Bitcoin - Another sign that Fed credibility is waning.

ferGOD Updated   
A Sick Feeling in the Belly of the Yield Curve

Another sign that Fed credibility is waning.

The socioeconomic point of view is that, as the Supercycle bear market develops, central banks will lose their mantle as being omnipotent directors of markets. Whereas in the bull market, central bankers like Alan “the Maestro” Greenspan were lauded because positive social mood was driving the stock market higher, in the bear market central bankers will be vilified as negative social mood causes a downtrend in stock prices.

Yesterday, Fed Chairman Jerome Powell sought to reassure Americans that the series of interest rate hikes that the central bank is embarking on would not tip the U.S. economy into recession. The bond market promptly ignored those soothing words and the yield curve flattened. A flattening yield curve, whereby the positive gap between short-dated bonds and long-dated bonds is narrowing, is a sign that the market is anticipating slower economic growth. When the yield curve inverts, with long-dated yields below short-dated, it has historically been a signal that an economic recession is on the horizon.

That historical relationship is most generally related to the yield spread between 2-year yields and 10-year yields, and that yield curve has been flattening over the past year from 1.50% to around 0.20% where it is currently hovering. So, not quite inverted yet, but trending in that direction.

However, in the so-called belly of the yield curve, the area between 5 and 10-year maturity, the message is already here. The chart below shows that the yield spread between 5 and 10-year U.S. Treasury yields has declined precipitously over the last year and, yesterday, turned negative. This yield curve inversion is a clue that a 2-yr /10-yr (2s 10s in industry vernacular) inversion is probably on its way.

Despite what the Fed says, a beast of a recession may be approaching.

U.S. Treasury 10-Year Yield Minus 5-Year Yield
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The Fed’s Deflation
Does Quantitative Tightening mean anything for stock markets?

So, finally the Federal Reserve has confirmed that it is starting the process of Quantitative Tightening. Quantitative Easing involved creating trillions of dollars out of thin air and using them to purchase assets such as bonds. This resulted in a massive increase in the Fed’s balance sheet. In 2003, the Fed’s balance sheet stood at $720 billion and grew to $900 billion at the start of September 2008. Since September 2008, though, the Fed’s balance sheet has gone ballistic, with the current valuation an eye-watering $8.9 trillion!

During that time, of course, the U.S. stock market has enjoyed a spectacular bull market, with the S&P 500 index advancing by over 570% since the financial crisis low in 2009, a Fibonacci 13 years. Curiously, another bull market lasted for 13 years after another “shock,” of the stock market crash in 1987. In that bull run, the S&P 500 index advanced by 618% before a vicious bear market saw it decline by 50% in two years.

The question is whether Quantitative Easing (QE) has helped fuel the bull market in stocks since 2009. Although it is a positive social mood which is the true driver of a bull market in stocks, to non-socionomists, there seems to be a relationship between QE and the advance in the S&P 500. However, this is spurious. The stock market continued to decline during the Fed’s first round of QE in 2008. The Fed did not cause markets to do anything. Crashing markets pushed the Fed to react.

Fast forward to 2022 and a similar thing is happening, only this time in reverse. Soaring markets, over the last few years, are pushing the Fed to react. As the trend in social mood appears to be peaking, the Fed feels confident enough to deflate its balance sheet and start Quantitative Tightening (QT).

Given the Elliott wave outlook for Bitcoin, that trend is set to become much more negative as this year progresses.
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May the Fourth be with you! And we might need it in the latter part of the day as the Fed interest rate decision hits the wires. A 50-basis point hike is priced in but there’s an outside chance of 75-basis points. Expect high volatility if it is 75, or indeed 25. Elliott wave analysis continues to point to declines in European and U.S. stock markets.
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Flash Crash - These things don’t come out of the blue.

This was all identified BEFORE the so-called “flash crash” that will rock the markets. Eagle-eyed Elliott wave analysts will notice a clear five-wave decline from the high and so, the overall decline might only just be starting.

So, buckle your seatbelt for even more volatility in financial markets.

Conventional analysis sees so-called flash crashes as random events. However, we show here that price movement is expected, no matter the circumstances behind it. Stay tuned to stay ahead of the herd.

The Fed’s Financial Stability report warned about deteriorating liquidity conditions in global financial markets. What did it expect? After flooding the markets with counterfeited digital dollars and now embarking on reducing that, it is not surprising that we are beginning to see air pockets in some instruments. And the trouble hasn’t even started yet in corporate bonds.
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It’s End of Term for Bulls!
School’s out. Let the food fight commence.
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This morning, a CNBC headline caught my eye. It said:

“Bulls finding it’s tough to buy the dip.”

Why is it “tough”? Because lately, every time the market tries to rally, a new sell-off takes it even lower.

But the real problem is not the market. It’s doing what it always does: “Market fluctuates,” to quote Seinfeld. The real problem is that many traders simply don’t know how to identify the larger trend.

I’m writing you all that to say this: Right now, the market environment is the toughest I’ve seen in years. The era of “easy trading” may be over, at least for now. So, to succeed, you need to develop skills that most people who call themselves traders simply don’t have.
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Terra(r) as the LUNAtics take over the asylum

There ain’t no algo for confidence. Or is there?

Nobody trusted anybody in the Wild West. It was a dog-eat-dog world where you took what you could because you were always one step away from death. Often this resulted in “Mexican stand-offs,” which gives us another fine excuse to watch this (from a Fibonacci 55 years ago!)

The Wild West in the financial markets has, of course, been the crypto currency universe. This week there has been an historic event with yet another blow-up. Whereas previous episodes have been with lesser-known cryptos, this one is a little different. TerraUSD (or UST) is a so-called stablecoin, meaning that it should be, well, stable (in value to the U.S. dollar). Whereas other stablecoins are backed by U.S. dollar cash, Treasury bills and bonds, TerraUSD is an algorithmic stablecoin, meaning that it uses complex coding to maintain a peg of one-to-one with the dollar. The scheme works by essentially using arbitrage between TerraUSD and a crypto currency called Luna in order to keep everything solid. In a sense, the whole scheme worked like a kind of Mexican standoff. Everything was fine until somebody flinched.

That happened this week when, out of nowhere it seemed, something broke. TerraUSD fell to 60 cents on the dollar on Monday. It bounced and then declined again, falling to 20 cents yesterday. The value of Luna, meanwhile, has crashed. As the chart below shows, from a high of $119 in April, today it was changing hands for $0.11. Yes, 11 cents! Luna would appear to be Lee Van Cleef. And its Stetson has just been shot into the grave.

What the crypto currency market is finding out is that everything (everything!) relies on confidence, and confidence cannot be created out of an algorithm. There is, though, a methodology of analyzing the markets, steeped in natural mathematics, that can give a lead indicator of when we might anticipate confidence to wax and wane. It’s called the Elliott Wave Principle, and as has been alluding to over the past few months, global financial markets have been flagging waning confidence. Expect more of the same.

Crypto has had the good, the bad and the ugly, and now coins like TerraUSD are looking for a few (billion) dollars more.
Stocks have bounced from yesterday’s lows and if you believe the media, it is because Fed Chair Powell pushed back on the idea of 75-basis point rate hikes. It’s not. It’s just that the short-term downtrend was exhausted, and a bounce was due.
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So... The storm begins
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The bear is happy and enjoying the show!
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“Bulls finding it’s tough to buy the dip.”
Why is it “tough”? Because lately, every time the market tries to rally, a new sell-off takes it even lower.
It’s a “risk-off” start to the week, with the blame being pinned on the fallout from Friday’s higher-than-expected consumer price inflation print in the U.S. Money markets are now pricing in 175-basis points of Fed rate hikes by September, implying two 50-basis point hikes and one 75-basis point hike. Bond yields are higher, stock markets are down, and Bitcoin has tumbled, all of which is consistent with Elliott wave counts.

Keep an eye on Japan where the bond market could be cracking as the Bank of Japan might capitulate on its yield curve control policy.
Markets are in a dither about the Fed meeting tomorrow, with a 75-basis point hike now expected. That would be the largest one-off hike since 1994. A full 1% increase is being mooted with some thinking that such a move could spark a rally in stocks because it shows that the Fed is serious about taming consumer price inflation. That’s not what Elliott waves are suggesting at this juncture.

Crypto-mageddon is also in focus with Bitcoin down some 20% this week so far. Elliott wave analysis suggests a low might be near, but there’s no concrete signs of a reversal yet.

European periphery sovereign bond yield spreads continue to widen, indicating increasing stress as the ECB embarks on its monetary tightening. Bloomberg reports that the ECB is keeping any crisis policy levels and tools under wraps so that the markets don’t test them.
It’s all about the Fed today, with expectations of between a 50-basis point and 75-basis point hike in the Fed Funds rate. A hawkish tone in the statement and press conference will probably be expected and so the surprise will be something more dovish.

It looks increasingly likely that the Bank of Japan will abandon its yield curve control policy. The 10-year interest rate swap rate, which usually tracks the 10-year JGB rate closely, is trading around 0.50% now, whereas the JGB rate is “fixed” by the BoJ at 0.25%. Many hedge funds are short and are looking for a bumper pay day as the fixing policy is abandoned.

The Crypto crash continues with bearish sentiment perhaps reaching a crescendo, at least in the short-term. It made the headlines on BBC news, and many are coming out the woodwork to comment, like Bill Gates, who likened the bubble to the “greater fool theory.”

Gates characterized cryptocurrencies and NFTs as a market driven by sentiment. “As an asset class, it’s 100% based on the greater fool theory—that somebody’s going to pay more for it than I do”, he said.

The “greater fool” theory is a practice where people invest in overvalued assets—regardless of their actual underlying value—in the hope that someone else will come along and pay even more for it.

He’s right, of course, but that’s true for ALL markets.
The Fed followed what the market was looking for and raised rates by 75-basis points. The probability of a recession is growing, and the Fed argues that it won’t be to blame. That is correct. Central banks are slaves to the business cycle and do not manipulate it as almost everyone thinks.
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The buzz today was about comments from high profile names alluding to the rising risk of a recession in the U.S. I guess they win top prize for stating the obvious, after a vicious bear market in bonds has characterized the first half of 2022. The traditional recession indicator, a 2-year, 10-year U.S. Treasury yield curve inversion, is close by, but a deteriorating global economy has been baked in the cake for a long time.

The next shoe to drop looks like being the property market. Last week, data from Sweden suggested that its residential property bubble is bursting and today, U.S. Existing Home Sales showed a continued decline in May. Surging mortgage rates seem to be cooling things down quite quickly. As prices start dropping, expect emotions to run high.
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Sentiment Shifting to Third Wave Down.

Buy the dip could be changing to sell the rally.

The personality characteristics of waves are set out. In an impulse wave, it is the third wave when recognition of the trend takes hold.

In a bear market in stocks, the initial wave down is characterized by surprise because the “fundamentals” are still good. When the bounce comes it is accompanied by a “buy-the-dip mentality.” It is during the third wave that we should expect to see evidence of the penny dropping and people beginning to sell.

This could be evidence, at a lower degree of the trend at least, that mood is shifting to a recognition that not all is as rosy as was previously thought. It would be consistent with our Elliott wave analysis.

From a much higher degree of trend perspective, as Frost & Prechter’s wave characteristics make clear, it won’t be until much, much later, during the c wave of the bear market that the final remnants of “buy the dip” mentality will disappear. At that stage, just about everyone will be running for the exit door.
U.S. Recession Looms

A contracting economy is increasingly likely. Indeed, the Non-Farm Payrolls report due out this coming Friday may well provide tangible evidence of a slowing economy.
Signs of Tension Building

Is a market “event” just around the corner?

It’s very rare that dramatic financial market events come out of the blue. Usually, there are at least a few signs that things are wonky. Narrow breadth in a stock market advance, such as during wave 5 or a B wave, is one example of danger looming, but there are multiple others, including the likes of corporate credit yield spreads widening.

The VIX index is the classic gauge of expected risk, being as it is a measurement of implied volatility in the stock market. The VIX bottomed out in December 2006 and proceeded to stair-step higher in a series of higher lows into 2007. That summer, two funds run by Bear Stearns failed in what was the kick-off to the subprime fiasco. The VIX continued to advance, not threatening to move back to the 2006 low, into 2008 and we all know what happened later that year. Even in 2020, when markets collapsed as the Covid pandemic lockdowns were enacted, the VIX had been making a series of higher lows since 2018.

Now, the VIX is once again displaying such price action having bottomed out in July of last year. This is a clear warning sign that nervousness is increasing.

Another interesting sign can been in the chart above, showing the very short relationship between Bitcoin and the S&P 500 futures market. It’s worth noting that Bitcoin’s weekend decline was followed by S&P 500 futures when they opened on Monday.

Some people are starting to question whether the implosion in crypto currencies could have a systemic effect on markets.

The stock answer is essentially no because mainstream banks and corporations are not exposed. But there IS a systemic link that most people don’t think about when market “events” occur. That link is confidence. When confidence goes, it can and does affect all markets.

Currently…Not a Low in Europe
Sentiment is at a bearish extreme for the future, but not immediately.

There was much jumping-up-and-down in excitement in financial media circles yesterday as the euro hit parity with the U.S. dollar, the first time it has traded at 1:1 for 20 years. Even though FX is a relative game, much of the media’s rationale for the decline in EUR-USD has been the economic weakness in Europe, especially Germany, where a major crisis concerning its energy stocks is developing.

Yesterday, the Zentrum für Europäische Wirtschaftsforschung (Centre for European Economic Research, or just ZEW) released its latest sentiment survey. Their Economic Sentiment measures responses to the question of how people feel about the outlook for the next six months. As the chart below shows, the reading is now below the 2020 Covid low, as well as the 2011 Eurozone Crisis low. Not far away are the lows of the Great Financial Crisis and those of the early-1990s post-reunification recession. Looking at this chart alone, we might be ready to conclude that bearish sentiment is at an extreme and, therefore, we should be on alert for a low in the stock market.

However, the ZEW survey also asks another question about how people feel concerning the current conditions. The latest reading in that index also tumbled but, at minus 45.50, it remains far away from the lows of close to minus 100 seen in all the significant stock market bottoms of 1993, 2003, 2008 and 2020. Survey respondents are very concerned about the future but still not feeling really bad right now.

It's when they feel totally despondent in the present moment that conditions might be right for, at least, an interim low.

ZEW Indicator of Economic Sentiment for Germany
Those Crazy Canucks were expected to raise interest rates by 75-basis points. Turns out they are even crazier, and the Bank of Canada raised rates by a full percentage point. The Loonie (Canadian dollar) was bid on this news, but Elliott wave analysis suggests that, as always, this is just short-term noise and, in fact, the Canadian dollar is set to weaken further versus the U.S. dollar.

Before the Bank of Canada, a bigger shockeroonie came when headline CPI in the U.S. accelerated at 9.1% in June. Cue a fast decline in the stock market which has subsequently been given back at time of posting - more evidence that economic statistic releases are just noise are just short-term babble and that the true trends of markets are driven by Elliott waves. Fed Funds futures are now pricing in a decent chance that the Fed raises 100-basis points at its next announcement on 27 July.

U.K. GDP came in higher-than-expected for May, and the stock market…declined. You get the picture.

Tomorrow, there’s a risk that U.S. Producer Prices might come in lower-than-expected given the decline commodities over the past few weeks with the CRB index down some 16% since its June high.

U.S. CPI (YoY%)
Was a “risk-on” day today with the rationale for the rally in stock markets being the decline in the consumer price inflation expectations component of the University of Michigan survey released on Friday. Sounds plausible, right?

Unfortunately, it’s just another example of the media looking for reasons. If lower consumer price inflation expectations were good for stock markets, then given the chart below, stock markets should have been advancing since March.

U.S CPI Expectations
The buzz in the financial media was all about whether stock markets had reached “peak capitulation.” After just a few days of stability/advance, some people are apparently beginning to think that the worst is over and that a bottom has been seen. Well, for a start, when a bottom does eventually arrive, it certainly won’t be talked about in the media because sentiment then will be overwhelmingly bearish.

In the U.S., mortgage applications have slumped to a 22-year low, yet more evidence is that the housing market is coming to a halt.

And money market futures are pricing a 50% chance that the ECB will hike by 50-basis points, not the 25 that had previously been expected. Expect some volatility.
Well, the Bank of Japan stood its ground on monetary policy, keeping it loose and still willing to buy any amount of government bonds to keep the yield curve where it wants it. The market is hearing what the BoJ is saying, but it doesn’t believe it. It shouldn’t be too long before the BoJ abandons its loose policy.

And then, big drama from the European Central Bank (if you believe the media that is). A “shock50-basis point hike in its policy rate (even though it was beginning to be priced) might, again, cause you to think that the currency would react in an “conventional” way, i.e., the euro strengthening. Err, no. As the chart below shows, the euro strengthened on the announcement but then faded immediately and weakened thereafter. Oh, how I can just imagine those market newbies scratching their heads as to why that happened.

Ah, but yes, of course, they have a ready-made excuse in the form of the Italian government finally collapsing. Italy has had a new government almost every year on average since 1945, so it’s a good rationale for euro weakness to have in the conventional analyst’s toolbox to be fair. But this news came well before the ECB announcement and so it obviously doesn’t stand up to scrutiny.

