to mom and pop retail investors. 

Nothing is screaming crash here, but continuation in high yield, currencies, stocks and bonds will push everything towards a crash moment. Don't forget crypto. BTC would likely implode in a crash, yet it too sits above long-term support. Gold broke its last line of support on Friday, so that is one key chart that has walked through the door opened by King Dollar. Whether the market bounces or falls or crashes, in my opinion there are days to weeks left for bearish trades in stocks and bonds.