What Financial Markets Are Telling Us: The Bulls Are Defying Economic Logic And Geopolitical Reality, And This Fragility Cannot Last

Divergences within financial markets are making for an uncomfortable and unforgiving investing environment and mirror the divergence in worldview between Eurasia and the West, with both pointing to future calamity. Yet 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 bearish. There are several negative factors across global asset classes. The action in currencies signifies $US strength. Inflation expectations are rising based on measures of Treasuries and TIPS. Expect the S&P 500 to fall over the next few days as investors grow weary of seeing bullish skies in such a foggy world.

Equity derivatives are telling us the market bullishness is intact, as the volatility of volatility (VVIX) index remains in the bullish camp and the index of tail risk volatility (SKEW) remains just below bearish territory. Taken together these imply that investors are loaded up on protection for their bullish bets, and unwilling to switch to the bearish camp. The VIX itself is moderately above actual volatility, signaling a normal state of affairs despite the complete abnormality of the times.

This divergence between a range-bound equity market and stomach-churning volatility in geopolitics and economic trends is reason enough to be bullish. But the divergence between equities and fixed income implies the opposite. The relentless rise in interest rates across the yield curve signals not only worries about inflation but money flowing out of bonds and into equities as a safe haven. This turns economic logic on its head, as even the most well known names in equities are subject to dramatic changes that rival the peripateia of Greek tragedies. Equities are never a safe haven because analysts can never know enough about a firm to predict what will happen to it over any sustained period of time. The broader investing public is much less knowledgable than analysts, making equity investing the art of risk management rather than the art of parking cash.

And the action in currencies loudly supports the bearish view. The $US strength against currency majors is almost mirrored in its strength against EM and other minor currencies. Many EM nations have grave foreign currency debt obligations, and still more face huge terms of trade problems as energy and commodity prices stay elevated. This points to declining global growth, which American firms can’t evade given their global supply chains and export earnings. The economic backdrop is bearish and mirrors the geopolitical reality, but equities are close to all-time highs because of speculative money flows that can turn on a dime. Consequently I continue to expect lower lows through this month and into the Spring.

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.