What Financial Markets Are Telling Us: Heterodox Thinking Is Taking Markets Higher But Odds Are This Is Just A Summer Fantasy That Ends Abruptly
The orthodox approach to understanding the global economy has given way to ebullient optimism that the best-case scenario will triumph over traditional forecasting metrics like confidence, volatility and the stated intentions of the Fed. Equity bulls have run roughshod over the shorts on the bet that confidence will turn positive as volatility declines and the Fed will quietly pursue its hawkish policies with no adverse affects on the economy. This seems like typical fantasy optimism but for now 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 and intermediate-term bearish. Yesterday's cross-asset action brought several positive factors for US stocks. Copper's chart is signifying global growth. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. Expect the S&P 500 to rise over the next few days before taking a breather at mid-month.
Equity markets are now betting that a soft landing or no landing at all will occur in the US, despite the Fed’s stated intentions and the grave geopolitical risks to Europe and much of the developing world. Ignoring these risks is easy when there is a potential upside risk that cures all, namely an increase in the labor force participation rate. Equity bulls quietly crave this because it would help achieve the Fed’s goals while boosting profit margins and confidence that the consumer intends to stay strong despite low confidence about the future. But for the reasons I discussed last week, this hope has a marginal chance of reifying due to the cultural changes the pandemic and the social justice protests engendered over the past two years. More likely is the worst case scenario that business confidence begins declining as leaders recognize the volatility in financial markets isn’t coming down and that fantastic hopes usually crater.
Bond market volatility as measured by the MOVE index has yet to calm down, while equity volatility has reduced but is still well above average. And the action in currencies is not just volatile but too diverse to mark a turning point for the $US. Even if currencies moderate from here, the high value of the $US means the global economy is in for a tough landing, somewhere between hard and soft. I see firms from large to small reckoning on a soft landing and that makes equity valuations much too high given the geopolitical risks that could reify this autumn and completely throw the global economy into a hard recession.
Commodities are quietly betting on a soft landing like equities: fossil fuels are trying to rally, precious metals have broken out into strong uptrends while ags and soft commodities are trying to bottom out and meats are rallying. But this is problematic since a rally in commodities means inflation stays higher for longer, and that means the Fed stays on the job and pushes interest rates higher for longer. Don’t fight the fed is an old maxim the market is currently ignoring, and I see a return to traditional ways as summer draws to a close.
My current positions are a moderate but relatively large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), Titan Machinery (TITN) and the levered ETFs UPRO and SPXU.