Three Words You Don’t Want to Hear in the Next 3-5 Months

I spend 90% of my day analyzing the various financial assets within my coverage basket. I produce long, intermediate, short and micro price forecasts for my members each day. On occasion, I make forecasts that are clear from an analytical standpoint, but are not from a real-world standpoint. The truth is, whatever the event catalysts are they always tend to show up at the right time.

Case in point.

The beginning of February 2023 I forecasted we were topping in our ongoing corrective structure upwards when the SPX Futures were at 4208.50. However, I was convinced the ES Futures price would first strike 4242 before embarking on a retracement that would, minimum, take it to the 3950 area. In retrospect, we came up short of my 4242 target and then...

CUE THE DRAMATIC MUSIC….

Then the regional banking crisis reared its ugly head from out of nowhere. Not only did prices hit my target of the 3950 area, we declined to the 3839.25 level, before finding a short term bottom. My point is, as an analyst, I'm never going to know what the catalysts are…but they remarkably tend to show up at the right times for validation.

…and now we have a silent catalyst brewing. One that has yet to rear its ugly head, but daily threatens us, to do so.

No, I’m not referring to the Trillion or more in unrealized debt losses on the books of major and regional banks that remain undisclosed (we’ll get to that shortly). Additionally, I am not referring to the pending bomb embedded in the commercial real estate market… (Work from home is here to stay…yet we have trillions of dollars in loans in empty vanity sky-scrapers). Side Note to CEOs: Good luck getting people who CAN work from home and accomplish their jobs, to back to facing a stressful commute, exposure to toxic work environments, office politics, etc….

I’m referring to the Debt Ceiling Standoff in the US.

Let’s start this discussion with the chart above. This chart should be familiar to you as I have posted it for the past several weeks.

The far right-hand side of the chart you’ll notice after potentially getting price back within maybe 10% (Red Arrows) of the SPX’s all time high…We would then lose approximately 30%-35% of GLOBAL WEALTH attached to the index. My analysis bears (no pun intended) that out…BUT WHAT WOULD BE, WHAT COULD BE…THE CATALYST TO CAUSE SUCH A SWIFT & DRAMATIC DECLINE?

Well, maybe it begins with hearing these three words…maybe reading about these three words…or listening to the TV and hearing these three words…

”MOTION TO VACATE”

What is a “Motion to Vacate”? Let me get back to that.

First, the debt ceiling, what is that? Since the US Congress rarely passes a budget anymore (last budget passed was August 1, 2019) they vote of something called a continuing resolution or (CR). This allows for the government to operate only for a specified period of time provided the debt does not grow past the statutory limit of the CR. During the timeframe of the CR, the government does things like sell US Treasury Bonds, pay Social Security, Medicare, fund the military, etc. normal course of operations stuff. When the statutory limit on what the US debt can be is reached, the debt ceiling needs to obviously be raised. Historically, this has been a perfunctory exercise. Raising the debt limit simply allows the government to continue to pay its bondholders interest, send out SS checks, Pay Medical expenses associated with Medicare, pay the paychecks of service men and women, etc. THIS IS NOT NEW SPENDING, OR FUNDS FOR PET PROJECTS. Not raising the debt ceiling would be similar to your bank freezing your checking account. You have the money, but you are prevented from to having access to it, therefore you cannot pay your bills. Your creditors will not care you have the money, they only care they don't have their payments. Hence, your credit score is negatively impacted, and your future ability to borrow becomes more and more difficult. Eventually you are deemed a credit risk.

Now imagine that, but on a far far larger scale.

Suffice to say, the implications would be dire. If the US defaults, regardless of technical or actual, the US economy would go into a recession very quickly. Just like when any of us do not pay our bills, to get a loan, we would have to pay much higher interest rates. Therefore, interest rates would go higher in the US. Why? Because why would anyone want to hold treasuries if there is no longer a guarantee to be paid on time. So US treasuries would be sold...thereby driving interest rates higher. That would cause Inflation to also go higher, and this tends to spiral. One negative after another, the economy eventually contracts and the US would enter a recession. To what magnitude? No one knows. This hypothetical scenario has never played out in real life.

