Newsletter - 10/1/2023
Well, I don't really believe that the sky is falling but if you listen to the Swamp, that's whats going to happen when the government shuts down.
I am writing this Saturday morning so there's still the 5% chance that a shutdown is averted but I don't think so.
It's all theater. All of it. None of it really matters.
The Week in Review
Shutdown. 4300ish.
That's what the market was obsessed with this week.
The battle I am watching is the war between the bulls and the bears. The issue is not if the market "should" be down, bc the market doesn't work like that.. The issues is that the market ended the week and the quarter and the bulls failed to capitalize and the bears merely defended.
Government shutdown (short term):
If you look at the historical returns of the market during past governement shutdowns, it is a coin toss if the market will be up or down. However, each shutdown was for different reasons and each shutdown occurred under different circumstances.
This one is very different given the current economic and geopolitical data points.
Will it be bad for the market? I think so but only because it might (finally) cause the first domino in a long string of dominos to fall.
I am not going to spend a lot of time talking about the ramifications of a government shutdown. I AM going to talk about what you should be REALLY WATCHING, regardless if the shutdown occurs or not. I will say this: the longer a shutdown occurs, the worse it will be for the stock market. Because the market hates uncertainty.
What to watch:
Instead of watching the theater in the swamp as a directional market indicator, here are couple of things I am watching that are far more important:
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Yields on the 10 year
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Japan Bond market
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Serbia
Let's unwrap each of these.
Yields on the 10 year:
The rate on the 10 year US debt is very important. Why? While there are a hundred technical reasons here are the two that I believe are most important:
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If and when bonds achieve a yield that is high enough, say 5% on the 10 year, then money will flow out of the stock market and into bonds and their guarnteed rate of return. While you and I might not do this, certainly if you are the manager of say an insurance company's investments, a guaranteed rate of return of 5% is much better than being at risk in the stock market.
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Rising yields will make it more expensive for the US to refinance their debt. This will have the effect of making the US "pay" more to refinance their debt which will put further strain on the US economy right at a time when the economy is already strained.
What's the yield level that could trigger a flow from equities to bonds? 5%. It's not a fixed number. It is the number that the Street is focused on and that's telling enough for me.
Where are yields and where are they going? You tell me:
Watch the 10 year. The higher it goes the more pressure there will be for assets to leave equities and flow into bonds.
Serbia:
Before moving into the discussion about Japan and currency swaps, the news that Serbia had massed their military at the border of Kosovo is a new geopolitical flashpoint that could not come at a worse time.
Last week a Kosovo police officer and three Serbian gunmen were killed at an Orthodox monastery in a gun battle along the northern border of Serbia. This brought to the surface decades of ethnic hate and it has now erupted.
If this flashes into a regional conflict, then Europe and NATO will have another war to deal with which it is ill prepared to do. Remember that Kosovo declared independence in 2008 but it was not recognized by, guess who? Russia.
Do I think this was "encouraged" by Russia? Maybe. Do I think this was on purpose? Well. the vice-president of Serb List, the main Kosovo-Serb political party resigned on Friday after admitting to setting up the group responsible for the attack.
Why am I paying attention to this? Because it would be a new front opened in the quasi proxy war with Russia and the West.
Remember that I have said there has been one thing and one thing only that "fixes," albeit temporarily, a bad US economy: war. Ukraine hasn't done it. Maybe Serbia could.
Before moving on to Japan, let's look at the charts.
SPY Commentary
There was crazy exhuberance by the bulls because of the Thursday rally. But the Bears defended the gap above and the market closed slightly lower for the week.
As far as i am concerned, the week was a "draw."
As you can see on the daily chart, price has entered an area that should be supportive (pea soup green box). Of course, with a shutdown looming and rates rising, the equities market might be relegated to the back seat while other factors are driving.
I often look at market structure to see if a move up or down is supported by the data. Thursday's move was not. There were five times as many stocks making new 52 week lows as there were making 52 week highs. That is not bullish.
Any move to the topisde WILL BE SHORTLIVED. Mark my words.
Our best buds: Japan
Ok. Japan. Why they matter to the US stock market. Bigly.
This is a complicated topic but I will simplify it, because I need to in order to fully understand why it matters.
In simplest terms, if Japan's interest rates go up too much, then it would be very bad for the US economy and stock market. Here's why:
Japan has been the US governement's best buddy keeping oil down, keeping the VIX down, and generally being the FED and Treasuries best foot soldier. They do this through the currency / swaps market. For the purposes of this section, I will focus on currencies and debt.
Ok, so Japan has been in deflation since about forever. Negative interest rates. People thre actually pay the banks to have their money on deposit.
The Japanese Central Bank, the JCB, has been artificially suppressing rates in order, among other reasons, to prevent inflation. For how long? Since the dawn of time. I kid but it does feel like that. Since the early 90s by my estimation.
Ok, but let's take a look at what's been happening to interest rates there:
Uh-oh. Rates are rising. AND so is inflation. Looks familiar to the US but the impact to the US could actually be much worse than the impact to Japan.
Here's why: the Japanese, when instructed by the US, buys or sells dollars or Treasuries. They do this as part of their plan to suppress volaitlity and the price of oil as well as US interest rates. Well they have lost control of oil, as I said they would. And they are about to lose control of volaitlity, which if you recall: volatility and yields are connected. Vol up? Yields up.
So up until recently, Japan has been able to manage domestic inflation so they have been more than willing to help the US. But then rates began to rise. And they keep rising.
