Tuesday, November 21, 2023

SPX Update: The First Impulsive Decline in ~450 Points, Plus More Fundamental Reasons for Bulls (Not) to Be Thankful


"Now did you read the news today?
They say the danger's gone away.
But I can see the fires, still alight,
they're burning into the night."

-- Genesis, Land of Confusion

In several recent articles, I've discussed some fundamental reasons why a meaningful new bull market seems unlikely, but today, for a change, I'm going to look at this from a completely different perspective and instead present yet another reason why a meaningful new bull market still seems unlikely (ha).

The following comes from a brand-new piece by The Wall Street Journal (link is to MSN's reprint of the story, for those who don't want to mess with paywalls):

The office sector’s credit crunch is intensifying. By one measure, it’s now worse than during the 2008-09 global financial crisis. Only one out of every three securitized office mortgages that expired during the first nine months of 2023 was paid off by the end of September, according to Moody’s Analytics. 

That is the smallest share for the first nine months of any year since at least 2008 and well below the nadir reached in 2009, when 47% of these loans got paid off. That share is also well below the rate before the pandemic, when more than eight out of every 10 maturing securitized office mortgages were paid back in some years. 

While the numbers cover only office mortgages packaged into bonds—so-called commercial mortgage-backed securities—they reflect a broader freeze in the lending market for office buildings. 
Many office owners can’t pay back their old loans because they can’t get new mortgages. Remote work and rising vacancies have hit building profits, making it harder to pay interest. Higher interest rates have pushed debt costs up and building values down. That combination is fueling a rise in defaults. The share of office CMBS loans that are delinquent has tripled over the past year to 5.75%, according to Trepp... 
In the first nine months of 2019, for example, 88% of CMBS office loans were paid off when they matured, according to Moody’s Analytics. As interest rates and vacancies rose, that share dropped to 71% in the first nine months of 2022 and to just 31.2% this year. 

Okay, so what's the big deal?  Well...troubles in the commercial real estate (CRE) sector could potentially contribute to a larger banking crisis. Here’s how: 

1. Loan Defaults and Bank Losses: As CRE owners face difficulties in repaying loans due to lower rental income and higher vacancies, the risk of loan defaults increases. If defaults become widespread, banks could suffer significant losses, particularly those with substantial CRE loan portfolios. 

2. Asset Devaluation and Balance Sheet Impact: If CRE property values continue to fall, this will lead to a devaluation of assets held by banks. Since these properties often serve as collateral for loans, a drop in value can weaken banks' balance sheets and increase their risk of insolvency.

3. Refinancing Difficulties: Higher interest rates make it more difficult and costly for property owners to refinance existing debt. As loans mature and refinancing becomes harder, more property owners may default, increasing the pressure on banks that provided the original financing.

4. Banking Sector Exposure to CRE: Regional banks, which have a significant exposure to the CRE market, could be particularly vulnerable. If they start to incur losses, this could lead to a loss of confidence in these banks, potentially causing depositors to withdraw their funds and creating liquidity issues.

5. Contagion to the Broader Financial System: Losses in CRE could create a domino effect where concerns about one bank's stability spread to others. This contagion can be exacerbated if investors and depositors begin to question the health of other financial institutions, leading to a broader crisis of confidence and potential bank runs.

6. Regulatory Capital Ratios and Stress Tests: If banks begin to suffer losses on CRE loans, their capital ratios could fall below regulatory requirements. This could trigger intervention from regulators and possibly result in banks being forced to raise additional capital or reduce lending, further tightening credit conditions.

7. Impact on the Economy: As banks suffer losses and tighten lending standards, this can lead to a credit crunch, where businesses and consumers find it harder to get loans. A reduction in lending can slow down economic growth, potentially leading to a recession, which would further exacerbate the problems in the CRE sector and the banking industry at large. 

Therefore, while the CRE sector is just one part of the banking industry's portfolio, its troubles can have far-reaching implications, potentially triggering a larger banking crisis through a combination of loan defaults, asset devaluations, and a loss of confidence in the financial system. The interconnectedness of the banking sector means that issues in one area can quickly spread to others, leading to systemic risks.

But hey, maybe everything will work out just fine.