We’ll just continue to let the noise flow and remain focused

Backward Guidance
As debt-deflation expectations rise, central banks are changing their tune.

The European Central Bank hiked its policy rates by 50-basis points this week, the first hike since 2011 and more than the 25-basis points that was expected by many (although money market futures had factored it in somewhat). ECB President Lagarde stated in the press conference: “We are much more flexible; in that we are not offering forward guidance of any kind.” In other words, the ECB essentially doesn’t have a Scooby Doo what is going on and so it doesn’t want to commit to any forecasts. Other central banks, such as the Bank of Canada, the Bank of England and the U.S. Federal Reserve, are also dropping the notion of forward guidance as fast as professional golfers are being banned from their tours these days. Why and more importantly, why now?

Forward guidance is defined on Wikipedia as:

a tool used by a central bank to exercise its power in monetary policy in order to influence, with their own forecasts, market expectations of future levels of interest rates.” 

That sums it up quite well. It’s the belief that if a central bank communicates what it is going to do well ahead of time, and doesn’t provide any surprises, it will benefit the economy because people and businesses will factor it in to current decisions.  

Forward guidance evolved into the financial market lexicon in the first decade of this century. Up until then, the idea of a central bank communicating ahead of time what it was going to do was pretty much anathema. Back then, it was thought that the “power” of central banks was that they could (and did) act without declaring any intentions. Volcker’s Fed hiked on a Saturday night in 1979 and the Bank of Japan hiked on December 25, 1989. That’s not to say that financial markets were caught off guard (central banks follow money and bond market pricing), but to the majority of people in the world it felt that monetary policy changes were more volatile.

Note the chart below showing the U.S. Dollar Index. When the U.S. dollar is strengthening, it can be thought of rising expectations of debt-deflation. With most of the debt in the world based in U.S. dollars, a rising exchange value of the dollar will increase that debt burden to non-dollar-based sovereigns and corporates who issue in the U.S. currency. This is a big reason why an appreciating U.S. dollar is considered bad for emerging markets, for instance. Central banks won’t say it (yet), but they are happy when the dollar is not appreciating.

So, it’s interesting that forward guidance became popular during a period when the dollar was depreciating, making central banks increasingly happy, and then fully adopted around 2011 when Mark Carney at the Bank of Canada was lauded for using it so well. That was when the dollar was bottoming out. Now, after more than a decade of U.S. dollar strength, intensifying this year, making central banks increasingly unhappy, they are falling over themselves to abandon the once-thought-magic tool. Back in 2011, a depreciating U.S. dollar had contributed to making central banks feel and look good. The opposite is true now.

Does this mean that, perhaps, the U.S. dollar is cresting and that another period of depreciation is coming?

We’ll leave that analysis for another time, but it will be interesting to see if it happens. What we might conclude, though, is that with central banks’ angst so elevated, the possibility of a new “Plaza Accord-style” agreement to weaken the U.S. dollar is growing.

U.S. Dollar Index
The day after Fed-day and talking heads on financial media have a range of opinions on what might occur now (‘twas ever thus). Some say the Fed continues to hike aggressively, some say it will ease off. We say, listen to the market and watch the 2-year Treasury yield. At this juncture, it continues to make higher lows and so the uptrend is intact, meaning that the market continues to lead the Fed into setting a higher Funds rate.

But evidence continues to mount that the Fed is raising rates into a weakening economy. The 4-week moving average of Jobless Claims is still rising steadily.

U.S. Initial Jobless Claims
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Nice to be back in the saddle as we roll towards the end of the northern hemisphere summer. This week is potentially the quietest of the year with traders and hedgies from London, Frankfurt, New York, Boston, et all, still at the beach / Italian lakes / Hamptons or many other destinations. Mind you, they will all probably take one eye away from their piña coladas on Friday when Fed Chair Powell speaks at the famous Jackson Hole Symposium organized by the Kansas City Fed

As things stand, the Fed might be concerned that financial conditions have eased over the past few weeks thanks to stable Treasury yields, higher stocks, lower commodities, and narrowing credit spreads. A hawkish Powell would likely coincide with some volatility. Indeed, some Elliott wave counts might be anticipating that.
Fire in the Hole?

Be alert for potential volatility this Friday.

Americans get bad press when it comes to geography with the famous slur being that a relatively small percentage hold passports and travel abroad. Having spent a year in college in Oklahoma I got a good sense of how massive the continent is and so I always defend the Yanks on this one. Nevertheless, every so often a story appears around how a small percentage of Americans can identify a country’s location on a world map. Right, well let’s turn the tables. I wonder how many non-Americans can identify where Wyoming is on a map? Thought not.

It is in that state where we find Jackson Hole. The town of Jackson is named after the famous beaver hunter David Edward “Davy” Jackson and the Hole refers to the vast valley that lies between two huge mountain ranges. Seeing this pic, a visit is definitely on my bucket list.

That link is to one of the things that makes Jackson Hole famous - the annual economic symposium held there organized by the Kansas City Fed. It is happening again this week and the Federal Reserve Chairman, Jay Powell, makes his speech there on Friday. It might have the potential to coincide with market volatility.

The Fed, like other central banks around the world, is still concerned about accelerating consumer prices and thinks that it can contain this by increasing interest rates and tightening financial conditions. At, of course, we believe that idea is somewhat spurious but, nevertheless, that is the prevailing conventional wisdom.

This is why Chair Powell, et all might be slightly concerned with the chart below, showing that financial conditions have eased noticeably over the last few weeks. Stable Treasury yields, higher stocks, lower commodities, and narrowing credit spreads have all contributed to this and it’s not what the Fed wants to see. There is a risk, therefore, that Powell will make hawkish comments on Friday.

If he does, and IF financial conditions start to tighten again (higher yields, lower stocks, etc.) the conventional media will, naturally, see the causality it wants to – that central banks direct the markets. But Elliott wave analysis is already pointing to higher yields and lower stocks in general, with the last few weeks being countertrend moves.

In fact, the way some structures look, particularly U.S. stock indices, we could say that perhaps the market is already anticipating a hawkish Powell. So, buckle up your wagon partners, it could be a bumpy ride out West.

National Financial Conditions Index
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Was that it? After the markets were paralyzed all week waiting for Fed Chair Powell’s remarks at Jackson Hole, the statement was brief and to the point. The markets look like they are taking his line as hawkish and that the Fed will continue to tighten monetary policy until consumer prices show signs of decelerating. Whoop-de-doo. U.S. stocks have declined but that was in line with existing Elliott wave analysis.

Now that’s out of the way and we roll into September, volatility looks likely to increase. The chart below shows that the VIX is maintaining its sequence of higher lows since last year.

Good evening and afternoon, and bon weekend!

Stress Levels Set to Rise
Despite all the noise, markets have never been this relaxed.

This year has seen the most dramatic bond bear market in history. Stock markets have declined. Property markets are wobbling. Consumer price inflation is rampant. The U.S. dollar has appreciated greatly, and emerging markets are under severe pressure. You might think that financial market stress levels are elevated. Think again.

The chart below shows the St.Louis Fed Financial Stress Index. It does what it says on the tin – a measurement of stress in financial markets. As you can see from history, stress levels have spiked during periods such as the Long Term Capital Management (LTCM) crisis in 1998, the Technology, Media and Telecom (TMT) bust in 2001, the Great Financial Crisis (GFC) in 2008 and the Covid economic lockdowns of 2021. Other peaks in stress include the Eurozone Crisis in 2011 and the global stock market slump of 2015/16. Now, though, on this measurement going back to 1993, financial markets have never been so relaxed. What the bally hell is going on?

The Stress index is made up of interest rates and bond yields, corporate bond yield spreads, the Treasury yield curve, short-term money market spreads (such that between commercial paper and Treasury bills), the VIX index, TIPS breakevens and the S&P 500 Financial sector index. The main reason why the Financial Stress Index is at a record low is probably down to the fact that corporate bond yield spreads, despite widening this year, remain relatively tight by historical standards.

Many corporates took advantage of the free money on offer when the Federal Reserve back-stopped the corporate bond market and flooded the markets with trillions of freshly printed Fed-tokens (aka: dollars) in 2021. Therefore, corporate balance sheets look at this juncture to be relatively healthy. However, as corporate debt starts to be rolled over, many are going to find it difficult to fund at much higher interest rates. This is the developing crisis which should contribute to the Financial Stress Index moving much higher in the months ahead.

St.Louis Fed Financial Stress Index
Mayday, M’aidez
The global economy could be heading for another slump.

Being a researcher, I am always happy when I learn something new, which I try to do once a day. I am particularly interested in etymology and so, when having an idea for the headline on this column I raised a smile. This is from Wikipedia:

The "mayday" procedure word was conceived as a distress call in the early 1920s by Frederick Stanley Mockford, officer-in-charge of radio at Croydon Airport, England. He had been asked to think of a word that would indicate distress and would easily be understood by all pilots and ground staff in an emergency. Since much of the air traffic at the time was between Croydon and Le Bourget Airport in Paris, he proposed the term "mayday", the phonetic equivalent of the French m'aidez ("help me") or m'aider (a short form of venez m'aider, "come help me".

So, now (for those who didn’t) you know, and you, like me, can bore all your friends with another bit of trivia (or perhaps do well at your next pub quiz).

I thought the term was appropriate given what has happened to the Baltic Dry Index, the benchmark index of container shipping prices for the world economy. From a peak above 5,500 in October 2021, the index has cratered and currently hovers just below 1,000. Historically, when the Baltic Dry Index has declined it has often been a portent for a slowing global economy. It peaked in December 2013 and declined into the economic slowdown of 2015 and 2016. Interestingly, it also peaked in August 2019 and had collapsed by 82% BEFORE the Covid-induced economic lockdowns of early 2020.

Now, after another 82% decline in less than a year, could the container shipping market be sending another distress call?

Baltic Dry Index
A country’s level of imports is a good reflection of consumer demand. Imports increase during economic expansions and decrease during contractions. U.S. trade data was released yesterday, and imports declined again in July. As the chart shows, it looks like the level of imports is turning down – yet another indication of a slowing economy.

U.S. Imports of Goods & Services
Reality Dawns in Corporate Bonds
A big rout last week could herald in some drama.

Up until now the corporate bond markets have been faring relatively well. Yields have risen dramatically this year, of course, but that hasn’t had an impact on the perception of credit risk. For that, we must look at the yield spread between corporate bonds and those considered credit “risk-free” like U.S. Treasury bonds. A widening yield spread means that the markets are factoring in an increasing level of default risk and, although spreads have been widening this year, they are nowhere near the extreme levels seen in previous economic downturns.

However, last week something changed in the corporate bond market and yield spreads widened dramatically, with redemptions in corporate bond exchange-traded funds occurring for the second week in a row.

The chart below shows the yield spread for CCC-or lower rated corporate bonds (aka junk). Last week’s widening was the biggest since March 2020 when the market expected a tsunami of defaults as economies locked down for the Covid pandemic. The spread reached a high of nearly 20% back then, dramatic for sure, but nowhere near the 42% reached in December 2008. Last week’s move could just be the start of something much more shocking.

CCC & Lower Rated Yield Spread to U.S. Treasuries
The Exploding Debt Burden
Is it sustainable or is debt deflation coming?

According to the Institute of International Finance, total global debt stands at over $305 trillion. That’s about 350% of global gross domestic product (GDP). Such numbers are, of course, mind-boggling but we have learned to live with them and accept a massive debt burden as normal.

As Elliott wave aficionado and bank credit analyst, A. Hamilton Bolton, noted, major recessions and depressions have historically occurred when debt has become excessive. But how do we know what is excessive?

One way of thinking about it is in terms of debt servicing costs. A household, company or government can have massive debts, but if they can service that debt through increasing revenues then it doesn’t really matter. Put another way, if the growth in money coming in exceeds the cost of servicing the debt, then that debt is not excessive.

In terms of a country, we could say that questions about excessive debt will be asked if the cost of servicing the debt exceeds the growth in GDP. Well, with interest rates and bond yields zooming up all over the planet, we’re fast approaching that point. The chart below shows that U.S. government spending on interest payments alone has made a new high. Pictures like this will be repeated in many other countries, corporate boardrooms as well as in household budgets.

For the ticking time bomb of debt, interest rates above growth rates could be the straw that finally breaks the camel’s back.

U.S. Federal Government Spending on Interest Payments
Liquidity Draining Quickly
More signs that monetary conditions are tightening across the globe.

As people in the U.K. and beyond discovered last week, the inevitability of something happening can turn to shock when it happens quickly. In financial markets, the march towards tighter monetary policy as central banks “fight” rampant consumer price inflation, could potentially lead to a little bit of shock due to the speed of events.

This year has already seen the fastest bond bear market in history as the markets priced in higher consumer price inflation well ahead, as always, of central bank policy changes. But now central banks have got the bit between their teeth and seem intent on tightening aggressively, even though they are just playing catch-up with bond yields. From a socionomic point of view, we could say that the downturn in social mood is allowing central banks to act in this way. However, the speed that liquidity is being sucked out of the global monetary system heightens the danger of accidents happening.

The latest example is shown below from Down Under. Australian M1 Money Supply has just posted the biggest monthly decline in the history of the series going back to 1960. Now, ok, you could say that perhaps we should normalize this data by something like, “percent of Gross Domestic Product,” and that such a large decline is merely correcting some of the massive increases in recent years. Nevertheless, it’s a hefty drain of liquidity in a major developed economy and thus worthy of note.

Combine this with the fact that the Federal Reserve is ramping up its Quantitative Tightening, and other central banks are pursuing much tighter conditions, the buffer of support that was there before for financial market liquidity is fast disappearing.  

Australia M1 Money Supply
The Wealth Effect
Behavior could be changing.

The “wealth effect” is an economic theory suggesting that people spend more as the value of their assets rise because they perceive themselves to be wealthier in monetary terms. Vice versa, they spend less when their assets decline. There is a debate about the wealth effect and whether the rise and fall in assets cause behavioral changes or whether there is just a coincidental relationship. Nevertheless, common sense and socionomics tells us that increased feelings of security go hand in hand with a positive mood, whilst decreased security links with a negative mood.

The chart below shows that the net worth of U.S. households and nonprofit organizations declined by $6,099,000,000,000 (that’s trillions for those keeping score) in the second quarter of this year. This is the biggest contraction in net worth on record, beating that of the first quarter of 2020, when asset markets collapsed during the Covid-related panic. The difference between now and then is that the Federal Reserve is in a different mindset, willing to flood the markets with excess liquidity in 2020 but pulling liquidity out of the system now.

Of course, we do not think that the Fed’s actions cause any movement in financial markets, but we’re pretty certain that markets are driven by human herding behavior. It’s herding behavior that has driven assets down this year already and, perhaps, knowing that the Fed doesn’t “have their back” could contribute to the intensity of the actions resulting from the negative social mood that is already in train.

Households and Nonprofit Organizations
The Atlantic Cable

99% of the financial market community thinks that stock markets declined because of a higher-than-expected consumer price inflation number from the U.S.

On a similar note, perhaps many people might think (fueled by conventional media) that lower-than-expected ZEW Economic Sentiment readings from the Eurozone and Germany contributed to the decline in the euro.

U.S.A Consumer Price Index
The Atlantic Cable

The Fed won’t admit to it, but it knows that if it is to succeed in its (misguided) mission to lower the pace of consumer price inflation, then the labor market must weaken. Today’s Jobless Claims data in the U.S. suggests that the labor market remains relatively strong, thus the Fed will not be thinking of changing course from its path to ever higher interest rates.

But, looking forward, as the markets do, trouble is afoot judging by the ever-flattening U.S. Treasury yield curve. This dynamic is clearly signaling that an economic recession is coming.

U.S. Initial Jobless Claims
So... The storm begins
Happy Carousel Day.
The bear is happy and enjoying the show!
Give 'em hell
Very interesting times are coming.
Well, it’s the usual pre-FOMC snooze-fest today with markets going sideways. The Fed is expected to raise rates by 0.75%. If the rhetoric around it is a hardened hawkishness markets might take fright. But it shouldn’t be a surprise as the 2-year yield continues to make higher highs, and it’s the market that (as always) leads the Fed.

In other news, Russia threatened all-out nuclear war with the West. The layman might think that financial markets were roiled by that “news”. They barely flinched. Market prices make the news, not the other way round.

U.S. Treasury 2-Year Yield
A Week Rationale for Being Bullish
The nonsense of this moving average “support”.

The journey of a technical analyst can be long and varied. Myself, I started my career like many do as a conventional analyst having graduated in economics and thinking that markets behaved rationally. It only took a couple of weeks in the real world to realize that this was not the case and so began my journey into working out what was the real driver of financial markets and the economy. One of the first steps on the technical analysis road is learning about moving averages. These simple and understandable tools are very useful in smoothing out data in order to determine trends but their one great drawback, of course, is that they, by their very nature, lag the actual data. Nevertheless, the venerable moving average family is the royalty of technical analysis indicators. And, within that family, the indisputable sovereign is the 200-day average.

