What Financial Markets Are Telling Us: Waiting For The Global Order To Re-emerge Means Lower Equity Prices Now

The trends in Eurasia are decidedly negative yet the markets are hanging in a tight trading range, which I see breaking to the downside this month. 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 bull steepening. But there was also one negative factor across global asset classes. Inflation expectations are rising based on measures of Treasuries and TIPS. Expect the S&P 500 to be range-bound over the next few days.

The collapse of bond prices reflect an overly aggressive Fed that’s more concerned with its reputation than for prudence. Inflation is running hot but the TIPs market is telling us that in the long term disinflation will set in with a vengeance, pulling inflation to the 2-3% range. Disinflationary trends from globalization and the surplus of Chinese savings haven’t eroded, but the Fed is concerned the war in Ukraine combined with bipartistan protectionism will result in permanently higher prices, and this will eventually filter into wage inflation and set up a vicious cycle similar to the 1970s. Against this is the more likely scenario that China slows considerably due to its moronic zero-COVID policy, raising the savings rate there and leaving the Russian economy with no safety valve as the Communist Party struggles to put its own house in order rather than sacrificing for the ineptitude of its littler northern brother. The result would be a more conciliatory China, the fall of Putin and the restoration of the global order. With that comes the return of disinflation.

Equities are effectively pricing this positive scenario in as the S&P 500 is only 5% off its all-time highs, despite the rise in interest rates. Volatility measures are slightly higher as the markets zigzag, but the volatility of volatility is still low and only the index of fat tail risk is elevated (the SKEW). Expect markets to fall as we wait to see which scenario plays out in Eurasia and whether the Fed will start to walk back its hawkishness.

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.