E How Soon The Recession?

VIX made the second Master Cycle low in 34 days yesterday, patterned after the May-June lows last year. Volatility shorts have been feeling no pain as VIX declined to the trendline of a Broadening Wedge formation. The conditions are ripe for a reversal.

-- The NYSE Hi-Lo Index looks bullish but hasn’t broken out above its February 1 high. The Cycles Model tells us to expect a significant low by mid-March.

(Bloomberg) The renewed rally in U.S. equities has left volatility markets showing little concern that the good times will end any time soon. Recession models beg to differ.

Wells Fargo’s model -- which draws on the spread between three-month and 10-year Treasury yields as well as economic figures -- shows chances of a U.S. recession within 12 months jumped in December and climbed to just above 40 percent in January.

But as the likelihood of a downturn increases, there’s a disconnect with implied one-year equity volatility that’s trending below its average for the past year.

“Despite the increased recession probability, long-dated equity volatility is actually trading lower than in previous years,’’ Pravit Chintawongvanich, a Wells Fargo equity derivatives strategist, wrote in a note. He adds that this dynamic reflects issues with how the market is structured more than outright complacency in derivatives.

Still, the gap may have some ominous implications. A similar split was seen prior to the 2008 financial crisis.

-- The SPX continued the rally into its (inverted) Master Cycle high yesterday, finding resistance at the lower trendline of its Broadening Wedge Formation.  Cycles require meeting both time and price targets. In this case, the Broadening Wedge formation may have overridden the Cycles target.  In addition, Wave (C) exactly matches the length of Wave (A). The next agenda item is a retest of the December low. 

(ZeroHedge) The market's hopes that today's snow-delayed Fed minutes would resolve the debate over the fate of the balance sheet unwind, were dashed with the Fed confirming what traders already knew: the Fed would remain patient, data dependent, focused on the fading inflation impulse, and would seek a plan for when the Fed's balance sheet unwind would end by the end of 2019 suggesting that the QT may continue well into 2020 if not later, dependent on what the Fed concludes is a sufficient amount of required bank reserves.

As Bloomberg notes, "small moves in stocks, bonds and FX as the Fed minutes portray a central bank that still sees a decent economy, slow-growing inflation, a tight labor market and an uncertain path for interest rates." The Minutes punctuated another rather quiet session that saw economically-sensitive stocks such as steel makers, chemical and industrial companies outperform against a flat tape.

-- NDX may have completed its rally today by challenging the mid-Cycle resistance at 7070.62 but closing beneath it. Should it reverse beneath the 200-day Moving Average at 7057.57, it will have completed the right shoulder of a proposed Head & Shoulders formation. If valid, new downside lows may be made. I will publish the target at the break of the neckline.

(Bloomberg) Federal Reserve officials turned into market analysts at Hindsight Capital LLC in the minutes of their January meeting.

Policymakers offered a laundry list of reasons why U.S. equities came under severe pressure at the end of 2018, nearly falling into a bear market.

Here’s what the Fed thinks caused the damage:

The Kitchen Sink: Everything Was Awful

“A variety of factors -- including FOMC communications, weaker-than-expected data, trade policy uncertainties, the partial federal government shutdown, and concerns about the outlook for corporate earnings -- were cited by market participants as contributing to a deterioration in risk sentiment early in the period.”

The High Yield Bond Index very nearly broke out above the December 4 high today. This may be giving too much solace to investors as the High Yield Index is on the same pattern as stocks. A Major low appears to be due in mid-March. 

(Bloomberg) U.S. junk bonds look expensive after their prices have jumped since last year, and buying leveraged loans is a better bet now, according to Vancouver-based money manager Leith Wheeler Investment Counsel Ltd.

The firm has been increasing its exposure to loans relative to high-yield bonds since the middle of last year, as it has found loans trading with higher yields than bonds, said Dhruv Mallick, a portfolio manager. That’s true even if the two forms of debt are of similar quality, he said.

10-Year Treasury Notes are bouncing off the Intermediate-term support at 122.23 and may be forming a potential triangle formation in which it tests the 50-day Moving Average at 122.23 before moving higher. The Cycles Model suggests there may still be time to work on its directionality.

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Disclaimer: Nothing in this article should be construed as a personal recommendation to buy, hold or sell short any security.  The Practical Investor, LLC (TPI) may provide a status report of ...

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Gary Anderson 2 months ago Contributor's comment

Interesting news about Deutsche Mess.