What Financial Markets Are Telling Us: The COVID Cycle Is The New Normal, Which The Bulls Can Live With

Despite worries that everyone alive will now get COVID, the markets are sanguine that consumers around the globe are done with pessimism and panic and will continue spending, even if that means in quarantine. The volatility risk premium points to a higher market over the next few days (though volume may be light due both to seasonal factors and because the VRP could easily reverse and catch investors offside), while my technical reading of key stocks in the S&P 500 is bullish. Yesterday's cross-asset action brought several positive factors for US stocks. Oil's chart is signifying global growth. The US yield curve is bull flattening. But there was also one negative factor across global asset classes. Inflation expectations are rising based on measures of Treasuries and TIPS. Expect the S&P 500 to be range-bound over the next few days.

Financial markets reflect stability in global growth as Omicron is seen part of COVID’s seasonal/cyclical nature and most central bankers save the Fed are signaling that easy money policies are to be expected while the pandemic persists. As I wrote earlier this week I expect the Fed to drift back to dovishness as economic data into year-end show slow but stable growth rather than worrisome signs of enduring inflation. The volatility spike that followed Thanksgiving resulted in what seemed a scary move down that reflected steeply slowing global growth, but that downturn ended with a whimper as the SPX did nothing more than partially fill a gap from October. Underlying bullish investor sentiment was made clear on the ensuing rally where hedging actually decreased (per the SKEW index). So the bulls are in control and will send the market back to old highs and marginally beyond in the New Year, as we wait to see if any of the ominous geopolitical developments across Eurasia erupt (e.g., Ukraine, Afghanistan, Lebanon, Iran/Israel). Actual volatility has risen beyond that of the VIX (reflecting expected volatility) and the volatility of volatility (VVIX) briefly gave a sell signal this week, which signals that marginal new highs are more likely than a raging bull market.

Key to watch is the US yield curve, as short rates look to retest the earlier highs while long rates are moving lower as inflation expectations have moderated since the Autumn. This is a neutral backdrop that supports mildly bullish equity sentiment. Similarly the $US has no clear trend, as a few EM currencies are rallying while among the majors only the Chinese Yuan looks strong. Commodities are in a holding pattern as well, all signaling global growth will be slow but stable, giving the bulls the slight edge over the bears.

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