Perennially Boring Income Investors Are Getting Unruly And Causing A Minor Lehman Moment For The Global Economy — What Fixed Income, Currency, Commodity And Equity Markets Are Telling Us
The Bank of England’s move to stabilize markets was an awkward move to head off a Lehman moment in the UK, which easily ramifies to the global economy due to both Britain’s political-cultural place in the world and the City of London’s foundational role in financial markets. Even if a major Lehman moment never occurs in fixed income or derivatives markets the psychological damage has been done, notwithstanding yesterday’s short squeeze in equities. The close in the S&P 500 was poor and individual names like Apple had unequivocally awful days. Consequently the volatility risk premium failed to give a buy signal and 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 bearish. Yesterday's cross-asset action brought several positive factors for US stocks. The US yield curve is falling and in the current context that is bullish. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. I expect bonds to reverse course and consequently expect the S&P 500 to fall over the next few days.
Volatility is hurting both investors and the real economy, while disinflation has yet to broaden out and accelerate, which means the Fed isn’t going to let up until we come to the brink of a Lehman moment. Barring such a financial breakdown, high interest rates will persist well into 2023 and that means lower lows for equities. The key question now is not how low do we go but far into 2023 do we have to wait for a new bull market.
Bond market volatility has exploded again, meaning higher rates are still ahead of us across the maturity spectrum. The rally yesterday was in reaction to fears of financial instability in London, making for a lose-lose situation where either rates fall and equities fall because of a Lehman moment or bond market investors get disorderly and rates rise and equities fall in consequence.
With bonds getting disorderly it’s natural that equity volatility is high and certain to stay elevated if not go higher. Key is both uncertainty over 3rd quarter earnings but also the unpleasant disinflation that’s keeping the Fed downright antagonistic to the American labor market and increasingly the S&P 500. Not only are wages tight but commodity prices are differentiated, with fossil fuels declining but foods rallying or making short-term bottoms. So the “core” rate of inflation isn’t falling fast enough while the minor headline inflation declines we’ve seen of late sadly portend decelerating selling prices and constrained corporate margins. And to the extent declining inflation depends on declining home prices the consequences for consumer spending are dire and severely impact both margins and earnings.
The only particularly good financial news for the Fed is that industrial commodities are still falling while precious and industrial metals are either falling or trying to rebound from steep selloffs. I see the price of copper as a key indicator of sentiment and should the futures fall below 3.23 then October is certain to be as bad or worse than September for the S&P 500. As long as the $US rages ahead the outlook for nearly all financial markets is negative.
My current positions include a large cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and SPXU, all of which still nets out to a meaningful short position in equities.