Disinflation Delay Evokes Dread From The Bulls But It’s Exactly What The Data Shows — What Fixed Income, Currency & Commodity Markets Are Telling Us
Despite a queasy geopolitical and macroeconomic atmosphere the visceral feel of bullishness was readily apparent when the S&P 500 barely blinked in the face of reports of a Russian missile killing two individuals in NATO member Poland. Even disjointed earnings reports from retailers and over-the-top hawkish comments from Fed Governor Bullard this morning have failed to ignite a sell-off, clear evidence of the overwhelming power of the bulls at this moment. This divergence can’t last much longer without a seachange in economic data, and not even the bulls can descry that from this week’s data points. Still the volatility risk premium points to a higher market over the next few days, while my technical reading of key stocks in the S&P 500 is short-term bullish and longer-term bearish. Yesterday's cross-asset action brought several positive factors for US stocks. The US yield curve is falling and in the current context that is bullish. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. Expect the S&P 500 to rise modestly over the next few days before diving down in December.
Fixed income volatility is rising again despite rates falling, reflecting geopolitical uncertainties as well as limited confidence in the recent rally. Both short and long-rates are likely retest their highs from earlier in the month. Equity volatility in the derivatives markets has diverged from the cash markets, with the VIX near 30 but actuals below 25. Over the last 12 years such divergence nearly always presaged trading range markets or worse over the next 2 months. I expect equities to trade slightly higher as we approach Thanksgiving but fall precipitously from there as volatility metrics manifest in earnings warnings across the US economy.
Continued dramatic disinflation is what the market needs to extend this bear market rally through December, and so far commodity markets aren’t yielding that result. Fossil fuels are generally uptrending but vulnerable to a reversal, while metals are trying to hang onto their modest uptrends and ags, meats and softs are generally well-behaved, with some rolling over. This stability across the commodity complex is happening in the face of a monster FOREX rally that has brought out the $US bears. The fundamentals simply don’t align with bullish optimism and as hawkish Fedspeak hammers this point home the markets will top out and make a run back to the all-but forgotten lows of October 13.
My current positions include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and the ETF SPXU, all of which nets out to a large short position in equities.