What Financial Markets Are Telling Us: Volatile Newsflow Is Driving Volatile Markets, With No End In Sight

Equity markets are hanging tough this week despite the fate of the world hanging on a binary outcome: either Putin will be taken out by his inner circle in short order, or he will destroy Ukraine and gain confidence he can best NATO by threatening yet more. I continue to expect the former and arguably so do the equity markets, but other markets reflect a more dispiriting outlook. The volatility risk premium points to a higher market over the next few days, but my technical reading of key stocks in the S&P 500 is bearish. There are several negative factors across global asset classes. The US yield curve is rising and in the current context that is bearish. Inflation expectations are rising based on measures of Treasuries and TIPS. Expect the S&P 500 to fall over the next few days.

Currency markets and bond market volatility reflect the global angst that Putin will play more of his horrific cards as NATO reveals its weakness by bickering over how to arm Ukraine. The $US has seen large moves in both directions that reflect the binary outcomes and their unpredictability. This is particularly true against EM currencies, where large spikes up were followed by large spikes down. Against the €, however, the outcome is clearer, as Europe is set to weaken in the short-term even under the best care scenario. The primary problem for Europe is energy dependence on Russia can’t be immediately remediated, and complicating the shift away from Russia is the diversity of European nations in their energy mix and supply-demand dynamics. Full European integration is obviously the solution and this would give the € a boost, and there is hope this will be done briskly as German rearmament is a visceral issue that will prompt other EU nations to agree on how to truly unify Europe. But this happy outcome still depends on Putin’s inner circle taking him out soon, and here there is more skepticism than optimism, as even Mikhail Khodorkovsky sees it happening in a year or so rather than this week.

Bond market volatility reflects the dilemma facing both world leaders and central bank policymakers, as the short-term inflationary spike of the war (married to previous spikes caused by supply chain disruptions) will naturally be undone as Europe weakens. The posture of the Fed is particularly troubling since it’s probable that inflation is overstated in normal times, and disinflationary trends are likely to intensify due to the digitization that the pandemic hastened across corporate America. So the case can be made for easy money for some time, yet that risks ruining central bank credibility as many pundits believe inflation is here to stay because of a decade of easy money following the GFC. The divergence of views doesn’t help markets, and consequently I expect the S&P 500 to fall considerably until Putin is taken out and world begins a long road back to normalcy.

My current positions include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETF UPRO.