This measurement of the long-term trend is the most widely used and cited in the financial markets. But, why? For nearly all markets, there are not 365 trading days in a year but less than 260 due to weekends and other holidays. Is that why the 200-day moving average is used? Perhaps, but if that was the case, it would make more sense to use a 250-day average surely. Whatever the reason for its use, the fact is that the 200-day average is ingrained into the psyche of market participants.

Some people, like me, use the slope of the 200-day moving average to give a quick and easy reference for the (lagging) long-term trend. But many people, particularly rookies and (how shall we say?) less-knowledgeable conventional analysts (Ed.: “Naïve hacks” --- PQ Wall) look at the level of the 200-day moving average as some sort of magical support and resistance. Examine any chart, though, and you will instantly see that the 200-day moving average sometimes acts as support and resistance but more often doesn’t. A holy grail it is not.

The 200-day moving average for the S&P500 index started sloping down in June, indicating that the lagging trend is down. Not only that, but it also acted as resistance in August from which the index declined rapidly. You might think that the moving average support and resistance mob would be bearish, right? On the contrary. Enter the 200-week moving average.

That the 200-week moving average looks like it might have provided support this month is being cited by many as a reason to stay bullish on the stock market. Naturally, they point to previous times it has acted as support before but, as the chart shows, the record cannot provide reliable evidence. And as for the case for using a 200-week moving average? Ach, come on! At least a 200-day average has some sort of logic to it, even if it is slightly flawed. Using this 200-week analysis smacks of a classic case of cognitive dissonance whereby bulls are searching for evidence that supports their view.

If, as we suspect, this bear market in stocks continues, we’ll be watching for the time that the 200-week moving average is cited as providing resistance in an ongoing downtrend. That’s when we’ll know that bearish psychology has become entrenched.

This is noteworthy because it is coming at a time when our Elliott wave analysis suggests that a bear market is in its infancy

S&P500 index
The Atlantic Cable

The European Central Bank raised its policy interest rate by 75 basis points as expected with President Lagarde reiterating that the ECB is not providing any forward guidance and taking decisions on a meeting-by-meeting basis. As well know, central banks follow the market and so true forward guidance come from short-dated bond yields. With the 2-year German Schatz yield continuing to rise, at this juncture it looks like the ECB will continue to hike rates.

U.S. jobless claims could be starting to flash a wee warning light for employment again with the 4-week average rising for the fourth week in a row. Meta Platforms (Facebook), the share price down around 80% year-to-date, is hinting at job cuts and it is not alone as the general bear market gets going.

On that note, the twin bears in U.S. stocks and U.S. Treasury bonds have delivered the worst return this year for a 50/50 portfolio in data going back to 1920. 1974 was the worst on record, surpassing 1931, in the midst of kicking off the Great Depression. Could this year be signaling something similar?

2-year German Schatz yield
And the next “shock” comes from…


I have only been to Japan once, but I absolutely loved it. What an amazing country and culture, steeped in so much history and tradition. From the white-gloved taxi drivers in Tokyo to the gorgeous food and incredible scenery, it truly is a place like no other. I’m booking my next trip soon.

Famously shunning much immigration, the Japanese culture has remained undiluted and national traits shine through. There are many words to describe one such attribute which, of course, is a generalization. Determined, steadfast, tough, dogged, and tenacious are all synonyms for stubborn, and that is the word I think of when observing the Bank of Japan now.

Today, the Japanese consumer price inflation data for October was released. Forecast by economists to come in at an annualized rate of 2.9%, the headline rate printed at 3.5%. Whilst this is far below the rate of change in consumer prices in developed economies elsewhere, it is near the peak seen in 2014 which was the fastest rate since 1990.

And yet still the Bank of Japan (BoJ) persists with its ultra-loose monetary policy, keeping its policy interest rate at minus 0.10% and maintaining yield curve control by intervening to hold the 10-year government bond yield around 0.25%. But pressure is relentlessly building for the BoJ to abandon this policy and let the 10-year yield find its own level. As the chart below shows, the 30-year yield is already moving higher.

When the BoJ does abandon its policy, as it surely will, expect the 10-year yield to zoom higher and the Japanese yen to strengthen. Elliott wave analysis is already pointing to such moves being anticipated. Such an event will come as a “shock” to most people, but you will be prepared.

Japanese Government Bond Yields
The Atlantic Cable

The Core PCE Price Index in the U.S. continues to accelerate on an annualized basis. At 5.1% in September, it’s the fastest rate since March and will be used as evidence by the Fed to continue on its rate hiking path and not take a step back as some politicians want it to. The U.S. Treasury 2-year yield is still making higher highs and higher lows, and until that ends expect the Fed to keep following with a higher Fed Funds rate.

It's not just in the U.S. where politicians are grumbling about central bank policy. The Harmonised German Consumer Price Index printed at 11.6% on an annualized basis for October which will put the ECB under pressure to continue to hike rates despite what Eurozone politicians say. The growing rift between politicians and central banks on both sides of the pond is an indication of the enveloping negative trend in social mood. Expect anger to mount.

And finally, don’t look now but Amazon warns of slower sales as the economy weakens. The market is, of course, well ahead of events with the Amazon share price breaking a multi-touch uptrend line in place from its listing all the way back in 1997 during Q2 of this year. As the man sang, times they are a-changin’.

Good afternoon and have a wonderful weekend!

Core PCE Price Index
Mood, my dear boy, mood.

Choppy waters dead ahead.

When ex-British Prime Minister, Harold MacMillan, was asked about what might derail a government’s plan he answered, “Events, my dear boy, events.”. He was referring to unforeseen events that could crop up unexpectedly. (Of course, those following socioeconomic analyses have an edge in this. Witness the Brazilian incumbent president being beaten in yesterday’s election after a negative trend in social mood started last year, evidenced by the stock market topping out).

In the financial markets, it is the scheduled events that get the focus of the crowd.

This week and next are filled with event risk. On Wednesday, the Federal Reserve announces its latest monetary policy decisions and outlook. On Thursday, the Bank of England will do the same. Friday sees the U.S. employment report and next Tuesday is the mid-term U.S. elections. Two days later, the closely watched U.S. consumer price inflation data is released.

Strap yourselves in for some rocking and rolling.

Indeed, as the bear market has developed this year, two aspects stand out that point to the fact that “surprises” could still lie ahead.

  • Firstly, the historic rise in bond yields has not been accompanied by underperformance in corporate bonds as usually happens when a global recession looms. That’s a big wave that has yet to hit the boat.

  • Secondly, implied volatility levels are not anywhere near the extreme levels seen at previous lows in stock markets. The VIX index (implied volatility for the S&P 500), hovering around 25, is still well below the 40-plus levels seen at previous bottoms.
This Should Tell Us When the Fed is Finished
(in the meanwhile, give me novacaine)

You’re doing great. Just a little bit longer, and then we’re done.

You know that feeling when you’re in the dentist’s chair and getting a tooth drilled? There is nothing you can do about it, so you close your eyes, brace yourself for any sudden pain and wait. The dentist stops drilling and you’re thinking, “Please, let that be it,” only for the dentist to come back with, “Open wide, please” and, as your heart sinks, continues with more drilling. For many, that is what this year feels like in terms of central banks and monetary policy.

Yesterday’s Federal Reserve press conference was taken by the market as a sign that the Fed is not done drilling yet as it is not letting up on its aggressive monetary tightening. The fact that the 2-year Treasury yield has continued to make higher highs and higher lows (an uptrend – Captain Obvious) has been telling that to anyone willing to listen to the real determinant of interest rate policy, but still the masses continue to worship at the alter of the omnipotently-perceived Fed and hang on every word.

Notwithstanding the level of the 2-year yield, though, there is another indicator worth watching to help us work out when the Fed might stop hiking the Fed Funds rate. Indeed, the almighty Jerome Powell himself has strongly hinted that it is this which will determine it. The difference between the 18-month Treasury Bill rate and the 3-month Treasury Bill rate is the specific yield curve (or spread) that Powell has talked about, but it can be effectively proxied in the chart below, replacing the 18-month rate with the 2-year yield.

When the 2-year yield moves below the 3-month rate, which will be a negative number (inversion) in the chart, that is when the Fed will think that the economy is tipping into a recession and that its job is probably done. Back in 2019, this curve inverted, and the Fed did start to ease monetary policy, adding liquidity by expanding its balance sheet which ballooned in early 2020 as the economy tanked.

When the Fed does stop hiking rates, of course, it will mean diddly squat in terms of causality for financial markets, but at least you will be one step ahead of the Church of Fed congregation.

U.S. 2-Year Treasury Yield Minus / 3-Month Treasury Bill Rate (%)
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Finally, more tremors in the crypto world as one high-profile exchange, FTX, gets fried (excuse the pun) amidst a liquidity crunch and is rescued by its rival, Binance. The latest Elliott wave analysis suggests that Bitcoin is currently tracing out a triangle, anticipating an eventual thrust lower.

Give 'em hell
Trade active:
Enjoying the show!
This is noteworthy because it comes when our wave analysis suggests that a bear market is in its first stage.

No place for the faint-hearted

With the world changing rapidly and becoming more dangerous with horrors unfolding, a life of luxury could be a thing of the past for many.
Bloodbath - The message? Be afraid, be very afraid.

It's obvious now that this crypto bear market is starting to break things and there’s a growing fear of “contagion”.

What contagion really refers to is simply a broadening loss of confidence and history tells us that can happen very quickly.

What the cryptocurrency market is finding out is that everything, relies on confidence, and confidence cannot be created out of an algorithm.

Will this time be different?
Trade active:
Let me make it crystal clear: if BTC is unable to crash below $5.5k by the end of this year, I will be the ultimate sucker and refrain from the market and tradingview forever.
The big short knows what the best tool is to crush the market.
No probability, just certainty.
Trade active:
Serenity before the storm will end soon. Are you ready?
You can die with dignity by surrendering now. Leave your last words.
Trade active:
Don't ask for my mercy when it's too late.
There are more signs of the U.S. labor market weakening with the ADP Employment Change and JOLTs Job Opening both coming weaker than expected. Also, the Chicago PMI crashed in November. This is all lagging evidence compared with the stock market, of course, but it does increase the probability that a bearish Elliott wave outlook is correct because unemployment in particular has yet to even start to reach levels associated with cycle lows.

And finally, watch out for some volatility around 13:30 ET when Fed Chair Powell delivers remarks. After a period of “risk-on,” the “surprise” might be if his speech is on the hawkish side. But then, Elliott wave analysis is anticipating imminent declines in many stock markets and so perhaps, if it transpires, it shouldn’t be that much of a surprise at all!
Private Equity Bubble Burst
Liquidity has dried up.

Nothing smells more like a brewing crisis than investment funds not allowing investors to redeem their money. I remember sitting on the patio of the Emirates Golf Club in Dubai, enjoying a post Pro-Am drink with Annika Sörenstam (blatant name-drop for golf geeks!) in 2008, just as the Great Financial Crisis was developing. An employee of the sponsor, an investment firm, took a phone call and looked stressed. After a while he came back and told us that the company had decided to “close the gates” on redemptions in its property fund because so many investors were trying to withdraw their cash. We must protect them from themselves, he told me. I smiled, through clenched teeth, and mumbled something like “this is worse than I thought.”

News comes this week that Blackstone, the behemoth private equity firm, has made a similar decision in relation to its real estate fund. With redemption requests flooding in, it has only partially given back funds and is essentially “closing the gates” to investors. Property, of course, like private equity, is famously illiquid at the best of times but add in the fact that global monetary policy has tightened at breakneck speed this year and, suddenly, many investments have no bidders. Buyers have disappeared leaving assets to be left on books.

Naturally, the markets have been anticipating this situation for many months when it comes to private equity firms. The chart below shows the Invesco Global Listed Private Equity ETF (ticker PSP). After topping in November last year, PSP looks like it might be tracing out a sharp zigzag correction, (A)-(B)-(C), with a brief corrective rally in wave (B). If this analysis is correct, a potential target for wave (C) to end is at $5.16 where it will equal the length of wave (A) in percentage terms.

By then, we can expect investor panic to be at its height.

Invesco Global Listed Private Equity ETF
U.S. Consumers Tapped Out – Icarus Gets His First Credit Card 
This trend does not bode well.

We’ve said it before, but U.S. consumers are the lynchpin of the global economy being, as they are, so vital to the performance of the largest economy on the planet. Keeping an eye on what the U.S. consumer is doing therefore makes a lot of sense.

The chart below shows the personal savings rate for U.S. households as well as the level of credit card debt. The savings rate spiked higher during 2020 due to pandemic-induced economic lockdowns as well as the fact that the Fed’s helicopters dropped money outside everyone’s home (those “stimy checks” will become infamous in financial history). Credit card debt declined in 2020 and into 2021 as the U.S. consumer spent this cash pile.

However, since the middle of 2021 the savings rate has continued to decline whilst credit card debt has ramped up markedly. The savings rate is now near an all-time low whilst credit card debt is at an all-time high. Clearly, U.S. consumers are, in aggregate, flying very close to the sun.

The key is employment. Thus far, the labor market has not come under any strain but there are signs that it is beginning to wobble. Should unemployment start to rise, as seems likely in 2023, credit card debt will deflate, and the savings rate will rise. In those circumstances, the U.S. and the global economy will be in dire straits (and U.S. consumers will not be getting their money for nothin’).   

U.S. Consumers
Investor Psychology - Not Just Another Crypto Air Pocket

The big market story of November 2022 was the sudden “epic unraveling” of the cryptocurrency exchange FTX. It fits a long history of post-peak reversals among exchanges. The speed and depth of FTX’s collapse are vitally important, as it foreshadows the character of the coming third-wave decline in stocks. Many observers have drawn comparisons to other infamous corporate frauds in the wake of the dot-com mania peak in 2000 and the housing bubble peak of 2006-2007. The two most compelling comparisons are to Enron, an energy trading company that went bankrupt in December 2001, and Bernard L. Madoff Investment Securities, which dissolved in December 2008 when its founder Bernie Madoff admitted to fraudulently misrepresenting client returns for at least 17 years. Like FTX, both firms were trading enterprises that were considered modern-day wonders of financial engineering. All three were built around leaders who burnished reputations as clever financiers through the peak of their respective bull markets. At a gain of more than 374%, Enron stock’s three-year rise into September 2000 reflected this status. By the standard of the final Grand Supercycle highs of 2021-2022, however, it was a piker. The bottom two graphs on the chart show the surge in the price of tokens issued by FTX and Crypto.com. In less than a year, they rose more than 2200% and 1570%, respectively.

Enron Stock Price

The unraveling of Enron and Madoff Investments also took longer to come to light, arriving when the 2000-2002 bear market and 2007-2009 bear market respectively were more than half over. FTX’s bankruptcy, in contrast, came just 11 months after the Dow’s January peak. Enron’s fall from grace was a slow-motion event by comparison. As the arrow on the chart shows, the primary architect of Enron’s accounting fraud, Jeffrey Skilling, resigned as CFO on August 1, 2001. It took four months thereafter for Enron to dissolve into bankruptcy, with the filing coming on December 2, 2001. The share price dropped to just 25 cents three days earlier and was delisted from the NYSE on January 16, 2002. The collapse of Madoff Investments is harder to decipher because it was a private company, but the writing was clearly on the wall by November 25, 2008. That’s the day Ruth Madoff, Bernie Madoff’s wife, withdrew $5.5 million from a Madoff-run brokerage firm. By comparison, the failure of FTX took only 9 days. By all accounts, it began on November 2, 2022, when CoinDesk reported on a leaked document that revealed the crypto trading house was woefully short of assets relative to liabilities. Basically, the emperor had no clothes, and the world suddenly knew it. “It’s fascinating to see that the majority of the net equity in the Alameda business is actually FTX’s own centrally controlled and printed-out-of-thin-air token,” said one industry wag in the CoinDesk report. By November 11, FTXand 101 affiliated debtors filed for bankruptcy,” forcing the resignation of its “charismatic” founder Sam Bankman-Fried. At the time of its bankruptcy filing, various accounts placed FTX liquid assets at $900 million against liabilities of $8.9 billion.


