Tipping Point

If you think the last few weeks were crazy, then last Friday certainly takes the cake and borders the ridiculous. Watching the futures being halted before NYSE opened made us salivate as the prospect of insane profits seemed to be in our greedy grasps. But not so fast – once again primary dealers stepped in the very second the market opened and and spoiled the party by banging up the cash indexes; until about lunch time when everything started to flatline. Towards the end of the day there was a rally attempt but it failed, ending the day in an almost perfect a,b,c (marked in green below).

SPX at tipping point.

So now we find ourselves at a tipping point. Looking at the chart above, the triangle we expected early on has realized itself and seems complete from a technical point of view. However, looking at the tape from Thursday and Friday, it is now clear that a buyer lurks around the 850/860 level and will have to be overcome in order to trigger that last plunge to the downside we have been waiting for. There is a possibility that the triangle will get stretched sideways and will resolve after election day – it doesn’t take an IQ above room temperature to figure out what the game is here.

From a sheer wave count prospective the picture is distinct. I don’t think that we’re dealing with an ending diagonal here, which are found at the termination point of larger patterns, indicating exhaustion of the larger trend. Exhaustion is clearly not the present sentiment, at least judging by the vehemence and volatility of the past few days. What we are looking at is a textbook symmetrical triangle, which attempted to break right after wave {e} concluded. However, we need to acknowledge the fact that a plunge was prevented from occurring twice now, and we will need to see a successful attempt in a very short order now, probably tomorrow, otherwise the triangle will most likely stretch out towards the presidential election.

The areas and levels to watch are marked in pretty colors above – if you’re colorblind you will most likely get wiped out this week. If we stay in the yellow a plunge is imminent. Blue means churn galore, probably until the election, and if we push beyond the red a rally is becoming more likely. I have also marked preliminary targets in gray, for both the bulls and the bears. Although I’m mostly in cash after Friday, I’m still giving the bearish case a 65% probability – split between 40% going to the immediate plunge downwards, and 25% to the ‘big churn’ leading to election day.

I’m giving a sustained rally a 35% possibility as several indicators now are starting to shift in favor of the bulls. The spread between Moody’s BAA bond yields and the 30 T-Bond yields ($TXY) has started to narrow a little bit, from -5.3 to -5.17 (again, I do not have real time data on this, so this might have changed on Friday). Our trusted 30 year T-Note yield ($TNX) yield also pushed up hard after a brief plunge to the downside, which may be due to investors pushing back into equities to snap up ‘deals’. Of course the other (and in my mind more viable) possibility is that the Feds have been flooding the bond markets with short and long term paper, thus pushing yields up.

TED spread widening.

Supporting the bearish case is the good ole’ TED spread, which has started to widen again. Not by much, but considering that inter-bank loans now enjoy a liquidity guarantee by central banks worldwide, this is a bit unexpected (in a good way).

Baltic Dry Index doing a Wiley Coyote.

Also supporting the bearish case is another indicator I frequently look at – the Baltic Dry Index ($BDI), which has ‘enjoyed’ a 90% drop in a matter of 5 months. While the public watches the Dow, professional traders are watching the TED spread, Mr. VIX of course, and often also the Baltic Dry Index. If you’ve ever wondered what it costs to send a Capesize freighter full of coal from Ecuador to Rotterdam, the Baltic Dry Index is your number. Compiled at a 200-year-old shipping exchange in London, this index tracks prices on the world’s largest cargo ships. Bulk freight is the stuff that drives economies at the most basic level – grain, coal, iron ore – so the BDI offers a pretty good proxy for the overall health of global trade. If shipping is expensive, that means nations are hungry for raw materials, and economies are flush.

The current plunge can’t purely be laid at the feet of the banking crisis: A standoff between China and Brazil over the price of iron ore has shut down one of the biggest commodity trading relationships in the world. But frozen money is a big part of the story here, too. Shippers around the world rely on old-fashioned letters of credit to ensure payment, and banks just aren’t issuing them right now. Without that guarantee, no exporter in his right mind would load 90,000 tons of coal onto a ship and send it to another continent. As of right now, a growing amount of commodities are stranded in ports worldwide.

So, it’s fair to say that the credit market remains in a deep freeze and until we see some thawing here reflected by a strong swing up in the BDI I have serious doubts as to the probability of a sustained consolidation rally in equities as represented by the anticipated intermediate wave (4) of primary {1}.

Gold moving WITH equities lately.

Gold has been doing exactly what I have been proposing for months now. The now not so precious metal actually touched 680 on Friday, but snapped back – along with equities. It is very interesting how the once inverse correlation has now reversed as Gold is now moving alongside equities. Which is exactly what we expected would happen – even Gold is considered a risky investment right now (although it truly does not deserve that label) due to its past gyrations, which were of course PPT induced. However, another factor is that Gold is being regarded as a commodity and not as a currency right now, a common phenomenon during economic contractions. This will change once we enter the hyperinflationary period of this secular bear market.

We might see a sympathy rally in the next few days, but I remain confident that the target zone of 650-600 will be met, if not soon then by the end of November. At that point I might actually consider buying some physical Gold bullion or coins. It’s possible that Gold will drop a bit further, but the downside potential now appears to be limited.

There is no doubt that this week will be at least as erratic as what we have been witnessing as of late. My suggestion would be to limit your exposure to about 50%. Yes, fortunes will be made next week, but at the same time, a lot of folks will get wiped out. You don’t want to be all in as even a 50% participation will most likely meet the profit goals you have set for yourself. And if things take an unexpected turn, you still stand to trade another day. The good news is that the consolidation rally should be upon us in a matter of days or at least weeks. The option market is broken right now and I can’t wait until I see Mr. VIX below 40 again.

Keep it clean, don’t yield to fear or greed, and above all stick with your system. We are stainless steel rats and as such we will succeed, no matter which way the market swings.

Cheers!