What Financial Markets Are Telling Us: It’s Fine To Get A Little Wild Up to Christmas As Long As One Sheds Excess Weight Into The New Year

Exuberant traders are gearing up to retest the S&P 500’s old highs this week in keeping with the holiday spirit. The volatility risk premium points to a higher market over the next few days (though volume may be light since the VRP could easily reverse and catch investors offside), while my technical reading of key stocks in the S&P 500 is bullish. But there is one negative factor across global asset classes: copper is pointing to declining global GDP expectations. Consequently expect the S&P 500 to rise modestly over the next few days.

The fall in copper and the divergence between the S&P 500 and small stocks (Russell 2000) signals that global growth is at risk, due partly to the Fed’s new hawkish policy as well as the rise of the Omicron variant. And declining global growth feeds back into political issues that tend to pull down equities. Consequently this week’s risk-on sentiment is likely to be as short-lived as the Christmas season, with US domestic political tensions and wider geopolitical tensions likely to heat up and feed back into global growth expectations. Biden’s persistently low approval ratings could be tested should the surge of migrants fleeing omicron lockdowns to the maquiladoras of Northern Mexico start pressuring the border, or by a host of intractable geopolitical issues like Russian aggression against the Ukraine, Afghanistan’s hunger-driven implosion and the concomitant explosion of ISIS, or Iran-Israel cyber wars. Geopolitical tensions typically drive the $US higher, and that would exacerbate the existing dollar-driven decline in global growth as EM nations are forced to choose between higher interest rates and associated austerity, or economic policy nonsense as exemplified by Turkey’s Erdogan.

I expect the rally to fizzle out as we approach Christmas and a period of consolidation to follow, which could prove a significant buying opportunity if geopolitical concerns don’t boil over. The key reason for maintaining exposure to US equities despite Fed hawkishness and declining global growth expectations is the transitory nature of inflation. The fixed income markets are signaling that inflation expectations decline over the course of the 2020s, while gold has remained stable despite the spectacular rise in current inflation. The Fed will not be taking the punch bowl away so much as normalizing policy to pre-pandemic parameters, where interest rates were low and that spooned liquidity into equities. Key to watch is whether the South Korean won resumes its uptrend and copper and weak EM currencies like the rupee block and the Mexican peso bottom out.

Yesterday I added a position in Titan Machinery (TITN), and my other current market positions include a large cash position, and the following holdings: Activision (ATVI), Amgen (AMGN), American Express (AXP), Johnson & Johnson (JNJ), 3M (MMM), and a small net long position in the S&P 500 (the levered inverse ETF SPXU and levered ETF UPRO).