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Hell or High Water

The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Monday, October 27, 2014.


The Ebola thingy has now hit New York because authorities think it's still 'containable' and 'safe' to import. Unlike the import of inert manufactured objects from China however, this constantly changing and dangerous contagion is not welcome because despite the confidence of authorities, eventually its impact will be felt in the economy once its realized it will just keep mutating and spreading until it's too late. We live in a very connected world these days, where it will be impossible for authorities to stop people from finding out the truth. This thinking may not seem important at present, however it will six-months or a year from now. This thing is going to unfold like many of the (bad) sci-fi movies you have watched over the years, only in slow motion - until it's not.

Putting such thinking aside for now however, as postured last week, this week we have the October FOMC Meeting, a firm stock market, declining Treasury inventories, and therefore little reason not to follow through with the telegraphed cessation to Fed QE. And while it could be said with the Fed's new mandate to consider global conditions in setting policy, with just about everybody else in the civilized world (East, West, etc.) talking to the contrary, it would be surprising not to see follow-through in this regard, especially considering what this would do to the currency markets. As purported last week, the Fed wants a healthy status quo picture going into the election next month (strong stocks, bonds and dollar - low gasoline, gold, etc.), and it will be so - hell or high water.

After the election however, after November 4th, this manufactured picture could change quickly once the support of QE leaves the market place with such a high degree of complacency amongst retail investors, as they have been hit so hard over the head by the status quo there's little resistance remaining evidenced in recent small speculator betting practices. That is to say, they have been short squeezed to death these past years, and are finally exhausted. Professional traders (think hedge funds), as evidenced in elevated OEX and NDX open interest put / call ratios, are a different story, however with seasonal strength expectations likely to lift spirits starting any time now, they should soon fall in line with the retail trade as well.

A great deal of pressure is going to be coming down on these characters to improve performance or lose more investors (pension funds are redeeming), and hedges become expensive month after month, which has been a large part of the reason macro-mangers have underperformed significantly. So it's either stop the hedging or lose more investors. Again, this trend should become increasingly popular going into November, a time of seasonal strength for stocks that based on historical patterns, would last into next year. And the month of November could have a nice boost in this regard if Republicans take the Senate, and reaffirm their hold in the House. If the Senate goes to Republicans on November 4th, this would be spun as stock market positive because the Democrats will lose all powers except those of the President to make new laws, tax more, etc. (i.e. less inference in business.) Such an outcome is not certain, especially considering how desperate Democrats are to win, however, with the economy is such dire straights for growing numbers; it's a distinct possibility.

Of course the fact talking heads on CNBC® are already talking about this means it will likely be largely priced in prior to next week. That said, more gains in stocks should still be expected next month if gains are experienced this week due to sheer momentum, which would be signaled with a strong monthly close in the S&P 500 (SPX) / CBOE Volatility Index (VIX) Ratio by Friday, back above the 21-month (swing line) exponential moving average (EMA) denoted in purple below. What's more, if this were to occur, this chart pattern would be telling you to expect a volley back up into the 'sine fan', believe it or not. If it does not finish the month above the 'swing line' however, which would not be surprising considering the present open interest put / call ratio configuration (discussed last week), then any vexing above the SPX / VIX Ratio early next month off the election could be faded aggressively, with the expectation of a failure that will look like 'seasonal inversion'. (See Figure 1)

Figure 1

This is because the SPX / VIX Ratio has not finished below the 21-month EMA for two consecutive months since 2011, making this a possible departure, which is when the latest round of lunacy in stocks began. Based on the momentum of the rebound in stocks last week however, and the fact the SPX finished Friday above the 21-week EMA, apparently the smart money should be betting on continued strength into month's end, and then into November naturally. The thing is, past the election on the 4th, if open interest put / call ratios were to remain generally low (except for the VXX), and hedge funds finally threw in the towel, meaning the OEX and NDX charts would plunge, overly confident bulls (and there are a lot of them) might be in for a surprise going into Christmas this year unless the Fed were to reinstate a new and improved (buying stocks?) QE program. (i.e. which it is sure to do at some point.) It's either that, or as suggested in the chart below, US stocks are set to crash -- buybacks or not. (See Figure 2)

Figure 2

Because if stocks start declining against weakening commodities, where commodities are poised for further declines and sure to fall once the macro 'trap door' is swung open, a falling Dow / CRB Ratio can mean only one thing - crashing stocks - or at least increasing volatility. (i.e. think broadening top tracing out into next year as Fed responds to stock sell offs with new QE into both bonds and stocks.) And again, if hedge fund managers finally stop buying puts soon, this volatility is assured. The desire for self preservation caused these idiots to buy puts without checking the ratios as stocks rallied, and it will be this same desire for self preservation that causes them to cease when it appears to be the right thing to do - for the wrong reason. Therein, while nothing stopped hedge fund managers from protecting away potential profits for years due to the fear of being fired, now that their biggest clients are walking, this same fear will likely have them off side just when they need the protection for real. (i.e. which will collapse the ratios.) (See Figure 3)

Figure 3

Of course if Vlad starts World War III, which he recently threatened to do, then it's not difficult envisioning stocks selling off against commodities no matter how speculators (think hedge funds) are positioned. What's more, such an outcome would also account for a reversal in the above ratio, which as you can see is in position for just such an event from an Elliott Wave perspective as well. Add to this open interest put / call ratios on GDX and GDXJ are relatively elevated at the moment, with November approaching, which has historically rendered some important bottoms for precious metals shares, it does not appear too reckless to point out the possibility of at least a bounce running into options expiry on November 21. Such an outcome would still allow for last minute tax loss related selling in December, however with the sector already essentially 'washed out', one does need wonder if that will be a factor this year. These are the conditions, where nobody expects it, that important bottoms are made.

That being said, and at the same time, a lasting bottom in stocks, any stock, is not made when margin debt is still at all time highs, including precious metals shares. So, although yet another tradable bottom may be upon us here in November if put / call ratios remain buoyant, make no mistake about it, as with all other such instances over the past few years, unless a surprise easing campaign comes from the Fed, any gains should be fully retraced, and then some. (i.e. and if this QE is not huge, the question is, will we get more of what we have now - selective QE not including precious metals shares to be suppressed by the machines.) But QE schizophrenia could happen if the broads break lower right after the election, which as alluded to above, is a distinct possibility. Any lasting breach of 1800 on the SPX will cause the shortest pause in Fed history, and give many speculators a bad case of whiplash because the financialized economy can't handle falling stocks, so expect the Fedsters to act with lightening speed in this regard.

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