This week, while most were focused on the clown show in Washington or fintwit, I was focused on this curious headline:
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This is super important because if Japan starts focusing on buying back its own bonds, it will have less $$$ to help buy back US Treasuries. If they don't buy back US Treasuries then the FED has lost a major partner in helping keep US interest rates low.
In an overly simplistic nutshell:
If Japan dumps US Treasuries to fund buying back their own debt,
US sovereign debt yields will go UP and
the Stock market will go down.
There's a crapton more to this relationship but it really comes down to this: up until now the JCB has been helping the US by buying US Treasuries to help keep yields down (not working btw). It's simple supplky and demand.
What happens when the primary buyer of US debt decides they must focus on their own house? Yup. The US has to raise yields to attract buyers to buy its debt, and interest rates go up even more.
The JCB had many news flashes this week about supporting its currency and debt markets. This is all new and it is not a good thing for US interest rates.
The Nightmare Scenario:
So let's look at the worst case scenario of what could happen.
Japan stops buying US debt.
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US yields go up - inflationary.
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Inflation goes up more - inflationary.
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Higher US sovereign rates force corporate rates up even more - inflationary.
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Corporate debt costs more to acquire and to refi - inflationary.
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Commercial real estate and tech have to pay more on their existing debt and little new debt is offered - recessionary.
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Higher rates cause those banks with a lot of commercial real estate debt to fail - recessionary.
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Banks fail, causing the market to crash - recessionary but also deflationary.
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Market crashes and causes more corporate balance sheets to worsen - recessionary.
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Corporations lay more people off and those people have less to spend - recessionary.
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Less people spending causes corporate profits to worsen which causes the market to crash even more - recessionary.
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The cycle above starts to feed on itself - DEPRESSION.
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The FED bails out the banks - inflationary.
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The populace rises up and burns down the institutions - the worst nightmare for governments.
And round and round it would go.
Do I think this will happen? 50/50. But another interesting announcement was made by a central bank this week:
Now why would the Bank of England be announcing a PERMANENT bailout fund for NON-BANKING institutions??? We know why.
Because they will need it.
And if they need it, so will we. But of course the US announced theirs last week, quietly.
The pain is coming and that's why I believe we will see a +20% drawdown at a minimum. The question is when?
And for that answer, I watch the debt markets, interest rates, and charts.
WEEKLY HOW WALLSTREET SCREWS YOU:
In this week's episode of how Wall Street screws you, let's talk about decimals.
Prior to 2001, all pricing for stocks was done in 1/16, 1/8 and 1/4 pricing. So the bid and ask between stock would look like this: 100 1/4 X 100 3/8. or a $.12 spread.
Because Wall Street and the SEC are always looking out for you and I, they decided that we were too dumb to use fractions and instead we needed to use decimals. Everyone praise the almighty ones!!!
But of course, they had an entirely different agenda. Prior to 2001 the primary way that Wall Street made money was by buying at the bid and selling at the ask - the spread.
After 2001, a new way to make money "suddenly" became extremely popular - using computers. Wall Street has been using computers sincde the 70s but now they had a new fun way to screw us.
And because of decimalization, and because computers are faster than humans, and because humans need more than a penny to profit, the institutions were able to make money by running millions of trades per hour by making pennies or fractions of a pennies.
And this ends this week's episode of how you are being screwed.
UPCOMING WEEK:
This week its all about the gaps, technically speaking. There are gaps above and below the current price (seen on the SPY and QQQ charts above). Whichever one gets filled first will dictate the short term direction.
I am sorry I cannot be more specific but I follow price action and right now, price action says its undecided directionally.
Longer term, the market is going down. I've covered at length why. Now we just have to wait for the first domino to fall.
QUARTERLY CONTEST WINNERS:
The rules for the contest were:
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Whoever is the closest on a combined percentage basis to the actual numbers of the SPY gets 1 FREE VIP MONTH.
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Whoever is the closest on a combined percentage basis to the actual numbers of the QQQ gets 1 FREE VIP MONTH.
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If someone's numbers for THE CLOSE of the SPY or the QQQ is exact to the WHOLE NUMBER, they get an additional 2 MONTHS FREE VIP.
The winners of the Quarterly Contest and a NEW CAR (no) are:
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SPY total: JS (don't know who this bc no screenname was attached but email me and I will award)
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QQQ total: Malschaun
Each will get 1 month of VIP access!
And the winners of TWO FREE MONTHS for calling the close of the SPY to a whole number is 2TIX and JS!
JS you get THREE FREE MONTHS of VIP!!!
CLOSING COMMENTS:
I know the website is lacking but I just am too busy to make it better. Sorry.
We have a lot of new members in chat - please make them feel at home!!
The merch store will open soon and VIPs and Traders will both be getting nice PERMANENT discounts.
Here are just some samples of what we will be available for purchase:
If you have any requests for tshirts or other, let me know and I will add it.
Don't forget the Discord live chat is STILL FREE but it will be closing to new members soon. In the meantime, come and join us - its the best community out there: Discord.
Thankyou Family!
theBoss
BLOG POSTS:
Did a post on How the FED manipulates the VIX this week.
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Nothing above is investment advice nor should it be construed as investment advice. It is offerred for entertainment purposes only. Always consult your advisors before investing any money. Do not "follow" or "mirror" any trade ideas provided. Mr.NotAdvice is not a licensed or registered investment advisor. Do your own research.