The stock market looks like it wants to break out. Gold looks like it wants to break down. The European banking system remains on the brink of disaster. And US Federal tax collections fell out of bed in May.
Is there a common thread that runs through all that? And if so, what does it mean for your money?
The short answer is, “No,” but we can draw inferences from observing each set of data.
And by way of a spoiler alert, even the data that looks bullish at first likely has a deeper story to tell.
The S&P’s Possible “False Breakout” May Mark A Significant Downwards Turning Point
First, let’s look at the technical side of stocks. On Monday, the S&P 500 broke out above an important resistance level at 2742. But it didn’t get far, closing at 2747. As you can see from the projections of the cycle wave bands, it could be headed for roughly 2785, or even 2825 over the next week or two.
Or maybe it isn’t. The tell will come in the next day or two. If the SPX can’t sustain a move above 2742, which it barely broke on Monday, and closes back below that level, such a turn would have bullish traders throwing in the towel. False breakouts like that often mark significant turning points.
So it all depends. If they can hold above 2742 for a couple of days, the rally will extend, and traders will go on fighting the Fed. They would almost certainly need to liquidate bonds or something else to do that. So if stocks do rally, look for your bond funds to lose value. There’s just not enough liquidity around to support concurrent bull moves in both stocks and bonds. The money to support a rally in one asset class must come from liquidation of another asset class.
If they can’t hold above 2742, we could finally start to see stocks begin the decline that I have been forecasting, as the Fed pulls money out of the system. July is the likely starting point for that. That’s when the Fed increases its money draining operations from $30 billion per month to $40 billion.
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In the interim, if stocks don’t take the hit, maybe commodities like precious metals and crude oil will. That’s the message we’re getting from the action in gold.
Downturn in Commodities Could Mean “Tight Money” Is Starting to Bite
Gold is looking for a 13 week cycle low. Cycle projections (not shown) point to a low of 1278 over the next 2-3 weeks. The 1280 area remains critical support. If it breaks conclusively, things could get a lot worse for a lot longer. There’s a projection of 1258 on the 9-12 month cycle, and the low for that cycle isn’t due until year end, ideally. However, if gold holds above 1280 in the short run, it would suggest that the down phase of the 9-12 month cycle will play out as a consolidation. That would bode well for the next upturn.
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Now here’s the really big problem for gold bugs. 1278-80 isn’t just short term trend support. It’s trend support for the secular bull market in gold that began 17 years ago. If gold ends the month of June below 1280, at the very least the next move should be to 1200. It could get worse. With a rollover in the 4 year cycle, gold could go all the way back to the 2014 low around 1050.
But as the great philosopher Monty Python taught us, always look on the bright side of life. If June closes above 1280, the odds would be that gold is on its way to a breakout through that massive resistance area between 1370 and 1393. Clearing that would result in a conventional measured move target of roughly 1700. That’s derived by adding the distance from the low to the resistance level, to the resistance level. Rounding the numbers off a bit, the height of the base pattern is around 330 points from low to resistance. And the top of the base pattern is around 1380. 1380+330= 1710.
Now, I can’t predict whether or not gold will break down here. But we don’t need to. The market will tell us what to expect, based on what it does over the next couple of weeks. So let’s keep an eye on it.
The rationale for the stock rally is that the economy is strong, and that we’re all ok with a little more inflation. But a breakdown in gold and other commodities, particularly crude oil, would signal that we’re not going to get that inflation. Gold is the inflation and crisis hedge of choice for many investors, both large and small. Crude is the inflation hedge of the really big money.
Crude has been in a bull market for 2½ years. It seems to be on the verge of at least a big correction. Crude is notorious for having huge bull and bear swings. After a 2½ year bull market, a big bear phase could be starting.
It stands to reason that as the Fed pulls money out of the financial system, all types of financial assets and derivatives could be negatively affected. I would not assume that falling prices in the commodity spectrum would be bullish. By the same token, financial crisis could cause a spike in the price of gold.
So I’m not big on intermarket analysis. A correlation that looks strong, even causative, in one era, can reverse in another. But if I saw deflationary indications in the commodities, I would take it as a warning sign that tight money is starting to bite into the leveraged speculating community. Falling prices there could lead to margin calls that could easily metastasize into other asset classes, stocks in particular.
