What Financial Markets Are Telling Us: A Declining Yen For Japanese Assets Portends Falling Equities Everywhere

The breakdown in the Japanese yen is more than just a verdict on Japanese malaise but also a portent of a slumping Asia. Once crowned the world’s growth engine Asia is reeling from inflation and a stronger $US and consequently global investors are ratcheting down economic expectations for all regions. Earnings estimates for the leading US companies will have to follow suit, and that’s principally why the current consolidation in the S&P 500 marks the penultimate stage in a bear market rally. The volatility risk premium is pointing to a range-bound market over the next few days, while my technical reading of key stocks in the S&P 500 is short-term bullish. There are several negative factors across global asset classes. Oil is pointing to stagflationary conditions. The US yield curve is rising and in the current context that is bearish. Expect the S&P 500 to be range-bound over the next few days before a head fake to the upside and a subsequent move lower into mid-June.

Equity derivatives are remarkably positive despite the clearly negative intermediate-term tone to equity indices. This suggests maximum pessimism is still a ways off, and the current consolidation won’t provide ballast for a run back to the highs of January. Bond market volatility has simmered down but given the historic fall in bond prices since last Autumn what is needed is for volatility to drop precipitously. Instead the technicals suggest both short and long-term rates are headed back to the May highs, which portends falling equities as well.

Rates are moving higher for the simple reason that inflation is persistent, owing to the war in Ukraine. Commodity inflation has ceased but the pass-through to consumers likely hasn’t, so inflation readings will be elevated for some months more. Fossil fuels are steadying but not peaking, ags and meats have not peaked as a group while metals are non-trending. All these markets are subject to new bull runs should the war persist in Russia’s favor. The symmetry of inflation risk means the Fed won’t turn dovish until equities have fallen substantially, which I see occurring at S&P 3700 assuming no further geopolitical shocks flatten us in the meantime.

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.