Ok, now that you know this would be bad...let's get back to "Motion to Vacate".

So, what was once perfunctory, is now seen as leverage to negotiate on behalf of a minority party.
Unfortunately, this new class of representatives have heard of this tactic, but never seen it used with fruitful outcome to a minority party. The reason is NO US President wants to negotiate something, that has been historically seen as a mere technical expectation of operating the government. Therefore, ALL US presidents refuse to negotiate the Debt Ceiling and simply expect a clean (CR) to raise it and allow the government to pay its CURRENT obligations.

Enter the new Speaker of the House. Kevin McCarthy.

Kevin McCarthy was voted in as speaker of the US House after an unprecedented 11 rounds of voting in HIS CAUCUS. To achieve those votes, he assured the holdouts he would support using the Debt Ceiling to extract demands from the current President.

This new class of representatives made their point of view clear, if you cannot be successful negotiating, we will remove you as speaker and install a new speaker would could be successful negotiating with the current administration. (Like that makes a lot of sense).

The removal of the speaker would begin with only one member of the speaker’s caucus making a “Motion to Vacate” the chair, on the floor of the House of Representatives. This would automatically trigger a floor vote to remove Kevin McCarthy from his speakership. The same speakership his caucus had to vote 11 times before they could agree on him as their leader. This unproductive move, knowing the current administration wouldn’t negotiate with the last guy, digs both sides into their respective positions. There is no practical reason why a new speaker would somehow miraculously change the outcome.

Hence the probability of a technical default would escalate exponentially.

So, I’ll conclude with how I started.

In the above chart you can see clearly that if my analysis is correct, and a catalyst shows up in time for validation purposes only, we could soon be in for a decline of minimum (4350-3200) of 26% in a relatively short amount of time. I speculate something would need to change, a new shoe to drop of some magnitude, leading up to that.

Additionally, I say minimum because our 2020 Covid-low of approximately 2,200 I believe needs to be revisited to validate a super-cycle event. (See Below Chart)

Maybe that area is not visited within this near term decline I am forecasting (4350-3200) we experience by end of this year. However, I do believe we will sub-divide in such a manner that eventually, those levels become realistic to our future selves.

Lastly, I'll revisit the fact that aside from the Debt Default possibility becoming more realistic by the day...the banking crisis still looms.

This is an issue that will not go away until banks who hold long maturity dated treasuries can substantially reduce those holdings, as that area to store and earn interest on capital has a variance of 2-3% with what banks and money markets are paying their depositors to store capital with them. These unrealized losses on these long dated treasuries will have to be resolved. To sell these holdings would drive bonds prices down, and rates higher....potentially further exacerbating the problem. In addition, over trillion in commercial real estate loans that need to be paid off or refinanced in the next year as those loans come due. The Banks will have to hoard capital to solve their problems, and who on Wall Street wants to refi commercial buildings with few tenants? Is trillion in commercial real estate debt about to default?

In summary, this post accomplishes one thing for me. It explains to my followers in detail the problems we're currently facing and may soon face. As traders, this is an educational piece. However, in fairness, there's a lot of speculation contained in this post. I want my followers to aware of the potential hazards we face trading this market each and everyday. I'm ready, willing and able to go long this market, provided I am afforded both the analytical basis and the trading set-up. I can manage risk, and having protocols in place will protect me to a large extent in the event any bullish thesis goes bust.

Nonetheless, I struggle to find any practical basis to be anything but short this market when set-ups are clear...and choose to remain flat when price action is retracing higher. But I will say, my trading strategy for the foreseeable future becomes crystal clear if in the next three to five months I hear the words, ..."Motion to Vacate" being used in the US Congress.

Judging by my chart, whether it's the US debt ceiling, the baking crisis, commercial real estate loans, or some other unknown...A catalyst should be showing up to validate the BIG RED ARROW ON THE RIGHT OF THE CHART ABOVE.