What Financial Markets Are Telling Us: Political Divergences Are Mirrored in Financial Markets, And This Usually Resolves in Bear Markets

Political leaders are desperately trying to coordinate on issues ranging from the War in Ukraine to the Iran nuclear deal but little is getting done to relieve the suffering, and this bodes ill for global confidence. Equity markets are valiantly trying to maintain the uptrend began in March 2020 but I see this effort petering out over the next few weeks. 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), but my technical reading of key stocks in the S&P 500 is neutral. 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. But there were also several negative factors across global asset classes. Gold is signalling inflation fears. Oil is pointing to stagflationary conditions. Consequently I expect the S&P 500 to fall over the next few days.

The holy grail of international economic policy is policy coordination, where nations coordinate their fiscal and monetary policies to achieve the shared goals of low-inflation economic growth. No country has to do much when all are pulling their weight, and this helps limit budget deficits and overshooting by central banks. This in turn builds confidence and reflects in higher equity valuations, which in turn spurs entrepreneurial ventures and capital spending and the wealth effect, leading to a balanced economy. Lost in all of this is the ecological effect, which is understandable as the world has yet to form any consensus on what to do about ecological immorality and existential threats from climate change and possibly oceanic change, let alone how to coordinate any actions.

Through the 2010s there were many instance of implicit policy coordination, and the holy grail was found temporarily during the pandemic. Equity markets surged once policy coordination and the brilliance of American and European pharma companies made clear the world would recover. Now we are reaping the consequences of those good intentions as the Fed pushes ahead with QT while China does the opposite, Europe dithers and the world awaits food inflation and shortages that amount to a stagflationary shock not seen in modern memory. I see nothing ahead but lower equity valuations that reverse some of the gains during the pandemic.

But I’ve been predicting swift market reactions and instead equities are trending lower in a jagged and ultimately gradual manner. Derivatives markets reflect the divergent viewpoints, with equity measures like the VVIX squarely bulliish, the SKEW flirting with bearishness and the VIX trading reasonably relative to actual volatility. It’s the bond and currency markets that show worrying volatility or the manufactured lack of volatility, with the MOVE index projecting persistent inflation while badly managed nations like Argentina, Turkey and Pakistan manage their currencies in a delusional attempt to stave off capital flight and higher inflation. Commodity markets reflect the true bearish conditions of the global economy, with gold rising along with productive commodities in the face of rising US interest rates and a moderately stronger $US. I see the stagflationary impact of rising commodities seeping into the equity markets and pulling the S&P 500 back to its February 24 lows and eventually much lower.

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.