What Financial Markets Are Telling Us: Future Food Shortages, WMDs & The Suffering Of Ukrainians Don’t Make A Bear Market

The myopia of global equity markets continues strong as the consequences of Putin’s malevolence make little difference to global investors. The Russian rouble is up despite absurd rules and interventions by Russia’s authority, a sign that financial markets are in a consolidative phase with no import for future trends. 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 short-term technical reading of key stocks in the S&P 500 is bullish. Yesterday's cross-asset action brought one positive factor for US stocks. The US yield curve is falling and in the current context that is bullish. Consequently expect the rally to fizzle out when the S&P 500 hits 4550, setting up for a major downturn toward month-end.

Volatility metrics tell a slightly different story from the cash equity markets: the VIX is above 20 but below actual volatility, a sign of bullishness that isn’t matched by the range bound trading in the cash market. Similarly the volatility of volatility (VVIX) and the tail risk index (SKEW) are squarely in the bullish camp. This implies investors are bullish for the intermediate term, but not taking action in the cash markets, which have seen rallies on low volume and declines on high volume. This mild disparity points to the optimism that the Ukraine situation will not have dire global consequences, which is mitigated by the fact that investors are generally good at analyzing geopolitical event risk rather than predicting such events. So the markets are consolidating within the large range set from mid-January to March, with old highs within striking distance.

The bond market tells an altogether different story of fear. It’s not just fear of a Fed mistake but fear that the Fed can’t help but make a mistake since there are no good choices. Were the Fed to follow inflation expectations they would be move dovish, but that would stoke the bond vigilantes and likely steepen the yield curve, thereby hurting equities and slowing growth in turn. So the Fed projects hawkishness which is flattening the yield curve, which equities can handle but which historically has always preceded recession. The $US dollar’s strength similarly portends slowing growth and is a self-fulfilling prophesy since EM nations import significantly in $US. Slow growth is a recipe for lower valuations but the market is hopeful that earnings growth remains vigorous and holds valuations steady. I don’t see this happening and expect a market decline even if the Ukraine war continues as a stalemate and global leaders figure out how to live with high commodity prices.

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.