To understand the full importance of the firm’s collapse and its place within the unfolding bear market, we start at the stock market’s all-time highs where we find a key critical difference between FTX and its failed predecessors. FTX was far more bound up in the bullish psychology that created the Great Peak. The chart shows how perfectly FTX’s use of bull market iconography lined up with the final price highs, in September 2021 as the token, which goes by the symbol FTT, hit its all-time high. Coincident with that peak, FTX signed
NFL quarterback Tom Brady and his then-wife Gisele Bündchen to star in a $20 million ad campaign. In one commercial, Brady says to his wife, “I’m in. Let’s call everyone.” It was a bull market top signal of the highest quality, and we knew it in real time. Having cited ample precedent for similar peak endorsements in the past, “It was hard to imagine a more ideal setup for a bear market.” That same month, FTX blanketed the World Series with ads and on-field images of its logo. With FTX’s name even affixed to the umpires’ sleeves. These pop culture enticements are significant because they generate a whole new wave of enthusiastic and totally unsophisticated investors. The “lunatic fringe” comment shown on the chart was made with respect to a raft of other crypto breakthroughs such as a one-week, round trip in a Squid Games cryptocurrency that gained 23 million percent and then crashed to zero. In early December 2021, another FTX pop culture signal: its purchase of the naming rights for the Miami Heat’s basketball arena, which happened earlier, in April 2021. The “bearish implications” of the deal are based on what happened when three mania participants —CMGI, Enron and PSINet— purchased similar naming rights in 2000; the NASDAQ declined 78% from March 2000 to October 2002. Crypto.com’s purchase of the naming rights to the Los Angeles Lakers arena was even more precisely timed. We wondered aloud if it was “The Kiss of Death for Crypto?” History’s affirmative verdict is in. Crypto.com Coin’s decline of 93% is commensurate with FTX Token’s 98% plunge.
Another distinguishing trait is that even as the price of its token tumbled, FTX came to be regarded as the cream of the crypto crop. In June of this year, the company was hailed as a savior by offering to bail out teetering crypto lender BlockFi Inc. and Voyager Digital, another crypto exchange. Of course, those lifelines snapped in November. “Voyager Digital’s legal team said it’s ‘shocked, disgruntled, dismayed’ at having to reopen the bidding process for its distressed assets.” They weren’t the only ones. Various financial writers described FTX’s collapse as “unforeseen,” “completely unexpected” and “shocking.” But it wasn’t, for students of market psychology.

Yet still, optimism bubbles to the surface. There it is again in the Voyager Digital legal team’s insistence that it can still raise capital. Even though he is being sued for promoting Voyager Digital shares, a billionaire NBA club owner “continues to believe in the industry and assures that there is still a lot of value in the sector.” “Crypto’s Collapse Spells Opportunity for Wall Street’s Old Guard,” says a Crain’s New York Business headline on Tuesday. On the same day, Fidelity Investments, the Boston-based mutual fund giant, announced a new crypto trading service. “Fidelity Crypto is your opportunity to buy and sell bitcoin,” and promises the ability to “trade crypto with as little as $1.” It all points to one thing: The bull market psychology that FTX’s ads and sports promotions expressed at the high is far from dead. Through October, FTX was still viewed as the “crypto world’s source of stability.” “Only now is the frightening scope of this fiasco becoming clear for everyday investors,” says a November 16 Bloomberg story headlined, “FTX Was an Empty Black Box All Along.” Stay tuned. When the residual credulity attending the old uptrend can inspire a scam enterprise bailout of other “fallen angels,” there can only be much more to come.
As Advertised: Boomtime for Crypto-criminations

Another aspect was a call for “a new era that focuses on crypto crime and scandal.” This one comes straight out of the mania history books where John Kenneth Galbraith and Charles Kindleberger described how a swindling class is invariably exposed as formerly dear financial assets plunge in value. Sentences of 24 years for Jeffrey Skilling (later reduced to 12) and 150 years for Bernie Madoff are the product of their respective recrimination phases. FTX’s demise signals that the blame phase is here; it promises to dwarf all predecessors. Curiously, Sam Bankman-Fried remains a free man. John J. Ray III, the overseer of FTX’s bankruptcy, assessed his confidence game this way: “Never in my career have I seen such a complete failure of corporate controls.” Ray speaks from a deep well of experience, as he also oversaw Enron’s dissolution. Ray added that FTX’s leadership was “potentially compromised,” but he also called it “inexperienced” and “unsophisticated.” Look for Bankman-Fried’s attorneys to build his case around those traits, which will be another unprecedented historical irony because in the past, it is the victims that have always borne the burden of inexperience. MarketWatch says Bankman-Fried regrets “agreeing to the bankruptcy filing” because “he could have saved the company by raising outside funding.” As in a twitching corpse, the bullish impulses continue to fire. Bankman-Fried can’t help himself; at this point he appears to be addicted to pushing people’s bullish market buttons. Take his famous vow to give away his entire net worth, estimated at $26 billion when FTX was at its peak. In the extreme, philanthropy is a bull market activity. Over the course of the bull, as their fortunes grew, it became fashionable for billionaires to make such pledges. In 2010, Warren Buffett and Bill Gates established the Giving Pledge, a campaign to encourage billionaires to contribute a majority of their wealth to philanthropic causes. Jeff Bezos, with a net worth of $124 billion, is the latest to join the club, which now includes 236 members. In 2022, SBF made headlines like this one with his promise:

A 30-Year-Old Crypto Billionaire
Wants to Give His Fortune Away

—Bloomberg, April 3, 2022

For a good summary of the escalation in philanthropic activity through the latest bull market peak as well as its more recent morphing into “The Moral Vanity of Sam Bankman-Fried,” see this Daniel Henninger opinion piece in the November 30 edition of The Wall Street Journal. Just weeks ago, Bankman-Fried was described as the John Pierpont Morgan of digital assets, willing to throw around his wealth to bail out the industry. One report this week said he’s now down to one credit card and $100,000 in the bank. So, we guess in one sense he made good on his vow. In April 2000, as the NASDAQ started the 2000-2002 bear market, a similar wave of philanthropic energy engulfed Silicon Valley. “So, philanthropy fever indicates we are closer still .” Consciously or not, Bankman-Fried clearly exploited this peak-mood trait. According to Joe Kernan of CNBC, Bankman-Fried told him he used virtue signaling to entice people to invest money. He added that Bankman-Fried admitted that he did not believe in it. MarketWatch reported that Bankman-Fried “said his high-profile philanthropic campaign built around the effective altruism movement was far from sincere.John Law would be proud. Law, “a Scottish adventurer, economic theorist and financial wizard,” helped foment the Mississippi Scheme of 1719, which led to the South Sea Bubble and wrecked the finances of France. Be advised that the coming perp walks and Congressional hearings will not be confined to cryptocurrencies.

The Everything Bust Is on The Way...
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As mentioned earlier on October, 28. Under the headline:

And the next “shock” comes from…Japan,” we stated:

When the BoJ does abandon its policy, as it surely will, expect the 10-year yield to zoom higher and the Japanese yen to strengthen. Such an event will come as a “shock” to most people, but you will be prepared.

Bish Bash BoJ (Part 2) 
The Bank of Japan follows the charts.

Bank of Japan stuns markets with yield control policy change,” thunders the Financial Times. “Global Markets Jolted as BOJ Surprises with Yield Policy Change,” roars Bloomberg.

The Bank of Japan (BoJ) announced Tuesday that it was changing its policy of keeping the 10-year government bond yield capped at 0.25%. The cap will now be at 0.50%. The 10-year yield has rocketed higher. This has been received as a shock by conventional media and analysts. Our followers, though, should just shrug.

For the past few months, our has been warning readers that the Bank of Japan would very likely be abandoning its policy of yield curve control. Our insight wasn’t some special information from officials, but merely the price action of the bond market. We noticed that the 10-year Japanese Government Bond (JGB) yield had started to exhibit support at the reaction high point of what was very probably a major double bottom pattern. Elliott wave analysis also pointed to the fact that a historic low had been established in 2019.

Contrary to conventional wisdom, the “shock” would have been if the Bank of Japan had continued to maintain its policy!

In typical central bank fashion, though, it can’t fully admit defeat just yet and so is still trying to cap the bond yield at 0.50%. The chart points to this barrier being abandoned at some point as well.

JGB 10-Year Yield
Global Credit Cycle Increasingly Negative

Expect 2023 to be filled with downgrades. (Ed. Which are traditionally late and less than useful, often coming after a company’s debt and common stock prices have already been clobbered, but fine, if you still think technical analysis has no place in your discipline…)

The most remarkable aspect to this year’s bear markets in bonds and stocks is that corporate credit has held up reasonably well. Yield spreads of corporate bonds to U.S. Treasuries have widened indicating underperformance but are nowhere near the levels seen in bear markets of the past.

One major reason for this is that many corporate borrowers took advantage of the historically low interest rates on offer during the 2020 Covid crisis and raised a lot of funds. Therefore, this year there hasn’t been a desperate need for finance officers to come to the market. However, that will start to change in 2023 as corporate debt maturing rises steadily into 2026. Of course, next year at least, corporates will be forced to refinance their debt at much higher rates and, for many, this will prove to be, shall we say, challenging. S&P Global expects default rates to double in 2023 compared with this year. There are already signs of cold feet emerging with the iShares iBoxx $ Investment Grade Corporate Bond ETF (ticker LQD) recently seeing its largest-ever one-day outflow. 

The chart below shows our proxy for the global credit cycle. It is based on the AAA and CCC U.S.$ corporate yield spread to U.S. Treasuries. Having turned down in 2021, the global credit cycle is becoming increasingly negative and still has much more scope to trend lower.

Expect 2023 to have a distinctly bearish focus on corporate debt.

The Global Credit Cycle
Is this chart bullish or bearish?
Or both?

By many measures, sentiment in financial markets is still not extremely bearish, especially when one looks at the corporate debt markets. However, the chart below shows that conditions could be getting close to the point when doom and gloom pervades.

It shows the U.S. Conference Board’s measure of confidence emanating from a survey it conducts with U.S. corporate Chief Executive officers (CEOs). The latest reading clearly displays that confidence has continued to decline rapidly from the record high reached in 2021. CEOs, like many, are anticipating recessionary conditions in the U.S. economy and, as you can see, confidence tends to decline before U.S. recessions hit (the shaded areas).

Confidence is now lower than it was before the brief 2020 recession and close to the level reached prior to the recession of 2001. In fact, corporate chiefs are now gloomier than they were in early 2008, just ahead of the Great Financial Crisis when, at the end of that year, confidence hit its lowest ebb.

What are we to make of this evidence? On the one hand, we must acknowledge that confidence is close to levels where the economy and the stock market bottomed out. However, like everything in the financial markets, it’s not an exact science and an understanding of context is crucial.

Elliott wave analysis still suggests that the stock market is in a declining trend and so, from that point of view, we can anticipate that CEO confidence, although very low, will probably become even gloomier in the months ahead.

In the meantime, may all our valued followers have a very Merry Christmas!

US Conference Board
This Deep Retracement of Doom
It’s a clue that drama could unfold in early 2023.

The swift reversal in stock markets during the middle of this month is particularly noteworthy, it has produced some significant price patterns. In the Vanguard Total World Stock Index ETF (ticker VT) for example the weekly bar chart shows an outside week that engulfs the previous four. This is solid evidence that sentiment has changed from the bounce optimism back to the higher degree of downtrend pessimism.

Another clue, though, jumps out from the chart and that is the fact that the reversal came around the 0.786 retracement of the decline from August to October. That decline looks like being wave 1 of (3) and, with the deep retracement often occurring in second waves, the bounce into December is wave 2.

If this is correct, wave 3 of (3) down is just getting underway. A third of a third has the potential to be highly dramatic and so we should be prepared for an exciting start to 2023.

I am wishing a safe, healthy, and prosperous New Year all!

Vanguard Total World Stock Index ETF
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So... The storm begins
Give 'em hell
Are you ready?
The feeling is that the market will "CRASH"
Workin’ for the man every night and day
Real wages have plummeted. There’s a chill wind in the air.

January is hard yards for most people. After the merriment of the northern-hemisphere mid-winter festival (aka Yule - Christmas and New Year) many resolve to live healthier lifestyles to get rid of the hangover. Belt tightening also occurs in monetary terms after the pre-Yule splurge for the season of giving and feasting. The third week of January is often noted as the most depressing week of the year because the monthly paycheck has yet to arrive in the bank. This January, there’s another factor that will be causing consternation.

Wages in real terms (adjusted for consumer price inflation) have collapsed since 2020. This, of course, is due to the fact that consumer prices have been rising at an accelerated pace, whilst nominal wages have generally not kept pace, and it is why workers are striking across many countries. As J.M. Keynes wrote in The Economic Consequences of the Peace (1919):

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.

Make no mistake, revolution is in the breeze and governments know it.

The decline in real wages in the U.S. is shown below. It is the steepest decline in real wages in the history of this series, larger than that experienced from 1979 to 1981. Those of us who can remember the early 1980s recessions will know how grim those days were. So grim, in fact, that they marked the end of the negative trend in social mood that had been in place for over a decade.

Should we not be considering whether this decline in real wages will coincide with another nadir in sentiment and lead to brighter days ahead? There’s a chance of that but our Elliott wave analysis continues to point to further declines in the main sociometer for the U.S. economy – the stock market. Thus, we must gird our loins and brace for things to get a lot gloomier.

Don’t be surprised if 2023 sees an increase in civil unrest.

U.S. Weekly Real Earnings (CPI-Adjusted US$)
The Atlantic Cable

The coming debt-deflation is looking that it might claim a high-profile casualty as Bed Bath & Beyond Inc. announces that it is seeking options to sort out its ongoing woes, including bankruptcy. The company is finding that bond holders are unwilling to swap out their existing debt for new issues to help it through. This is what happens in debt-deflation. Lenders disappear and unsustainable borrowers must take the hit.

There was stronger-than-expected employment data today from the U.S. with the ADP number and Jobless Claims suggesting a still-robust labor market. Tech firms are laying people off (Amazon the latest to announce) but the Fed will not be thinking about pausing on rate hikes until the labor market starts to show some signs of weakening. The U.S. Unemployment Rate is released tomorrow and is expected to stay at 3.7%.

And finally, Groundhog Day is still weeks away and yet it feels like it when watching U.S. politics. The fun and games surrounding the election of the speaker would appear to be setting the scene for more stalemate, something that will be increasingly talked about in financial markets with regards to the debt ceiling.

Bed Bath & Beyond Inc.
The Atlantic Cable

The U.S. labor market remains a key focus because, on the face of it, it has held up incredibly well so far. Initial jobless claims keep on declining but as the chart below shows, continued jobless claims are on a rising trend from last year. Continued claims have risen into every U.S. economic recession and we expect this time to be no different.

The big central banks (Fed, BoE, ECB) delivered rate hikes as expected with the Fed and Bank of England sounding relatively dovish in comments. The ECB was hawkish and Eurozone long-end bond yields declined markedly as traders marked up prices, perhaps thinking the ECB is too hawkish and hiking into a recession. Our view is that recessions are coming anyway and that bond yields remain on higher-degree upward trends.

And finally, Indian tycoon Gautam Adani has seen $58 billion erased from his personal fortune in the span of just trading days as confidence in his business empire has disappeared.

It’s perhaps a foretaste of what’s in store for many other assets as the deflationary depression moves up the gears.

U.S. Continued Jobless Claims
The Coming Credit Bust 
A recession will see lots of stress.

I was listening to a talking head on financial television this week and she said that “corporate bond spreads always peak during a recession,” meaning that’s when corporate bonds hit their worst level of underperformance. I thought that sounded correct but checked the chart just to make sure.

As we can see below in relation to junk bond yield spreads to U.S. Treasuries, it’s true with regard to the three U.S. recessions seen this century. Of course, yield spreads have widened (corporate bonds have underperformed) during periods when there has been no recession as well but, when there is a recession, yield spreads have never reached their peak before it.

So, the sixty-four-thousand-dollar question is (man, I am old, that’s $708,000 in 2023 dollars!), will there be a recession?

Well, after such a long yield-curve inversion, where short-end yields are above long-end yields, it would be a historic, statistical miracle if there were not. As we have stated before, though, the recession often hasn’t come until the yield curve starts to normalize. In the past, this has occurred when the market starts to sense that short-end yields should be lower and leads, as always, the Fed into cutting rates. The problem is, however, with consumer price inflation still well above the Fed’s target, can short-end rates really be lower? The money markets are certainly beginning to sense that, pricing in Fed rate cuts next year. But the yield curve remains inverted.

Perhaps, though, this time the yield curve normalizes, not by short-end yields coming down, but by long-end yields moving higher. In fact, given the Elliott wave analysis for bond markets, that would make a lot of sense. Such a scenario would be a big surprise in relation to current expectations.

The bottom line is that, with a recession a near certainty, it is extremely probable that the corporate bond market is heading for major stress.

U.S. S Junk Bond Yield Spread to U.S. Treasuries (%)
A Two-Year Cycle in Volatility
Watch out from the second half of this year.

Scotland beat England in the Six Nations Rugby Championship at the weekend (cue warm glow from your columnist), displaying a level of skill and ability which was unthinkable a decade ago. It prompted discussions with my friends about how we often find that team sport performances can go in cycles. A few years at the top end of the game, then complacency sets in, followed by hard work, and back to the top again. That sort of thing. (It’s also a great excuse to mention the victory as a segue into the point of this piece!) OK, truth be told, I was mentioning the victory regardless of segue!

Time cycle analysis is utterly fascinating. “Cycles; The Mysterious Forces That Trigger Events…,” by Edward R. Dewey, published in 1971, is a compelling read looking, as it does, at cycles in anything from lynx abundance in North America to stock market prices. Dewey’s cycle analysis, he stated on the front cover of the book, can be used to, “predict stock market prices,” prepare for flu epidemics,” and, “anticipate periods of social unrest.” Elliott wave and socionomic followers will recognize how familiar that sounds.

However, cycle analysis is fraught with nuances. J.M. Hurst, who was the first to really computerize cycle analysis laid down various principles for identifying cycles, one of which is the principle of variation. This recognizes that, in practice, there is variation from the ideal cycles as amplitude, and consequently wavelength, ‘drift.’. In other words, it’s far from an exact science. Nevertheless, sometimes, when a potential cycle is spotted, it’s useful to keep it in the back of one’s mind.

