Some of you may have noticed that an extraordinary period of tranquility seems to have settled over the stockmarket with it tracking sideways for over 6 weeks now within a very narrow range, with mostly small daily fluctuations. Meanwhile investors appear to be complacent and insouciant – the market is at new highs, and the government and Fed have got its back, right? – up to now this has been so, but it won’t be the case if they lose control of interest rates. This is viewed as a very dangerous situation, particularly as LIBOR (London interbank overnight rates) have been rising for months, and are going to force the Fed into doing a rate rise soon, which they will also do in an attempt to salvage something of their battered reputation.
For a while it was unclear what pattern was forming in the stockmarket, but now it is becoming increasingly clear that it may be a rare and unusual “Dumpling Top”, that we can see to advantage on the 3-month chart for the S&P500 index below. A defining characteristic of a Dumpling Top is that when it breaks lower it gaps down – this could happen at any time of day with a stock, but because of its liquidity, it is only likely to happen with the broad market if it gaps down at the open, which it can of course do. We can see on the chart that the risk of a breakdown is now growing, with the parabolic roof of the pattern bearing down on the index and forcing it closer to the support, and the fact that the 50-day moving average is now arriving at the pattern increases downside risk all the more, especially as it has now opened up quite a large gap with the 200-day moving average.
As we know, it is widely assumed that the Fed and the government will step up to the plate with their slush fund to propel another upside breakout, and while this could indeed happen, this time they may not get away with it. The market is now slowly becoming aware that LIBOR has been rising significantly for months from about 0.2% late last year to over 0.5% now, and the Fed just dropped a hint that they may raise rates this month, which would be in response to this and also to try to regain at least a little credibility. If they do we are likely to see a horrible convulsion of the kind that occurred last January. The ground could easily open beneath this market at this high level, just like in this video
, especially as the pattern now forming also has the characteristics of the plateau of a Tower Top. With a Tower Top you have a near vertical rally, as occurred in June – July, then a period of narrow sideways movement, then a breakdown followed by a steep drop, which is normally more rapid than the ascent preceding the top.
The year-to-date shows that the entire rally from the February lows may be a bearish Rising Wedge…
Assuming this interpretation is correct, then what are we going to do about it? First off, with the market still at a high level and set to open up a little this morning, we are a very good point to take appropriate measures. These may include taking profits in long positions where we are up substantially, staying long and pulling stops up close below, hedging with bear ETFs or better still Put options, or speculating on the drop by means of Put options etc. Call options on VIX should prove to be very efficacious. We will be looking at strategies in more detail in coming days, including the potential impact on the PM sector. VIX is in position to soar so we will look at VIX and VIX Calls as a matter of priority.
End of update.
Posted at 10.00 am EDT on 1st September 16.