In Centralia, Pennsylvania, deep beneath the surface of the town, there's an old coal mine.  In 1962, that mine caught on fire.  At first, nothing much happened at the surface and many residents underestimated or ignored the developing danger.  Which worked fine for quite a while, actually.  It wasn't until the 1980s that people really began to understand the true scope of that heretofore unseen devastation -- after sink holes began opening up and swallowing sections of the town.  At which point it was discovered that the ground beneath the entire town was unstable.  The town was ultimately almost-completely abandoned.  (Incidentally, those fires are still burning, 61 years later!)  

Commercial Real Estate is one of several fires raging beneath the surface right now.  As is human nature, most people (either don't know about or) are ignoring CRE and will go right on ignoring it until a sinkhole opens up in their own backyard.  At which point they'll stampede for the exits.  The trouble is, once "everyone" knows something, it's often too late to act.  Just like the homes in Centralia, collapsing assets have little or no value once everyone has recognized the true risks.

Ironically enough, the mine fires in Centralia were initially sparked by a raging dumpster fire (essentially; it was a trash dump burn) right after a big celebration, so we can see this story has more than one parallel to today's market.

Anyway, like I said, maybe we can just ignore that and everything will be fine... or maybe the market will suddenly remember that the Fed standing still isn't going to fix this or fix bank balance sheets or fix Treasury oversupply (and so on), and that this rally is trying to launch itself from unstable ground.

If the market suddenly remembers that, the rally could end as quickly as it began.  But sometimes it takes a bit of time for the market to get up to speed -- if it didn't, then there wouldn't be a market, as everything would just zip instantly to the correct value, with no zig-zagging in-between.

The big news today, though, is that SPX seems to have formed the very first clean-high impulsive decline we've seen since its target capture back in October:

Concurrent with this, SPX has finally cracked its melt-up channel:

For people new to Elliott Wave, I do want to stress that this (on the chart above) is a micro impulse down, so it's entirely possible it only leads to a small c-wave down and then resumes moving higher. But I also want to take this opportunity to point out that simply following the two signals above would have saved bears a whole lot of pain.  

I want to take a moment to try to pass on a bit of edumacashun in Elliott Wave, as this is what I was attempting to outline on November 8, when I wrote:

In conclusion, there's no quick and easy roadmap in the current position, so we'll just have to watch for potential impulsive declines in real-time and take it from there. Waiting for impulsive turns can sometimes help bears stay out of trouble in the event the "straightfoward bull count" shows up, since that approach prevents one from shorting the entire ride up to new highs. It also gives one a clear stop (against the high where the (pending) first impulse down began), as opposed to the current situation, where the only crystal-clear level is way up at 4607. None of that is trading advice.

So now we have a clear stop -- i.e.- "the high where the [no longer pending, but finally actual] first impulse down began"; in this case, that's 4557.05.  This is one of the ways I utilize Elliott Wave in trading (as always, absolutely nothing I write is trading advice, consult with your broker, etc.).  

But as a hypothetical:  For example, now we have our first impulse down, so if I shorted (for sake of illustration) 4540 with a stop at 4557.05 then (presuming I'm playing ES (e-mini SPX futures) and excepting overnight gaps) my presumed risk would be ~18 points, which is a fair bit better than losing ~450 points.  It's not foolproof, and sometimes the apparent impulse is not an impulse -- but the start of the first impulse down gives one a level to act AGAINST, which serves to define one's risk more clearly and may keep one from "holding and hoping" their way into bigger losses.

I've been doing this for a long time, and when I write "there's no quick and easy roadmap in the current position," I'm giving my best read of the market -- and "I have no good read" is, for me, anyway, a signal to step back and be patient.  Which is why I tried to convey that it was a good time for "waiting for impulsive turns" in order for bears to "stay out of trouble."  

Anyway, this rally has been a solid illustration of why I've developed the rule of waiting for an impulsive decline (or rally, sometimes) when the market turns ambiguous.

Of note, NYA and COMPQ are both in the general ballpark (plus or minus a bit here) of resistance zones:


In conclusion, we'll see if this apparent impulse goes anywhere, or if it turns out to be just a speedbump.

As is tradition, I'll be taking Black Friday off, since it's a half-session anyway and I don't get paid enough to work on holidays.  Happy Thanksgiving to everyone!  Trade safe.

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