An article in the Financial Times told me that a new survey from J.P. Morgan reveals that volatility is now the number one risk that investors fear, taking over from liquidity. So, I looked at the VIX index, the volatility measurement for the U.S. stock market based on options pricing.

As the quarterly bar chart below shows from 2005, starting from the low point in the fourth quarter of 1993, there could be said to be a roughly 2-year cycle in the VIX. It’s not perfect, of course, showing ‘variation,’ but it’s probably good enough to be noteworthy.

On this basis, then, the VIX will be entering a window where a spike can be anticipated from roughly the second half of this year. That might tie in with our Elliott wave analysis, suggesting that stock markets should be in a downtrend during that time.

VIX Index
Forget Hard or Soft. How About NO Landing? 
Sentiment is consistent with a bear market rally.

One of the scariest experiences I have had was flying back to Europe from New York in a 747. An overnight flight, we were coming into land at Dublin airport in a winter storm when, as the wings were oscillating 100 feet from touchdown, all of a sudden, the engines went back into full power, and we roared back up again. A bit of a squeaky bum moment for all on board but then the smooth, calming voice of the captain came over the intercom. Apparently, the aircraft coming in behind us was way too close and so no landing was the safest option for us. (The Guinness went down well during the layover).

I thought about this yesterday when I heard an economist talking about whether the U.S. (and global) economy would experience a hard or soft landing as it slows down. Forget that, he said, “there’s a strong possibility of NO landing.” In other words, the economy will not slow down and there will be no recession. Sure, some data is staying strong such as the labor market, but manufacturing data is slowing down markedly. In any case, the most interesting thing about this belief is that it is consistent with a bear market rally, especially early on in a new downtrend, when people still cling to hope that the bull market is back on track.

The rally in the global stock market index, as proxied by the Vanguard Total World Stock Index ETF (ticker VT) still looks to be corrective. A potential three-wave, A-B-C, zigzag corrective advance in wave (2) could be getting set to end between the 0.50 and 0.618 retracement of wave (1), corresponding with the extreme of the previous fourth wave of one lesser degree. A strong clue that this is a classic bear market rally comes from the fact that On Balance Volume has not confirmed and has actually declined during the advance.

We continue to anticipate that the bear market in stocks, cryptos (and the economy) is far from over and that a hard landing is probably ahead.

Vanguard Total World Stock Index ETF
An Historically Fast Retrenchment in U.S. Real Estate 
It’s even faster than the sub-prime meltdown.

Existing family home sales in the U.S. have collapsed. Since a peak of 6,490,000 units being sold in January 2022, the latest data shows 4,020,000 sales in December. The speed of the decline from the peak in existing home sales is the fastest since at least the early 1970s. Not only is it more dramatic than the decline seen from the 1978 peak, which was a prelude to the devastating double-dip recession of the early 1980s, it is faster than the decline which foreshadowed the sub-prime housing crisis starting in 2007, which rolled into the Great Financial Crisis of 2008. And it doesn’t look over yet.

The chart below shows the iShares Dow Jones U.S. Real Estate ETF (ticker IYR). It peaked in December 2021 and since then looks to have tracked a downtrend line which has just been re-tested. The lower panel of the chart shows On Balance Volume (OBV), a calculation of horsepower. Notice the bearish divergence at the 2021 peak, with OBV not matching the new highs in IYR. Now, after a three-wave rally from the October low, OBV has essentially moved sideways, not a convincing vote of confidence in the advance. This could be a clue that another decline is coming in IYR, probably corresponding with ongoing weakness in the housing market.

iShares Dow Jones U.S. Real Estate ETF
The Immaculate Disinflation
It certainly would be a miracle.

An interesting phrase has entered the lexicon over the last few weeks. The “Immaculate Disinflation” is being used by many to describe the fact that consumer price inflation is slowing down (disinflating) but the economy is remaining buoyant, particularly the labor market. Economists and analysts adhering to this view have alluded to the historical tendency for periods of disinflation to coincide with recession and rising unemployment. With that not occurring now, sentiment is quite optimistic. Well, let’s check the history.

The chart below shows the annualized rate of change in U.S. consumer prices going back to the late 1940s, with the shaded areas representing economic recessions. Just by eyeballing the chart we can see that periods of disinflation do not automatically relate to recessions, the 1990s being a prime example. What stands out though is that it is periods of elevated consumer price inflation which appear to coincide with recessions. Whether or not the subsequent disinflation starts before, during or after the recession, is a moot point. The recessions starting in 1957, 1969, 1973, 1980, 1990, 2001, and 2007 all started around the time that consumer price inflation was peaking after having been elevated relative to recent history. The recessions starting in 1948 and 1981 coincided with the period of disinflation which came after the elevated period of consumer price inflation. The exception to this rule-of-thumb was 1950 to 1953 when a spike in consumer prices was followed by disinflation, with no recession appearing until the disinflation had lasted for two years.

So, what are we to make of this newfound biblical reference appearing in financial markets? The optimism it emotes would appear to be wholly consistent with a bear market rally in stocks, when people start to think that, perhaps, things are not as bad as they seem. If that is true, best to batten down the hatches and prepare for very rainy weather.

U.S. Consumer Price Index (YoY%)
Investors Flood into Bonds
At exactly the wrong time.

Over $19 billion has been invested into high-quality corporate bond exchange traded funds (ETFs) since the start of the year according to the firm EPFR which monitors such flows. This is the largest start-of-year flow into the corporate bond market in the history of the data set going back twenty years. Clearly, investors are being lured by yields that appear very attractive compared with the past fifteen years. However, Elliott wave analysis suggests that investors may be piling in at the wrong time.

The chart below shows the iShares iBoxx $ Investment Grade Corporate Bond ETF (ticker LQD) using weekly bars. The dramatic decline in the historic bond bear market of 2022 we label as wave 3 of a decline which began back in 2020. From last year’s low a three-wave advance is clearly visible, and we label that as the corrective wave 4, noting that it ended at 112.51, just below the 0.382 retracement of wave 3 and within shouting distance of the extreme of the previous fourth wave of one lesser, a common zone for fourth waves to complete.

If this labeling is correct, LQD is now embarking on a decline in wave 5 which should see the price fall to below last year’s low of 98.41 and cause these new investors into the corporate bond market serious angst.

iShares iBoxx $ Investment Grade Corporate Bond ETF
Like Lambs to the Slaughter 
Retail investors are piling into the stock market. Get ready for a decline.

Individual investors have been flooding into the U.S. stock market, buying a net $1.5 billion worth of shares each day on average this year. That makes it the fastest pace ever according to the data provider, VandaTrack. Is this bullish or bearish?

It has traditionally been observed in technical and sentiment analysis going back to the late 1800s and the days of Charles Dow that retail investors, or as Dow referred to them, the “weak hands,” were always late to act. In aggregate, they would either wait until the stock market had advanced before being confident enough to get in (or the fear of missing out became too great), or they would hold on to losses as the stock market declined, only to sell when the pain got too much. Not surprisingly, such behavior occurred at turning points. But does the same dynamic still hold merit?

On the face of it, retail investors in 2023 are completely different from those in 1923, or even 1983. Access to the same information as professional investors is available and there is miniscule chance of anything been known to Wall Street that isn’t known on Main Street. You might think that the sophistication of today’s retail investors would preclude them from acting at the wrong time.

But here’s the key. The vast majority of retail investors are still looking at the stock market only once a day, if that. They go to bed at night with a news report telling them, “the Dow closed up (or down) another x-amount of points today,” and they think, ‘maybe I should get in (or out)’. It’s only after the trend has been established for a while that they eventually act.  

The chart below shows that this retail surge into stocks has occurred in what looks to be wave C of a corrective advance in wave (2) of the Vanguard Total World Stock Index ETF (ticker VT). Retail didn’t get in during wave A.

Wave (2) could have completed around the 50% retracement of wave (1) and at the extreme of the previous fourth wave of one lesser degree, a common reversal zone. Volume has not confirmed the advance.

This is a very compelling Elliott wave structure, so textbook that it perversely begs skepticism. But, if it is correct, and we have no reason to think otherwise at this juncture, the coming decline should be dramatic and prolonged.

Vanguard Total World Stock Index ETF
The Atlantic Cable

This week saw extremely large outflows from junk bond ETFs and inflows into short-term Treasury bond ETFs in a possible sign that sentiment is changing to "risk-off". The rally in HYG (below) was not confirmed by volume and so was probably corrective. Further declines seem likely.

The MBA Mortgage Market Index in the U.S. came in in much lower-than-expected in the latest data point reflecting reduced demand for home mortgages. The index is hovering around 23-year lows as the real estate market continues to stagnate.

And finally, expect crypto “bros” (and sisters) to be up in arms over comments from Agustin Carstens saying, “the battle has been won,” alluding to the fact that a “technology” will never be proper money like fiat money is. Who he? Oh, the Head of the Bank for International Settlements. That is, the central bankers central bank for fiat money.

iShares iBoxx High Yield Corporate Bond ETF
The Atlantic Cable

The latest minutes from the Federal Reserve’s Open Market Committee meeting struck a hawkish tone, but that was to be expected. As the chart shows, the prospect of Fed rate cuts next year is being pared back rapidly.

Analysts at Citi see U.K. consumer price inflation tumbling to a 2% annual rate by the autumn. Base effects will be a big driver, but the Elliott wave outlook for crude oil remains bearish and that will be helping the dynamic. Can such a rapid disinflation turn into deflation? We wouldn’t be surprised considering the Elliott wave outlook for stock markets.

And finally, the S&P 500 equity risk premium (the excess yield earned on dividends as opposed to Treasury bills) is now at the lowest level since 2007. This makes stocks look extremely expensive relative to bills and bonds, and probably another sign of the blind optimism during this bear market rally in stocks.

Fed rate cuts
Stocks Still Very Expensive 

A report from Morgan Stanley caught my eye this week highlighting the relationship between stocks and bonds. The so-called “equity risk premium” measures the extra yield that investing in stocks will give you compared to investing in bonds.

At just 155-basis points (1.55%) the gap between the dividend yield in the S&P 500 index and the yield on Treasury bonds is the narrowest it has been in decades. This means that equities are still the most expensive they have been in a generation.

The chart below shows a proxy for the equity risk premium, the relative performance of the S&P 500 ETF (ticker SPY) versus the Treasury bond ETF (TLT). As you can see, stocks have outperformed bonds incredibly since 2020 and, on a relative basis, are now far beyond how expensive they were in 2007, just before the Great Financial Crisis.

With bond markets unlikely to recover anytime soon, this is yet more evidence that the stock market is very probably on the cusp of a dramatic downturn.

Stocks versus Bonds
The Atlantic Cable

Core PCE (Personal Consumption Expenditures), the Fed’s preferred measure of consumer price inflation, came in much higher than expected in January at 4.7%. It has been disinflating steadily since its peak last year but the latest reading will add to the emerging market perception that the Fed is far from over in tightening monetary policy.

German GDP (Gross Domestic Product) shrank in the fourth quarter of 2022, against expectations of a slight expansion. Elliott wave analysis points to the probability that the DAX index might have completed its bear market rally and is about to start another decline.

And finally, zero-days-to-expiry options trading in the U.S. stock market has exploded in recent months and starting to gather some focus as being a potential landmine. The VIX bottomed at the start of this month and has been edging up steadily. Brace yourself for another “volmageddon” as stocks turn into the expected decline.

Good evening and afternoon, and have a peaceful weekend.

U.S. Core PCE Price Index (YoY %)https://i.imgur.com/ENZOtPx.png
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Give 'em hell
Are Bank Failures Bullish?

Give me a break.

Well, something was bound to break after such a historic bear market in bonds and a rise in interest rates, and Silicon Valley Bank will go down in history as a high-profile casualty. Other banks are failing too and there will be more to come, with ripples affecting crypto (not so) stablecoins. Central banks have acted to protect depositors, but the markets started Monday on a shaky footing.

One theory doing the rounds is that this episode is actually bullish for stock markets because it will mean the Fed and other central banks will stop hiking interest rates. I must admit, I nearly sprayed my morning coffee all over the screen when that little chestnut was mooted on financial tv. It’s another sign of the psychology pervading this Supercycle top, in that people still believe in the power of central banks to direct markets and that they will make sure all is well. Elliott wave analysis tells a different story.

The chart below shows the global stock market as proxied by the Vanguard Total World Stock Index ETF (ticker VT). We showed this chart on 7 February and stated:

A potential three-wave, A-B-C, zigzag corrective advance in wave (2) could be getting set to end between the 0.50 and 0.618 retracement of wave (1), corresponding with the extreme of the previous fourth wave of one lesser degree. A strong clue that this is a classic bear market rally comes from the fact that On Balance Volume has not confirmed and has actually declined during the advance.

The subsequent decline makes it probable that wave (3) down is just now getting underway which, if correct, has the potential to be highly dramatic. By the end of it, nobody should be talking about central banks being able to direct markets.

Vanguard Total World Stock Index ETF
The Atlantic Cable

Another prime example of the barn door closing after the horse has bolted comes from the predictable response to the banking wobble. All deposits in the U.S. are now seeminglyguaranteedand new bank regulation is on the way. Governments and Central Banks are, once again, increasingly desperate to keep stock markets up. Expect further such measures as the bear market proceeds.

Corporate bonds, having held up relatively well last year, look like they are finally entering a reality check. Expect this sector of the financial markets to be a big feature this year as corporates find it increasingly tough to roll over debt.

And finally, big Oscar winner, “Everything Everywhere All at Once” might be a good analogy for what might be in store for financial markets if, as seems probable, a third wave down is starting in U.S. stock markets.

Good evening and afternoon.

Junk Bond Relative Performance to U.S. Treasuries
The Coming Corporate Calamities, aka Requiem for The Era of Easy Money

It really IS the end of easy money.

Like a deer caught in the headlights of an oncoming vehicle, it’s a reasonably educated guess to say that the executives at Silicon Valley Bank (SVB) saw the value of the bank’s bond holdings plummet over the last year, and just froze. A mixture of shock, denial, and hope prevented any action from taking place to book at least some of the losses. It’s the classic stuff that always lies behind a financial blow-up. The result is that SVB has failed and, like my blaring 5.30 AM alarm, this has jolted the financial market out of its complacency. There’s no time to hit the snooze button.

The historically rapid rise in interest rates has, up until now, been something that many could just shrug off. Not those with crashing bond portfolios, of course, as many banks attempted, but those corporates and individuals that have not had to raise finance or roll over existing debt. When mortgages and corporate loans are re-set this year, there are going to be a few deep breaths being taken, and more than a fair share of tightened sphincters!

And that’s assuming borrowers will be allowed to re-finance. Lending standards have been tightening for months and this banking brouhaha will mean that they tighten even further. Despite the fact that short-end yields have declined over the last few days, borrowing levels are still much higher than they were and, if people were in denial about it before, there can be little doubt that the era of easy money is consigned to the history books.

The chart below shows the relative performance of corporate bonds, as proxied by the iShares iBoxx $ Investment Grade Corporate Bond ETF (ticker LQD) versus the iShares 7-10 Year Treasury Bond ETF (ticker IEF). A distinct Head and Shoulders pattern exists where the neckline has been broken over the last few days. The corporate bond market has held in reasonably well over the last year, but we fully expect this sector to be the next shoe to drop. Expect downgrades and defaults to soar as the rating services to play catch up with reality.

Corporate Bonds Relative Performance
The Atlantic Cable

U.S. consumer price inflation continues to disinflate but it will still be a focus for the Fed. What the Fed does next is the subject of great debate in the market right now. Looking at the decline in short-end yields, and the fact that the Fed follows the market, the probability of a Fed pause is increasing. The question is, if it pauses, will that be taken as a positive or negative for markets? Given the Elliott wave outlook for stocks, the likelihood is that whatever happens will be used as a negative narrative.

The Aussies are feeling less confident as the southern hemisphere moves through its autumn, with the NAB business confidence indicator falling below its long run average. Elliott wave analysis for the Aussie dollar, though, is bullish.

And finally, the correlation between Bitcoin and the S&P 500 has loosened a little in the last few days, with the crypto being bid up (with advocates naturally citing the banking chaos). A breakdown in the relationship might come given the current Elliott wave outlooks for each asset.

U.S. Consumer Price Index (YoY%)

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Spoiler Alert - The Hero Dies

This is a classic bear market rally
Happy Carousel Day.
“Bulls finding it’s tough to buy the dip.”
The bear is happy and enjoying the show!
The Atlantic Cable

The big story today has been the troubles at Credit Suisse with increasing panic about the bank failing and potential contagion. Financial media, naturally, has been dramatizing the story as if it has just come out of the blue, but the 94% decline in the share price from 2007 up until the start of this month painted the picture admirably. Our may all our valued subscribers, of course, has been all over the decline in Credit Suisse with the Pro Service Update, for example, warning subscribers in February 2022, when the share price was trading over $9, to anticipate a “devastating decline.” At time of writing, the share price is currently under $2.

