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.

Bitcoin Back at the 10-Year Support Line

Copper and BTC

Pennsylvania Buys Fettercoin

My bets on the election won't pay off because unless there's some shock result coming (GA might go to a runoff), the Democrats will hold the Senate. They might even gain a seat, but who knows because it'll take days to roll in. Assume they do. I looked back to find the other years the President's party gained Senate seats: 1934, 1962, 1970, 1982 and 2002. Ultra-popular FDR, JFK, Nixon, Reagan and Bush riding popularity waves and in the case of Bush, the fear-echo from the September 11 terrorist attacks. This year is not like any of those years. I wondered, what year was similar? And I think I found one: the 1930 midterm election. You'd assume Republicans were smashed that year and you're right to a degree. The GOP held the Senate though, by the VP's tiebreaker vote.

Crypto cratered yesterday. Support is busted and there are huge losses all over. Solana was hot in late 2020 and early 2021, and now looks like it will retrace all its gains.

The next moment of recognition could be coming to stocks. There will probably be divided government, but there won't be much of a brake on self-destructive foreign and economic policy. This was a very strong setup for the GOP and they barely gained ground. I do think the GOP might come back to win in 2024 because I think these midterms might be more like the 1930 midterm. The GOP lost the House and lost Senate seats, but held the Senate with the tiebreaker vote. The Democrats will lose the House and they might hold the Senate by the tiebreaker vote again or with a slim majority. The Republican President Hoover kept doing the same interventionist policies that kept failing, as the Baizuo admin will continue their failed policies into 2024. The hope around a Federal Reserve pivot, that there can be a soft landing or even no recession, is reminiscent of the market in early 1931, The Tragic Year.

Tomorrow's CPI report may or may not be a trigger for this realization, but it could be. The market has been very bullish. The market assumed a Red Wave would bring divided government, but it would also give hope that the bad policies collapsing the nation would be slowed or stopped. Now it doesn't look like there's any hope until 2025 at the earliest, and even that hope probably requires very bad things happenening between now and then because the surging crime and inflation to this point wasn't nearly enough. There are levels of crime and inflation that will change voting patterns, but they're far higher than today's levels. If the CPI comes in cool tomorrow, then no worries for bulls. The market will rally because inflation is solved. The Fed pivot story will gain steam and bears will be squeezed, perhaps into the end of the year.

If instead inflation comes in hot, there will be some realization by delusional bulls that nothing good is coming. There is no hope. They've been played the fool all year and it isn't going to end. The S&P 500 Index will start trading like BTC.

BTC Takes out Long-Term Support

The 52-week low is at $17,600. Probably the last level of support before $14,000. I added the line there to highlight it, but it isn't anything more than mildly psychological support.

As I was typing that area was tested and sparked a rally.

I posted this chart in late October:

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.

Gold Plunge Window Opens

BTC still holding up for now.

BTC Pop

Not a huge move, but is is the most bullish it has looked sdince October 4. That up moved failed right around this level. It's also notable that BTC (and ETH) are moving up with Google and Microsoft sinking the Nasdaq futures

BTC Analog

BTC Heading for a Breakdown

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.

Poor Low

The low yesterday is screaming for a retest. The level traders are watching for is 3650. Below shifts the market into a bearish position, above 3700 area is bullish. I added shorts near the close yesterday because what I see is the same move that has already happened three times. The percentage and nominal point move in some indexes and sector ETFs was almost a perfect repeat of the move in early October. Two differences. The move in October took two days. The move yesterday chased out a lot of bears. It might have been largely short covering by bears. 

Structurally speaking, today is a far more potentially-bearish market than yesterday, and arguably more bearish than it has been for weeks, if not a couple months. Totally meaningless for now if the market wants to move higher. I'm talking about potential energy. It'll become important when the market next turns down. However, if markets start reversing today, then do not be shocked to see a new low within days. Or today for that matter.

BTC bounced right at my support area as did QQQ. The 3500 also was a 50 percent retrace of the move from the March 2020 low to the January 2022 top. Of course a big rally would unfold and I missed it, despite having charted it several times. Bonehead error.

The collapse analog in gold is still extant. I can also see a case for going long here if you're bullish, but I'd like to see more strength before being long. A down move will be far larger than an up move from here.

My Domino's trade didn't pan out. Yet. I'm still holding my puts. I watched big gains evaporate, but I only have a small loss at this point. The market reaction to Pepsi and Domino's earnings, carrying up stocks such as McDonald's along with them, was very optimistic. In a nutshell, the markets sees the consumer as still strong, which technically it is given those results. I take the pessimistic view moving forward. I think these earnings were warm in the same way a family burning furniture keeps their house warm in winter. Both Pepsi and Domino's reported economic contraction because revenue increases were less than their price increases. The question is what happens with the relationship between costs, prices and consumer demand moving forward? Similar to what I'm saying about the market being more structurally bearish after yesterday, these firms have propped up their earnings in 2022 by raising their prices and potentially making their products less competitive if the consumer retrenches in Q4 or in 2023.

Specifically on the charts, DPZ could get ugly with an ongoing rally. MCD is far closer to its resistance line, but it has room for a 20 percent rally all the way up to around $300 by January. That would be an incredible bear setup if it transpires. DPZ would look ugly up there, whereas MCD would be screaming, "Short me!" I don't think that rally is likely, but it depends greatly on the broader market.

Finally, overall the markets are still doomed. I can't count how many people are complaining about the Federal Reserve's rate hikes killing growth when the interest rates are still negative 3 percent measured by core inflation. The West and most of the world is in a mess because of negative interest rates, yet people want more negative rates. If the Fed or politicians give in to this growing chorus, then more apocalyptic scenarios must be contemplated.

More proximate to the markets, crude oil is tracking with financial assets. In the short-term, stocks can ignore all manner of bad news, but if crude tracks higher, then inflation isn't going down much. The Fed funds rate will probably reach at least 5 percent and become a new floor. Assuming the economy weakens there could be rate cuts coming eventually, but if crude stays high maybe not. Look at the 1970s. Powell has specifically mentioned the mistake of cutting too early. My sense is most of the market, including most of the analysts and economists, are out to lunch. The mega bears and "hyperinflation" guys are on opposite sides of some issues such as where the price of BTC is going, but both of them understand the scale. Their debates are useful. Tune out the others.

Futures blasted higher while I was composing this post, past my get out line. I'll wait to see how the market behaves at the open before closing out short positions. The only two winners propping me up are gold and oil, both of which remain weak for now.

Bounce

3505 was the 50 percent retrace from March 2020 on SPX. Took the ES all the way up to one of my "get out spots." BTC ripped too.

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.