Look for “Euromoney” to Slow Next – and U.S. Stocks to Falter
The ECB released European banking data for April last week and it’s not pretty. Deposits are growing very slowly, and only mortgages are growing on the lending side.
The ECB cut its asset purchases to a rate of 30 billion euros a month in January. The financial system is reeling in Europe. Apparently, 30 billion a month in cash injections isn’t enough. Italian, Spanish, Portuguese, and Greek banks are all being kept alive with smoke and mirrors. Deutsche Bank is on its death bed. It’s clearly both too big to fail and too big to save.
The question is what the ECB can do about it. Will it rev up QE again, or try for some type of targeted program? Obviously, I don’t have an answer for that.
But since crisis in Europe sends Euromoney flowing toward Wall Street, that could be the prop that’s holding US stock prices aloft. At least for now. When the Fed goes to $40 billion per month in draining operations next month, that will be more than the dollar equivalency than the ECB is now printing under its QE program. And not all ECB QE ends up in the US, obviously.
Furthermore, the world must still pay for $100 billion per month in new US Treasury issuance, not to mention the sovereign debt issuance of other nations. Where will that money come from? The Fed and ECB are no longer printing any new money on balance. Obviously if investors anywhere in the world opt to buy Treasuries as a safe haven, they’ll need to liquidate something else.
So if Europeans are sending their cash to the US for now, I think we should also consider that Europeans will probably step up the pace of their deleveraging at some point, reducing their debts and cash. They’ll sell assets across the world to do that, particularly US stocks and bonds. Outright monetary collapse in Europe is possible if the liquidation grows into margin calls that fan out around the world. Maybe it won’t happen, but there will be plenty of selling both forced and voluntary. And that will impact us.
If you don’t think that Europe matters to us, check out this chart of European bank deposits overlaid with the S&P 500.
I give an in-depth monthly report on European banking data in the Wall Street Examiner Pro Trader Macroliquidity reports. A 90 day risk free trial is available. Here’s a key point in a nutshell, from the latest report.
The total increase in deposits since the the ECB restarted QE along with negative interest rates (NIRP) in September 2014 is now €1.2 trillion. That is underwhelming, considering that the ECB has pumped €2.8 trillion into the banks over that time.
Most of that money has disappeared!
Depositors have used some of it to buy assets in the US and elsewhere, converting their euros into dollars, with the money flowing through the US markets into the US bank accounts of the sellers. Enough of that can, and usually does, boost US asset prices.
Much of the rest of the missing money has gone toward paying down debt, thereby getting rid of the deposits that resulted from the loans. NIRP creates an incentive for depositors to use their deposits to pay off loans. Doing so reduces their cost of holding deposits or European sovereign paper with negative yields.
Surging deposits in Europe have in the past had a bullish correlation with US markets. The correlation had been strongest with Treasuries as Europeans with cash tend to buy US Treasuries. Some of the deposits created when the ECB prints money were also used to buy stocks.
The surge in deposits since 2016 has had no overt visible impact on the US Treasury market. US Bonds have been weak. No doubt they would have been even weaker without the Europeans buying. But European money did flow into US banks, and some of that money found its way into the accounts of dealers and traders who used it to buy US stocks. The correlation is clear on this chart.
So beware of the next downturn in Euro deposits. This data is only through April, and we know that the European banking crisis headlines exploded in May. A downturn in stock prices in June, coupled with a downturn in Eurobank deposits in the next data release at the end of this month would be a sign that the great unraveling is upon us.
US stocks are rallying longer than I thought they would, but this week holds the key to whether this is the last hurrah, or whether traders can sustain fighting the Fed a bit longer. The end result will be the same. Only the timing is in question.
Do not be tempted to get back into this market if you are largely out. And if you haven’t raised cash to a very high percentage of your portfolio, I would now do so with deliberate speed. The clock is ticking. To profit from any declines, I’d start a program of systematic put purchases with small amounts of cash, or other market neutral trading strategies.
As always, if you’re interested in making profits on the downside of the market, in addition to our ideas here, you can check out Shah Gilani’s put play recommendations in Zenith Trading Circle.
Later this week, I’ll report on the fall in US federal tax revenues in May.