Tomorrow is going to be lots of fun because the European Central Bank is announcing its interest rate decision. Having stated there would be no forward guidance a few months ago, President Lagarde has recently guided categorically that this meeting will see a 50-basis point hike in the policy rate. Now, though, with bankers’ buttocks clenching and stock markets down, will the ECB row back from that? We can expect volatility. Whatever it does, it will likely be taken as bearish by the markets given the Elliott wave structures in stock markets.

And finally, the U.K. Chancellor of the Exchequer (finance minister) delivered his budget today to Parliament. Funnily enough, this morning the U.K. Gilt 2-year yield was pretty much at the same level it was when his predecessor delivered the now infamous budget statement last September, which coincided with huge volatility. A quirk of Parliament rules is that the only time alcohol is allowed to be consumed in the chamber is by the Chancellor when the budget is being delivered. He didn’t look like he had a dram in the chamber but, given the ‘ho-hum’ shrug by the markets, we can assume he may be quaffing a couple in relief this evening.
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Debit Suisse. The End Game. 
Why is anyone surprised?

It’s been a good week for ranting on financial television. So many talking heads have been pontificating about the banking wobble with excited presenters asking them, “What’s going to happen next?” Many answers have been like, “This is all about confidence and sentiment, and so we need to get past that.” Cue me growling at the telly.

It's ALL about confidence, ALL the time. This is the key element that so-called fundamental analysts fail to understand. They think that if something looks good on paper then it should do well because that would be rational for an individual to think. But financial markets are driven by crowds of humans where non-rationality predominates. That is why we, and other technical analysts, study human behavior as manifest in price and volume statistics.

Credit Suisse, the (former) Swiss banking icon, is in the spotlight now, with a bailout attempt from the Swiss National Bank in operation as I write this. This all seems to have come as a big shock for financial markets. But it isn’t for our PRO SERVICE subscribers.

We have been writing about the problems at Credit Suisse for some months and forecasting its eventual demise. The relentless decline in the share price from 2007 was telling anyone willing to listen that there were deep-seated issues. On February 2022, even though the share price had already declined by over 80% since 2007, we noted that “the bear market is not over yet,” and forecast, “a devastating decline in wave (C).” Since then, the share price has plummeted by another 70%.

We last showed this chart in October, noting that, “it looks like an endgame” was in operation and, “especially given the massive volume during this wave, very probably indicating investor capitulation.” We have now reached the binary end. Either it survives or not.

Whatever happens near term in the banking sector, confidence should continue to disappear from stock markets given our Elliott wave outlook.

Credit Suisse Group
The Atlantic Cable

Well, the ECB went 50 in the end, increasing its policy interest rate by 0.50%, brushing aside concerns about banking stability. The market is increasingly thinking that central banks are finished raising interest rates with rates in a year’s time expected to be about the same in Europe (see below). So, I guess conventional analysts go back to looking at consumer price inflation. Should it start to accelerate again, there could be tears. Meanwhile, our Elliott wave outlook remains negative for stock markets.

It's all eyes on what the Fed will do next week now. The 4-week moving average of Jobless Claims in the U.S. blipped down, so the Fed will still be thinking that the economy is robust.

And finally, more signs that we’re back in the 1980s as South American crises continue to simmer. Bolivia has effectively run out of foreign exchange reserves leading to panic in the streets with people queuing to buy U.S. dollars. Expect scenes like that to be repeated in major economies as the bear market rumbles on.

Euro Interest Rate Expectations
This is What Debt Deflation Looks Like
Expect confidence in corporate bonds to plummet.

Typically sleepy Switzerland is the center of attention this week, after the shotgun wedding between Credit Suisse and UBS. Both banks didn’t want the deal but the Swiss regulator, Finma, insisted on it taking place, even going so far as changing the law and not allowing UBS shareholders to vote on it. Not only that, Finma changed the capital structure, with Credit Suisse bond holders being wiped out as prices have been written down to zero. Normally, bond holders are first in line to get at least some of their money back.

The so-called Additional Tier 1 (AT1) bonds, also known as contingent convertibles (CoCo), were born in 2013 as European banks began looking for ways to boost their capital ratios. It is widely known that AT1 bonds are risky and that if a bank gets into difficulties the bonds could get converted into equity or written down completely. Nevertheless, the wipe out of Credit Suisse AT1s has come as a shock to the system and now other bank AT1 bonds are being re-priced. This increases the cost of capital in the banking industry as a whole and will contribute to a general tightening of monetary conditions and lending standards.

This is what debt deflation looks like. Bonds become worthless. Sure, the AT1 bonds are a unique form of debt, but underlying all bond markets is confidence. The term credit is derived from the Latin word cred which actually means “believe.” When belief or trust goes, things can get very ugly as was aptly demonstrated by the financial crisis of 2008.

We have highlighted the fact that the corporate debt market has held up relatively well in the bond bear market thus far, but that we expected it to be the next shoe to drop. The Credit Suisse bond situation is a manifestation of that and we anticipate the disappearing confidence to drive corporate bond yield spreads wider. As the chart below shows, European corporate debt has a lot of scope to underperform.

ICE BofA Euro High Yield Index Option-Adjusted Spread (%) Inverted
The Atlantic Cable

It’s looking like boom time for lawyers as litigation against the Swiss authorities for wiping out the Credit Suisse bond holders seems inevitable. The European Union has backed the integrity of the AT1 bond market in an effort to stop confidence from evaporating. Some are saying that UBS has been gifted a very valuable asset and will benefit from it over time. In the short-term, judging by the three-wave advance to the recent high, the share price of UBS doesn’t look like advancing.

Volatility should be heightened this week with the Fed meeting today. The short-term interest rate market continues to price Fed interest rate cuts, now maybe as early as June! This could be consistent with our Elliott wave outlook for declining stock markets.

And finally, a major geo-political risk is almost under the radar this week. China’s Presidential trip to Russia might provide some headlines. China could agree to arm Russia. With China’s social mood trending negative since 2007, such a negative social action cannot be ruled out.

UBS Stock Index
Who Bails the Fed? 
The Fed’s in the red. A lot.

If you search the internet for the history of the Federal Reserve, you will come across a vast trove of conspiracy theories. The central one is that the Fed was established by powerful bankers after a clandestine meeting on Jekyll Island, Georgia and that those families still benefit from profits the Fed makes. We’re not going down that rabbit hole and will stick to the facts.

And the fact is that the Fed is running a huge operating loss right now. The chart below shows the level of the Fed’s liabilities of earnings remittances due to the U.S. Treasury. Having been pretty much always positive since the data started in 2011, it has now cratered to a $41 billion loss. What is going on?

The chart displays the difference between interest earned by the Fed on its portfolio of bonds and the interest paid on commercial bank cash stashed at the Fed (mainly reserves and the reverse repurchase “repo” facility) as well as any realized losses on bonds it has sold through its Quantitative Tightening (QT) program. Every time the Fed raises interest rates it exacerbates this loss because it increases the amount of interest it is paying out, whereas its existing bond income doesn’t change.

Does it matter?
Well, not really because the Fed enjoys the luxury of being able to create money when it wants or needs. And this loss will reverse as the Fed cuts interest rates.

Ah, but what if it can’t cut interest rates because consumer price inflation remains high?
That could be problematic, not from a solvency perspective but mainly from a political standpoint. Whether it can be dismissed as temporary accounting or not, the sight of a chart like this is fine fodder for the anti-Fed crowd.

Fed-bashers will find it wholly ironic that the central bank is involved with bailing out some commercial banks when it is itself running huge losses. As the bear market develops, driven by negative social mood, expect the Fed to be viewed in an increasingly unfavorable light.

Federal Reserve Profit & Loss
The Atlantic Cable

To give you an example of just how extreme the lack of liquidity is in the markets right now, check out the 5-day Average True Range in the U.S. Treasury 2-year yield. It has exploded to a high of 0.50%. For perspective, when Lehman Brothers failed in 2008 and when the Covid panic hit in 2020, the 2-year ATR only spiked to half the current level. Keep attention on risk management in this environment.

The ZEW Economic Sentiment readings for the Eurozone and Germany slumped in the latest reading for March. And this is coincident with the stock market declining. We expect sentiment to follow the stock market down.

And finally, the fall-out from events in Switzerland at the weekend continues with Saudi Arabia, a major shareholder in Credit Suisse, angry about its investment incurring losses. The decision by the Swiss authorities and the reaction from Saudi are just more manifestations of the negative social mood driving this bear market.

U.S. Treasury 2-Year Yield
Trade active:
So, what will be the Fed’s response? A “dovish hike” today is being talked about. Some are even talking about a cut! Whatever happens or is said, Elliott waves point to further declines in stock markets over the next few weeks. Expect volatility from 2pm ET.

Enjoy the show!

Good evening and afternoon.
Fed Finished Hiking?
Watch Out Stocks. 

As goes conventional thinking, if the Fed is preparing to end its hiking cycle and cut rates, then lower rates signal the all-clear for stocks. Ding dong, the higher-rates witch is dead and all that! Cue happy Munchkin singing! Ummm, maybe check that enthusiasm. It could actually be bad news for stocks.

There’s a lot talked about the yield curve, the 10-year U.S. Treasury bond yield minus the 2-year yield. When it becomes inverted (when the 10-year yield is below the 2-year yield), it’s taken as a sign that growth is going to be slowing and that a recession is looming. But, as we have pointed out previously, the inversion tended to come a long time before the recession.

The chart below shows the yield curve alongside the Wilshire 5000 stock index (a market-capitalization-weighted index of the market value of all American stocks) with the shaded areas representing recessions. You can see that it’s not until the yield curve starts to normalize that a recession manifests. Historically, this is because short-end yields are coming down, forcing the Fed to cut rates as it becomes obvious the economy is going into recession. Note that the stock market has tended to decline during those times.

Lower short rates / man-behind-the-curtain cutting good for the stock market?

Think again.

U.S. Treasury 10-Year Yield Minus / 2-Year Yield versus Wilshire 5000 Stock index
The Long Unwinding Road 
The stock market deflation of valuation is underway.

There are various ways to measure stock market valuations. One of the most famous is the one favored by Warren Buffett which measures the stock market level in relation to the size of the economy, or Gross Domestic Product (GDP).

The chart below shows the Wilshire 5000 Price Index divided by the level of Gross Domestic Product (in billions of dollars). With the stock market index hovering around 40,900 and GDP at $26.137 trillion (so $26.137 billion), the ratio currently comes in just over 1.5.

It had reached a high of 1.95 in October 2021, way above the previous peak of 1.37 set in January 2000 at the height of the dot.com bubble.

The average of this ratio since 1971 is 0.82 and so if we think that this metric should be mean reverting over time, then the stock market has much further to deflate relative to the level of GDP. Of course, that doesn’t have to mean that the stock market will decline in nominal terms. It could mean that the stock markets goes sideways whilst GDP continues to move higher. That would still constitute a bear market in stocks though.

Either way, it seems that this stock market valuation indicator is more evidence that the equity culture era is probably over for now.

U.S. Stock Market to GDP
The Atlantic Cable

The U.S. Job Openings and Labor Turnover (JOLTs) stats for February showed a deterioration of the jobs market with the fewest job openings since March 2021. This is consistent with the Elliott wave message looking for a continued downtrend in the stock market. Stocks topped first, now the economy is weakening.

And finally, the latest bubble to fizzle out is the E.U. housing market boom where prices have posted their first quarterly decline since 2015. More evidence that the global deflation of asset prices is gaining momentum.

U.S. Job Openings and Labor Turnover (JOLTs)
The Atlantic Cable

Fed officials continue to think about more interest rate hikes whereas the market is telling us that rate CUTS will be happening before the end of the year. Who is correct? Market pricing leads the Fed and so it’s quite probable that the Fed will end up following the market again. Try this for a scenario. Stock market tanks over the summer, as Elliott wave analysis is anticipating, causing the Fed to think about rate cuts.

Indeed, more evidence that the U.S. economy is weakening fast came last week with employment and services sector PMI data coming in weaker than expected.

And finally, remember those Additional Tier 1 (or CoCos) bonds that were wiped out in the Credit Suisse / UBS shotgun marriage? An index of them has recovered markedly thanks to investors buying up CoCos after the dramatic decline. Distress investors know the risks. Bon chance!

U.S. Interest Rate Expectations
She canna take any more, Cap'n! She's gonna blow! 
Warning lights are flashing for markets.

When I was watching Start Trek back in the 1970s, the concept of a device that you could have in your pocket and communicate with someone you could see on the screen was literally science fiction. It only took a few short decades for that to become a reality. What’s next? Teleportation?!

Being able to extract yourself quickly from a situation might be useful for some if the warnings coming from financial markets are to be believed. The rise in bond yields, which started quietly in 2020, exploded into everyone’s psyche last year when central banks were finally forced to concede that they had to start raising short-term interest rates. This new financial reality is, of course, having an impact across all aspects of the economy, coinciding with the developing negative social mood that has been driving declines in asset markets.

The volatility in short-term bond yields is an indication that the global economic machine could be in danger of a very hard landing. The chart below shows the U.S. Treasury 2-year yield and, in the lower panel, its 3-month Average True Range (ATR), a measure of volatility. Having been at its lowest level ever in 2020, volatility has increased dramatically and is now at the highest level since January 2008.

January 2008, you say? Indeed. A number of months BEFORE the so-called Great Financial Crisis came to a dramatic finale. It could be that the current elevated volatility in short-term yields is, once again, acting as a warning signal that the global economy is rattling and close to breaking point. That would certainly fit with our Elliott wave outlook for stock markets. If those forecasts turn out to be correct, by the autumn of this year four words could be on the lips of many.

Beam me up, Scotty!

U.S. Treasury 2-Year Yield
The Atlantic Cable

Continued Unemployment Claims in the U.S. continues to rise relentlessly, as seen by the 4-week moving average below. It does seem that the U.S. labor market is weakening and that it is only a matter of time before we get a weak Non-Farm Payrolls number.

The IMF is warning that the five-year global growth outlook is the weakest since 1990. The fund doesn’t have the most stellar track record regarding forecasting, so perhaps this information should be filed on the bullish side of the ledger.

And finally, China is reportedly set to open up its interest rate swaps market for foreigners. Another sign that the Middle Kingdom is still pursuing its long-term aim of increased use of the Chinese yuan to rival the U.S. dollar as the leading reserve currency eventually.

4 - Week Moving Average of Continued Claims (Insured Unemployment)
Sell in April, and Have Your Fill 
Summer is coming, so take it easy.

I write this on a wet holiday Monday in London. Having watched The Masters golf tournament from Augusta, Georgia over the weekend, the traditional time when Northern Hemisphere golfers get excited about the coming season, I was looking forward to batting a wee white ball around the countryside today. Alas, mother nature had other plans. But summer is coming, and it makes me think of an old market axiom.

Back in the 1700s, the London bond and stock markets were populated by a certain type. Mostly wealthy, land-owning gentry, they would have country estates outside of the great city. When it came to the summer, the “season” of garden parties, balls and festivities would beckon. Most exchange participants would retire to their country piles and enjoy a few months off.

Naturally, volatility in the markets would be subdued during that time because, as we Elliotticians are aware, the financial markets are driven by human beings and crowd behavior. If there is no crowd, market prices won’t move much, or at least if they do, with less discernible patterns.

Over the decades, a tendency was observed. The stock market would tend to stagnate or decline during the summer months. This gave rise to the famous axiom, “Sell in May and go away, come back on St Leger Day.” The St Leger horse race has been run every September in Doncaster, England, since 1776 and is a staple (one could be forgiven for the malapropism calling it a stable event ??) event in high-class U.K. society.

Statistical studies have shown that, indeed, Northern Hemisphere stock markets underperform in summer compared with winter. And that makes the chart below so compelling.

The global stock market index appears to be on the cusp of a decline in what could be a third, dramatic, wave. It looks like shaping up to be another year when selling in May and going away could be prudent.

But why wait until May?

Vanguard Total World Stock Index ETF
Get Ready for Junk Bond Crisis 
The yield spread looks ready to widen dramatically.

Corporate bonds have held up relatively well over the last couple of years, but that might be about to change. The chart below shows the yield spread between CCC-rated corporate bonds and U.S. Treasuries. When it is going up, that indicates that junk bonds are underperforming.

The spread has recently advanced from holding previous support, a good indication that the underlying trend is for junk bond underperformance.

We anticipate that 2023 will be seen as the year in which corporate bonds finally face up to reality.

ICE BofA CCC & Lower US High Yield Index Option / Adjusted Spread
Le Crunch 
A credit crunch is upon us.

2023 is fast becoming the year in which the stark realities of the end of the easy money era are becoming visible. There was already evidence that lending was being curtailed but the recent banking wobbles have exacerbated the process.

The chart below shows the amount of loans and leases in bank credit from U.S. commercial banks. The series has just witnessed the biggest two-week drop in the history of the series going back to 1973. The contraction in credit was across all sectors, from real estate to commercial and industrial loans.

In Europe, the last bank lending survey from the European Central Bank showed that banks tightened lending standards by the most since 2011. That was in the last quarter of 2022 and it’s very probable that the lending has been even more curtailed in the first few months of this year.

