For weeks, the bulls had nothing to celebrate.
The meme about the collapse in crude oil being a positive was slowly undermined as analysts crunched the numbers and realized that much of the U.S. shale industry was unprofitable.
And thus, that meant all the high-yield debt they’d issued was at risk of default. Which, in turn, jeopardized the entire high-yield bond market. Then, the currencies of emerging market countries came under pressure as Russia looked headed for a 1998-style crisis.
And all of this was complicated by radio silence from the Federal Reserve as officials entered a pre-announcement media blackout period.
But that’s all been washed away over the last 48 hours as stocks posted their biggest two-day price swing in three years encouraged, in large part, by Wednesday’s Federal Reserve policy statement. The Dow Jones Industrial Average gained 2.4%, up 700 points from its lows. It’s now just a little more than 200 points away from breaching the 18,000 level for the first time.
Separately, the S&P 500 gained 2.4%, the Nasdaq Composite gained 2.2% and the Russell 2000 gained 1.5%.
The catalyst for all this seems to hinge on the fact that the computer trading algorithms that dominate the market couldn’t detect the nuances of the Fed’s statement. They were set to scan for the terms “patient” as well as “considerable time” — with the former meaning rate hikes were approaching while the latter suggested the Fed was pushing back its timing.
Instead, as Bloomberg explored today, the Fed threw a curveball and included both. So despite the fact the Fed dismissed downside risks to its inflation forecast and failed to mention recent bond market volatility, and seemed to zero in on ending its 0% interest rate policy in April or June, the machines responded positively to the announcement.
And up we went.
The trouble is that other assets are not participating. Crude oil dropped below $55 a barrel. Junk bonds remain under pressure. Emerging market stocks are weak. And the CBOE Volatility Index (VIX), known as Wall Street’s fear gauge, remains above its 50-day moving average — a precondition for market downtrends.
Backing up, this looks like a particularly powerful short-covering rebound — encouraged by typical end-of-the-year positive seasonality — that could quickly be undermined by additional weakness in crude oil prices. At which point the energy sector profits, shale investment spending, junk bond market, EM currency downward spiral will resume.
And the slide in crude oil, given OPEC’s reluctance to cut production and warnings it is prepared for oil down at $40 a barrel, won’t stop until the U.S. shale industry starts buckling from the pressure.
The chart of the more holistic NYSE Composite Index shown above helps keep everything in perspective: Stocks have formed a nasty triple-top pattern, and have performed a common 62% retracement of their November-to-December pullback.
I’ve recommended clients sit out the fireworks from the sidelines after capturing big profits from the weakness seen earlier in the month. This includes a 39% gain in the VelocityShares 2x VIX (TVIX) recommended to Edge subscribers on December 12 and a 328% gain in the Dec $105 Nasdaq QQQ (QQQ) puts recommended to Edge Pro subscribers on December 10.
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