In the U.K., meanwhile, 56,000 2-year fixed rate residential mortgages are due to expire this summer leaving borrowers with much higher rates when they re-set. Expect to see consumer demand dampened as a result.

The shock of tighter money is really only just beginning.

Loans and Leases in Bank Credit, All Commercial Banks
The Atlantic Cable

The big excitement today was U.S. consumer prices data, and it showed a slower-than-expected rate of change at 5% annualized during March. What’s more, shelter prices showed marked slowing, and this is adding fuel for those with views that the Fed will be cutting interest rates a lot by the end of the year. History shows, though, that when the yield curve starts to normalize from inverted, it’s not good news for stock markets.

North of the border, a hawkish pause by the Bank of Canada as it kept rates steady for the second meeting in a row but gave some rhetoric warning that it may hike again if the economy doesn’t slow. Given the Elliott wave outlook for stocks, the weakness in the global economy should be feeding through soon.

And finally, the share of global reserve currencies in U.S. dollars fell to 58.4% in the last quarter of 2022. Meanwhile the Chinese yuan share of global trade has been growing.

There are big macro shifts going on right now.

Good evening and afternoon.

U.S. Consumer Price Index
Gold Up versus Oil. Should We Worry?
It could be more evidence that a recession is coming.

I caught a segment on financial television last week with an analyst talking about the fact that gold has been outperforming oil, and that it is a recession warning. I always try and jot these things down so that I can test them out later, and this is what I did with gold versus oil.

The chart below shows the gold futures prices divided by the crude oil futures price. When the line is going up, the gold price is outperforming oil. We can see straight away that, since 1994, there have been a number of occasions when the gold price has outperformed the oil price. Not all of these periods have coincided with an economic recession, but the last three U.S. recessions have all seen gold rise versus oil.

In the brief recession in 2020, when the war on Covid (World War C) resulted in societal lockdowns, gold soared versus oil as crude collapsed and gold advanced.

Gold started rallying versus oil in July 2008, just as the Global Financial Crisis was about to explode, and it continued to outperform oil into the second quarter of 2009.

And the yellow metal outperformed crude oil during the recession of 2001 after the dot.com boom and bust gave a leading indicator of what was coming.

The gold/oil ratio also advanced in the run up to the Russian debt crisis of 1998 when the failure of the hedge fund Long Term Capital Management (LTCM) created a systemic financial implosion.

Not every time gold rallies versus oil coincides with a financial crisis or economic slowdown but the fact that the ratio has been advancing since the middle of 2022 is worth noting. Given the fact that our Elliott wave analysis continues to point towards declining stock markets, an economic recession looks highly probable.

Gold Relative to Oil
The First Cut is the Scariest
Well, sometimes.

The U.S.-dollar-denominated corporate bond market has held up relatively well during this rising interest rate period. Sure, yields have risen, and prices have declined, but the relative performance of corporate bonds compared with government bonds has not deteriorated as much as in historic cycles. I heard someone say that corporate bonds don’t really start underperforming until the Fed starts cutting interest rates. So, let’s take a look.

The logic is that when the Fed starts cutting interest rates it means that the economy is going into recession and historically that has meant a so-called “hard landing.” Therefore, that is the time when people really start to worry about the corporate bond market relative to government debt, as downgrades and defaults rise.

The chart below shows the junk bond yield spread to government bonds along with the Federal Funds rate. We can see that in the last two recessions, it has indeed been the case that the bulk of corporate bond underperformance (yield spread widening) has occurred after the Fed started to cut interest rates. However, corporate bonds had been underperforming for some time before the Fed started cutting interest rates as the recession of 2001 hit.

However, we can get more history by looking at the yield spread of AAA-rated corporate bonds. That evidence from the late 1980s into the recession of the early 1990s supports the notion that corporate debt underperforms as the Fed starts to cut interest rates.

So, we can probably conclude from this limited data set that there is a case for anticipating corporate bond underperformance as and when the Fed starts to cut interest rates this time around.

Whether or not we should be expecting the Fed to cut rates anytime soon, well, that’s another story…

ICE BofA CCC & Lower US High Vield Index (OAS) / Federal Funds
The Atlantic Cable

The latest Bank of America Global Fund Manager Survey shows that investors are the most underweight stocks versus bonds since the financial crisis of 2008-09. This could be taken as a sign of extreme bearish sentiment, but the chart below shows that there is scope for more. Indeed, if the equity culture is in the process of ending, perhaps an underweight equities versus bonds (or overweight bonds versus equities to flip it) might become the norm.

And finally, there’s increasing talk about how Artificial Intelligence (ChatGPT, etc.) will be able to crack the markets and generate consistent profits. Let’s see how it copes when it has to actually call the broker on a phone when there is no liquidity, and the internet is down! Humans drive markets, and always will.

BofA Global Fund Manager Survey
The Atlantic Cable

Having declined since early March, the latest MBA 30-year mortgage rate in the U.S. rose in the latest data point and now sits at 6.43%. As the chart shows, the 30-year fixed rate mortgage average in the U.S. showed a historic annualized rate-of-change last year, more than double the rate-of-change seen in the recession of 1980.

The psychological effects of such rapid changes to the financial world are probably yet to seep through.

And finally, a Bloomberg article shows that over the last hundred years, the S&P 500 has never bottomed out before a recession. So, either there are more declines to come in stocks or we don’t get a recession. We know which way we’re leaning.

30-Year Fixed Rate Mortgage Average in the United States
Credit Deflation
The motor of the economy has stopped.

Two reports on Bloomberg caught my eye. Firstly, U.S. home foreclosures have now increased on an annualized basis for 23 straight months, as the housing market comes to terms with the unprecedented rise in interest rates over the last couple of years. Secondly, auto repossessions are booming as consumers fall behind on loan payments. In a stark reminder of the phrase, “there’s always a bull market somewhere” the report describes the optimism and ebullience at the North American Repossessors Summit, held near Disney in Orlando and with the stomach-churning strapline, “Putting the Magic Back in Repossessions”. Seriously. Check it out at reposummit.com.

Everywhere you look now, higher interest rates are beginning to bite. It seems increasingly likely that another round of bank consolidation is underway in the U.S. with many regional banks facing difficulties. The U.S. is unique in the world by having well over three thousand banks whereas most countries have less than three hundred. Smaller banks are losing deposits and people are moving to the big players. Mergers and closures seem inevitable, and that has an effect on the availability of credit. The decision to fund a tech venture capital firm, being made by SVB a few weeks ago, is now in the hands of an official at HSBC, a potentially very different model. Everyone in the market seems to be getting excited about the next Loan Officers Survey from the Fed due out next month but we don’t have to wait for that to recognize that the credit crunch is already in operation.

The chart below shows that U.S. Commercial Bank Credit is now contracting. The last time credit deflation was this extreme was during the Great Financial Crisis of 2008-09. Given that, in Elliott wave terms, the current bear market is probably one degree larger than that episode, do not be surprised if this contraction in credit persists.

Bank Credit, All Commercial Banks
The Atlantic Cable

Despite the obvious credit crunch that is starting, the corporate bond market remains uber-complacent. The chart below shows that the yield spread between BBB-rated and A-rated bonds is still very compressed despite increasing concerns about default rates rising. Expect downgrades to gather momentum and this line to advance in coming months.

Continued Jobless Claims in the U.S. jumped way above expectations in the week ending April 8th, another sign that the labor market is showing signs of cracking.

And finally, the U.S. Conference Board Leading Economic Index has declined to its lowest level since November 2020. The Dow Jones Industrial Average got to that equivalent in October last year, so the economy, as it always does, is lagging the true leading indicator which is the stock market.

We expect much lower levels in both metrics.

ICE BofA BBB US Corporate Index Effective Yield MINUS ICE BofA Single-A US Corporate Index Effective Yield
Junk Bonds & Stock Market Volatility
It’s the calm before the storm.

Much has been written about the fact that stock market volatility has remained subdued in recent months. Indices that measure volatility such as the VIX for the U.S. and the VDAX for Germany are near the lows seen in 2021, before the drama of last year’s financial market movements. Many are scratching their heads as to why this is the case, especially because of the extent of the rise in bond yields. Some say that because bond yields are much higher now, it’s only a matter of time until stock market volatility explodes higher as well. Well, yes and no.

The chart below shows the VIX index in blue, the measurement of U.S. stock market implied volatility. The yellow line is the yield on an index of junk bonds and, as can be seen, from March last year the junk bond yield is much higher and the VIX is lower, which seems to go against the grain of the historical relationship.

But look at the purple line. That represents the yield spread between junk bonds and government bonds. That is, it shows the relative performance of junk bonds. When the purple line is declining, the yield spread is narrowing, and junk bonds are outperforming.

Junk, and corporate bonds in general, have performed reasonably well thus far and so that is consistent with a stock market that seems not unduly concerned about anything at the moment. However, with the credit crunch upon us and debt deflation, downgrades and defaults on the way, it’s probable that corporate bonds are set for a period of underperformance and yield spread widening. That will likely coincide with the next downturn in the stock market and a big increase in volatility.

ICE BofA US High Yield Index Effective Yield / ICE BofA US High Yield Index (OAS) / VIX
A REAL Moment in History
Eurozone real yields are a shock to the system.

The past fifteen years have been historic times in global bond markets. The trauma of the Global Financial Crisis of 2008 ushered in the great experiment by central banks of Quantitative Easing, essentially creating new money out of thin air in order to prop up the system. That exacerbated many distortions in financial market pricing, a prime example being the proliferation of negative yielding debt. Bonds were actually issued with a negative nominal coupon meaning that lenders would pay borrowers. Let me say that again. Lenders would pay borrowers.

And some people think these are normal times we’ve been living through!

It's madness to lend money with a guaranteed loss but that situation has resolved itself with the bear market in bonds and the rise in yields. Negative yielding debt is now in the past. However, a similar type of situation still exists in relation to investor returns.

The real yield on a bond refers to the nominal yield minus the annualized rate of consumer price inflation. If an investor is earning a 5% coupon from a bond and consumer price inflation is running at 2.5%, then the actual (real) yield the investor earns is 2.5%.  

The chart below shows the real 10-year German government bond yield as calculated by the 10-year Bund yield minus the current rate of consumer price inflation. As you can see from 1961 to 2012, the real yield was positive. Over the past ten years, though, the real German 10-year yield has become increasingly negative, hitting -7.6% in November last year. Such a situation means that investors are guaranteed to be worse off by lending their money to the German government.

This doesn’t look at all sustainable, but how does it resolve?
Either consumer price inflation must slow down, or 10-year bond yields must continue to rise. We’ll probably see a bit of both.

Germany 10-Year REAL Yield
The Atlantic Cable

The U.S. debt ceiling drama is in focus this week and the market is nervous. Investors are already demanding a much higher rate from lending to the U.S. government for 6-months as opposed to 1-month (see chart below). Is this the beginning of the market discounting a U.S. default? We’ll be monitoring every day.

LVMH, the European luxury goods icon, has become the first ever European company to reach 500 billion in market cap. Could be a nice round number and “event” that marks an end to the rally in stock markets from last year.

And finally, it’s a weird market. Money rates are pricing in Fed cuts later this year whilst leveraged funds are the shortest of bonds they have ever been, expecting higher yields.
One of them will probably be wrong.

U.S. Treasury Bill 6-Month Rate Minus 1-Month Rate
Dancing on the Ceiling
Oh, what a feeling!

The dance over the U.S. debt ceiling has started in earnest now with Republican House Speaker, Kevin McCarthy, aiming to get a bill passed this week. The $1.5 trillion debt ceiling proposal might be passed, depending on how a few marginal Republicans vote, but it is opposed by Democrats anyway. Nevertheless, it’s the opening tune and people are moving towards the dance floor.

The issue has assumed a degree of urgency since last week’s statistics showed that U.S. government tax receipts were running below expectations. That means the government will run out of money sooner than expected, perhaps as early as June. The rate differential between 1-month and 6-month Treasury Bills has jumped much higher, reflecting investor nervousness over a potential debt default.

The U.S. 5-year Credit Default Swap (see chart below), a measure of the cost of insuring against a default, is hovering just below the level seen in 2011 during the last debt ceiling crisis.

Most people might look upon this drama as some sort of random event that could have profound implications for financial markets. It’s not random. It is the waxing and waning of social mood which is the driver of everything, and the reason why these arguments appear is because mood is waning negatively. In 2011, anger still lingered after social mood had driven the world into the Global Financial Crisis. Now, a negative social mood has driven stock and bond markets down over the past couple of years.

Expect more drama in the weeks ahead.

United States Credit Default Swap 5 Years
The George Bailey Effect on the Housing Market
Bank failures have lasting consequences.

George Bailey, the bank manager from the iconic movie, “It’s A Wonderful Life,” knew the outlook for the local community would be dire if his bank went bust. The recent bank failures in the U.S. and other banking wobbles have put a focus on what it might mean for bank balance sheet management in the future and subsequent effects in the wider economy. Morgan Stanley published a research note highlighting that it might mean a permanently lower valuation for Mortgage-Backed Securities (MBS).

Here’s how the logic goes. The recent bank runs, being very fast and digital, will mean that cash which just sits at banks in current (checking) accounts cannot now be assumed to be sticky money which doesn’t move. This means that banks will have to lower the duration of the assets they hold against their deposit liabilities. That results in less MBS the banks will invest in, and that translates into a wider yield spread to U.S. Treasuries (a lower valuation).

Less structural demand for MBS will probably weigh on property valuations, impacting the heavy corporate involvement in recent years, and is another ripple effect on the economy.

The chart below shows that the relative performance of MBS, having outperformed from 2020, started to decline just before the bank failures in March. We expect that underperformance to continue as well as the price of the iShares MBS ETF to decline.

MBS Relative Performance to U.S. Treasuries (MBB /IEF)
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The feeling is that the market will "CRASH"
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Leave your last words.
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Serenity before the storm will come soon.
JP Fed
Are their fortunes intertwined?

I would be surprised if you haven’t heard of Jesse Livermore but, if so, look him up. Known as “the boy plunger,” he started trading the stock market in his teens and became a legendary player, making and losing a few fortunes in the process. In the Knickerbocker Crisis of 1907, Livermore was short and making a killing. The financier, John Pierpont (J.P.) Morgan, was at the center of trying to fix the panic and he personally asked Livermore to cover his short positions. He did so and made an even bigger killing in the rebound.

J.P. Morgan was credited with saving America and so began an interesting history. Morgan was the main instigator amongst a secretive group of bankers in creating the Federal Reserve in 1913 and, in recent times, Morgan’s firm does seem to have enjoyed favored status, being gifted Bear Stearns in 2007 as a prime example.

So, should we be surprised that JP Morgan has been selected to take over First Republic after another frantic weekend in the regional banking drama? It seems that JP Morgan can do nothing wrong, but looking at the chart of the share price might tell us a different story.

What could be an eleven-year triangle ended in 2011 and, if it is a triangle, would very probably constitute a high degree fourth wave, meaning that the advance from 2011 is a fifth wave. The rally subdivides neatly into a five-wave advance ending at the 2021 high, with Elliott channeling anticipating the end of wave ((5)).

If this labeling is correct, JP Morgan’s share price is very likely beginning a multi-year downtrend. Given that it’s the Fed’s golden firm, might this coincide with an ever-increasing negative view of America’s central bank?

That might make sense.

JPMorgan Chase
It’s All About Jobs
Many are expecting a recession. Does that mean it won’t happen?

According to economic cycle theory, bonds turn first, then stock markets, followed by the economy itself and finally commodities. The bond bull market ended in 2020. The global stock market index topped in 2021. Commodities (CRB index) are still below the peak of 2022. Yet still the economy seems to be holding up. Is it all about to go pear shaped?

That’s certainly what money markets are expecting, with the Fed Funds futures strip pricing in the largest extent of rate cuts over the next 18-months in data going back to the 1980s. Nearly 2% of rate cuts are anticipated. That’s even more than what was expected in December 2007, just before the Great Financial Crisis hit.

In the end, it all comes down to jobs. Richard Russell, the legendary Dow Theorist and Elliottician, lived through the Great Depression and had some sobering anecdotes about it. The point he stressed over and over was that the economy and people can muddle through if, and only if, they have an income coming in. When a regular income goes, things can turn down very quickly.

There have been quite a number of big companies announcing layoffs over the last few months, for example, Morgan Stanley confirming another 3,000 job losses this week. Official labor market statistics have yet to show weakness, but the chart below might be a clue of an impending slump.

The 4-week moving average of U.S. Initial Jobless Claims could be starting a third wave higher after a clear three-wave decline which ended, curiously, at a significant Fibonacci retracement.
Will this Elliott wave pointer turn out to be correct in anticipating a severe rise in U.S. unemployment?

It’s going to be fascinating to find out.

U.S. Initial Jobless Claims
Crunchety Crunch
The credit crunch continues.

The European Central Bank published its Euro Area Bank Lending Survey (BLS) for the first quarter this week and it provides further evidence that the supply of, and demand for, credit is drying up. This is the headline paragraph from the report:

“In the April 2023 BLS, euro area banks indicated that their credit standards for loans or credit lines to enterprises tightened further substantially in the first quarter of 2023. From a historical perspective, the pace of net tightening in credit standards remained at the highest level since the euro area sovereign debt crisis in 2011. The tightening was stronger than banks had expected in the previous quarter and points to a persistent weakening of loan dynamics. Risks related to the economic outlook and firm-specific situation remained the main driver of the tightening of credit standards, while banks’ lower risk tolerance also contributed. The tightening impact of banks’ cost of funds and balance sheet situation on credit standards for loans to firms remained contained and broadly unchanged compared with the previous quarter. In the second quarter of 2023, euro area banks expect a further, though more moderate tightening for loans to firms.”

Lending standards also continued to tighten for housing and consumer loans, whilst demand for loans continues to drop with higher interest rates the main factor cited.

So, the ECB should be happy, right? This is what it wants in order to slow the economy and curb the rate of change in consumer prices. This, plus the stable consumer price inflation figures for April, will probably mean the ECB only hikes its policy interest rate by 25-basis points. A 50-basis point hike would now be a shocker.

The thing is, though, the ECB cannot control what risk committees in commercial banks are thinking. The histogram in the chart below shows the net percentages for responses to questions related to contributing factors in relation to decisions on lending standards. This is defined as the difference between the percentage of banks reporting that the given factor contributed to a tightening and the percentage reporting that it contributed to an easing.

We can see that it is overwhelmingly risk perceptions and tolerance which drive decisions on lending standards, and with corporate credit spreads yet to really widen, the worst of the downgrade and default cycle looks to be still ahead of us. Money market futures are already pricing in an interest rate cut from the ECB by the middle of next year. If, as we suspect, stock markets continue to decline, that pricing of cuts will very likely be brought forward in time.

Euro Area Bank Lending Survey (BLS) / Chart 1
The Atlantic Cable

The unemployment rate for the Eurozone dropped to a record low of 6.5% in March from 6.6% in February. Unemployment is a lagging indicator as laying people off, especially in Europe, tends to be the last resort for companies facing difficulties. Expect the employment market in Europe to weaken as stocks resume their bear markets.

Eurozone Unemployment Rate
This Supercycle Top
The Unites States is the last piece of the jigsaw.

The chart below shows stock market indices from four of the major world economies. If the global economy were healthy, you would expect to see major stock markets all in advancing trends. However.

Japan topped out in 1989 after its boom, and the Nikkei 225 index is still 25% below that high.

Germany, as measured by the Dow Jones Germany Stock Index, which is price-based rather than the total return method of the DAX, has moved sideways since its top in 2000, and is currently only 10% above that level. Marked against that turn-of-the-century high point, the Eurozone blue-chip, EuroSTOXX 50 index, is still 20% below it, Spain is 40% down and Italy 44%. In the U.K., the FTSE 100 index has, like Germany, meandered sideways since 2000 and is only 11% above that high now.

China, the Shanghai Composite index, peaked in 2007 and remains 46% below that top.

Compare that with the U.S. where the S&P 500 index has advanced by 1,036% from 1989, 164% from 2000 and 160% from 2007 (although it is worth mentioning that the Dow Jones Industrials Average priced in the “real” money of Gold peaked in 1999!).

One by one over the last few decades major markets have fallen over. The U.S. has been alone in keeping some sort of illusion of growth going.

If our Elliott wave analysis is correct, and the U.S. market is at the start of a bear market, the last piece of the Supercycle jigsaw is in place.

Stock Market Indices
The Atlantic Cable

The ECB hiked its policy interest rate by 25-basis points as expected and signaled that it is not pausing on its hiking cycle yet. This is in contrast to the Fed, where a pause is more likely.

The U.S. labor market Initial Unemployment Claims came in steady, but we still expect them to zoom up this year.

And finally, the U.S. banking whack-a-mole continues. The KBW Bank index still looks to have more declines left in it, according to the Elliott wave structure.

Good afternoon and have a wonderful weekend!
The Atlantic Cable

You must go back to 1953 to see a lower unemployment rate in the U.S. than it is today. At 3.4%, the labor market remains historically tight but there are subtle signs of weakness coming through. Look at the chart below and ask yourself, would I buy it or sell it? Exactly. A recession is coming.

Brace for excited headlines about Gold reaching an all-time high. Elliott wave analysis suggests it could be a fifth wave higher. Fifth wave advances in commodities and metals can be driven by fear and so can extend.

And finally, a geeky stat I spotted today is that U.S. citizens “intention to travel abroad within the next six months” is at an all-time high. A sign of strong confidence, previous peaks in this statistic have come just before the economy slumps.

Good evening and afternoon and have a majestic weekend!

Unemployment Rate
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“Sell in May and go away, come back on St. Leger Day.”
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Human nature never changes. There is a model. It’s called the Elliott Wave Principle and the associated social science of Socionomics. For almost a century, this has a track record of forecasting important changes in economic sentiment based on the waxing and waning of social mood.

If central bankers were paying attention to it right now, they would see that the global economy is very likely entering a recession and, perhaps, something much worse. In any case, central banks will continue to be led by financial market pricing when it comes to their policy decisions. No one body is in control. The aggregate markets are.

Might be a good analogy for what might be in store for financial markets if, as seems probable, a third wave down is starting in U.S. stock markets.

The psychology around the global economy right now seems to match such a description when paired with the Elliott wave structure. Ironically, the panic over the health of the global economy could be telling us that a strong third-wave advance is in its early stages.
ECB Deflation in Full Swing
Does it mean anything at all?

The chart below shows that the European Central Bank’s balance sheet (the assets it holds, mainly in the form of bonds) is now declining at a hefty clip compared with a year ago. This is part of the ECB’s strategy of tightening monetary policy to bring down the rapid rate of change in consumer prices. The monetary deflation has the effect of reducing liquidity in the financial markets as a previously large buyer of bonds steps away. Will there be any consequences?

Judging by history, it’s not that obvious that it will. We could make the case that the deflation of the ECB’s balance sheet after the inflation brought about by the Great Financial Crisis (GFC) fed into the looming Eurozone debt crisis in 2012, but it’s tenuous. Likewise, perhaps the monetary deflation that occurred after that inflationary episode sowed the seeds of concerns a few years later, when consumer prices were declining on an annualized basis. The ECB’s balance sheet had just moved into contracting on a yearly basis when the Covid lockdowns hit, resulting in another episode of monetary inflation.

So, now that inflation has once more turned into deflation, will a problematic issue emerge? It doesn’t have to, but the general reduction in liquidity will undoubtedly have an effect in some areas. Perhaps the most salient point is this. Stock markets have advanced from their Covid-panic lows and so the ECB, caught in that positive mood, feels confident enough to embark on deflation. If, as we suspect, social mood is turning negative and stock markets are close to embarking on another significant wave down, at some point the ECB will no doubt resort to a policy of monetary inflation again.

It’s what happens then that will be most interesting.

Central Bank Assets (Euro Area)
The Godot Recession
Will it ever arrive?

Waiting for Godot is a play by Samuel Beckett in which two characters, Vladimir and Estragon, engage in a variety of discussions and encounters while awaiting the character of Godot, who never arrives. It has been the subject of many different interpretations and philosophical discussions. That sounds very much like the financial markets at this time.

An economic recession in many countries is expected to come this year or next, and our Elliott wave analysis of stock markets suggests that this will happen. However, it is extremely unlikely that a recession will happen unless there is weakness in the labor market. The jobs market remains very tight as vacancies abound, especially in services, with not enough people to fill them. Data from the U.K. this week suggests that wage increases are running at 10% per annum, now above the annualized change in consumer prices.

But, of course, we must not forget that unemployment is a lagging indicator. Firms resort to layoffs as a last resort and within the business cycle unemployment is a mean-reverting metric. Thus, the chart below showing unemployment at historically low levels, far from being a sign that recession is NOT coming, is actually a signal that it could be closer than most people think.

Affluence creates poverty.
Marshall McLuhan

Unemployment Rates (%)
The Atlantic Cable

Rejoice! Rejoice? U.S. headline consumer price inflation prints below 5%. You might have thought this would have been treated as a positive sign, but markets just shrugged. Perhaps people now have CPI-fatigue and are moving on to looking at other stats, maybe employment, as to how to gauge what the Fed will do (as if the central bank’s actions is the main driver of markets!) Our analysis still shows that “sell in May and go away,” has a decent probability of working this year.

European Central Bank officials are mulling the idea that it will still be hiking interest rates in September. Bond yields continue to like being on an upward trajectory according to Elliott wave analysis and so do not be surprised if that turns out to be the case.

And finally, there’s a boom in first and business class air travel from people going on vacation. A friend of mine will be turning left as I will be turning right next month when we fly together (he promises not to laugh at me!). This paying-up for luxury is another sign of extremely high confidence levels, perhaps due to “full employment.”

Good evening and afternoon.

German Schatz 2-Year Yield
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The bear is happy and enjoying the show!
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Give 'em hell
Went to buy a $3 cup of coffee using Bitcoin - ended up paying $78 with fees & had to wait 6 hours for the transaction to go through…

The future of finance!
Bitcoin back below $27,000.

The maxis made a lot of noise yesterday for something that lasted not even 24 hours. Ignore their hopium.

Can’t wait to see their faces when we’re tumbling under 10K later this year.
Powell’s Burns Moment Cometh
The Fed Chair is probably haunted by the ghost of Arthur Burns.

The current bout of accelerating consumer prices that we are living through has brought back analyses and debate about the 1970s and how a similar problem was solved. Credit is wholeheartedly given to Paul Volcker who, at 6 foot 7 inches tall and regularly chomping a stogie, inevitably became known as the “hard man” of Fed chairs as he raised the Fed Funds interest rate to a 20% high by 1980. Consumer prices then disinflated for decades until now.

Putting aside the fact that we do not think the Fed chair, or the Fed Funds rate can influence the waxing and waning of consumer prices to any great extent, the person in charge of the Fed two-before Volcker will probably be in the forefront of current-chair Jay Powell’s thoughts right now.

Arthur Frank Burns was an American economist and diplomat who served as the 10th chairman of the Federal Reserve from 1970 to 1978. The annualized change in consumer prices in the U.S. had risen from around 2.5% in 1972 to over 10% by 1974. Led by Burns, the Fed had raised the policy interest rate from 4.5% to 13% over the same period.

But then came the slump in 1974. Having peaked in 1973, the Dow Jones Industrial Average had plummeted by 46% into a low in the last quarter of 1974. Spooked, the Burns Fed cut interest rates back to below 5% and, to be fair, consumer prices started to disinflate. By 1976, though consumer prices were accelerating again, moving back above a 10% per annum clip in 1979. Enter the big man, Volcker, who sealed his legendary status by slaying the “inflation” dragon.

The historical narrative is that Burns is pilloried for cutting interest rates in the mid-1970s, in so doing fueling the subsequent re-acceleration in consumer prices. For better or worse, his legacy is of being known as “the worst chair in Fed history.”

Powell, whose approval ratings are already the lowest since the Greenspan Fed over twenty years ago, is very likely going to face a similar situation to Burns if our Elliott wave analysis is correct and the stock market (and economy) tanks.

What will he do?
As subscribers are aware, the Fed will follow (not lead) what the money and bond markets are pricing in, so stay tuned to keep on top of developments.

U.S. Fed Funds and Consumer Price Inflation (%)
How To Pick Your Corporate Bonds (Part 1)
It’s a process for increasing the chances of a return ON and a return OF capital.

A talking head on Bloomberg Television this week was speaking about a new “golden age of credit.” Naturally, he is a manager of corporate bond funds and so is guilty, as is normal, of “talking his book.” According to him, this golden age is arriving because for the first time in decades, yields on bonds are extremely attractive. Heck, if you can earn 10% per annum, over fifteen years that compounds to a 317% return. For just investing in bonds. BUT, of course, bonds are far from risk free, especially those yielding 10%!

Interestingly, the corporate bond manager mentioned above expects, as do we, that downgrades and defaults will likely rise over the next year as the corporate bond market finally starts to crack. He made the valid point, though, that only a relatively small proportion of corporate bonds will default and so the trick is, obviously, to avoid those investments. Is there a method we can use to minimize the risk of such a disaster?

The conventional method would be to do a deep dive into the balance sheet and financial information of the bond issuer as well as taking a view on the company’s prospects. The problem with this method is that one can become psychologically invested in the story and ignore potential landmines. A different, more objective and dynamic way is to look at relative performance (or value).

Our starting point is the relative performance of the corporate bond market itself. The chart below shows the difference between the yield on an index of junk bonds and U.S. Treasuries, the so-called yield spread. As the spread is rising (widening) junk bonds are underperforming and when the spread is falling (tightening) junk bonds are outperforming. As we can see, the 5-day exponentially weighted moving average (EMA) is above the 40-day EMA and the 200-day EMA is beginning to slope up. The message from this chart is that the junk bond market is showing signs of an accelerating trend in UNDERperformance.

So, would you still invest in corporate junk bonds? You could, depending on your timeframe.
We’ll come on to that in part-2 so stay tuned.

ICE BofA US High Yield Index Option-Adjusted Spread (%)
The Atlantic Cable

The Old Lady of Threadneedle Street (aka the Bank of England) raised interest rates again yesterday and there is a definite whiff of concern from her over consumer price inflation remaining stubbornly high. This could already be getting priced into Gilts, with the yield spread over Bunds rising again. Last year’s spike became known as the “idiot premium” thanks to the Truss / Kwarteng budget debacle. Perhaps this will become the CPI premium.

Jobless claims in the U.S. came in much higher than expected. This could be evidence that the labor market might finally be starting to give way.

EUR-USD looks like it might have peaked, and a stronger dollar beckons. A stronger dollar can often coincide with a rush to safety. Perhaps time for a bit of “risk-off” sentiment to come through.

A report from Charles Schwab featured in the FT notes that what the U.S. stock market does before and after a final Fed rate hike, in data going back to 1928, is essentially random, with a wide array of outcomes. The subscribers of the newsletter have appreciated for months that the Fed doesn’t drive markets. This is yet more evidence.

And finally, I came across this interesting stat today. The 340 trading days since the S&P 500 made its most recent all-time high is the longest such stretch in over a decade and is the 10th longest stretch since 1950. The bear has moved in and is making itself at home.

Good evening and afternoon and have a joyous weekend!

U.S. TIPs 5-Year Breakeven Inflation Rate (%)
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Happy Carousel Day.
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The bear is happy and enjoying the show!
BREAKING: The state-ran Chinese media outlet, CCTV, has just broadcasted news about Hong Kong's upcoming #crypto adoption.

We've translated the coverage into English:

"Starting from June 1, 2023, guidelines for operators of virtual asset trading platforms will officially take effect.

Operators who are currently or planning to provide services related to virtual asset trading in Hong Kong must apply for a license from the Hong Kong Securities and Futures Commission.

Those currently operating in Hong Kong need to apply within 9 months after June 1. They can only continue to operate in Hong Kong after approval.

Operators who do not intend to apply for a license should start to orderly end their operations in Hong Kong. The first challenge we can see is the safety on the network, it's a significant challenge.

The second is the protection of customer assets, how they are stored and handled.

The third point, of course, is conflicts of interest. Because this platform can see the customer's orders, we pay special attention to their internal controls and their conflicts of interest.

Tsai Zhonghui emphasized that although the relevant system will take effect on June 1 this year, the Hong Kong Securities and Futures Commission has not yet approved any virtual asset trading platform to provide services to retail investors, and most of the virtual asset trading platforms accessible to the public are not regulated by the Hong Kong Securities and Futures Commission."
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Happy Carousel Day.
If the Fed is done hiking, it won’t be to our liking.
Brace for breakages.

It’s becoming more likely that the Federal Reserve is close to the end of its current interest rate hiking cycle. If so, we should be on guard for potential events occurring. The chart below shows a list of panics, crises and bankruptcies which have occurred after the Fed has gone through a period of raising interest rates. Note that recessions tend to occur after such periods.

This, of course, makes sense. Raising the cost of money has exposed situations which are unsustainable. We have already seen problems occurring in the U.S. banking system this year. What will be next? A possible candidate might be in the realm of private credit. The growth of this sector has been outstanding in recent years as non-bank entities such as hedge and pension funds have sought to enhance returns by lending directly to corporations. By its nature, the details of such transactions are opaque, but we can be confident that borrowers will be under increasing pressure when it comes to rolling over their debt.

If there is a growing problem with private credit, it will show up in underperforming share prices of the principal protagonists. We’re monitoring these closely so stay tuned to remain on top of developments.

U.S. Federal Funds Effective Rate
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One of the most famous images of the Iraq War in 2003 was when Mohammed Saeed al-Sahhaf, the Iraqi Media and Foreign Affairs Minister, was interviewed for television and declared that there were, “no American troops on the streets of Baghdad,” just as American tanks rolled through in the background of the screen. This cemented his nickname of Comical Ali.

I thought of such cognitive dissonance today as it becomes clear that a U.S. recession will not be officially declared.
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... is aggregate human behavior, not one narrative, that drives values in financial markets.
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As we close out the second quarter, the Nasdaq has its best first half of the year on record. And yet it is still below its 2021 high. Bear market rallies are often sharp and make people feel that the bull is back. Guess what we think? It’s not.

Good evening and afternoon and have a jubilant weekend.
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