Like The Bulls I’m Shocked, Shocked At The Dysfunction All Around Me: The Action For October 4, 2023
The Times details the chaos of the GOP in its front page leader but makes little connection with the dysfynction in bond markets caused by the very issue dominating the GOP debate, namely soaring budget deficits. Far from the Casablanca moment of putting aside personal interest for the sake of a greater morality the markets and the Congress are in the earlier movie moment of absurd moralizing over a political situation long tolerated until suddenly found intolerable. The upshot is that interest rates go up even more as we come to the end of the rout plaguing nearly all markets but the Dollar and a handful of commodities. The S&P 500 likely falls over the near term, but I expect a violent reversal soon as we hit 4100, and a major rally as earnings season gets underway later this month.
The bears have control for the moment as a passel of indicators reveal pessimism on corporate earnings and the macro environment. These include:
Inflation Expectations: Investors expect rising inflation over the coming years, implying higher interest rates to come, potentially bearish for equities.
MOVE Index Of Bond Volatility: Fixed income volatility is rising and implies higher inflation expectations and higher interest rates to come, potentially bearish for equities and the global economy.
Short-Term Treasury Rates: Short rates are rising, a portent of higher inflation and/or Fed rate hikes, potentially bearish for equities.
Long-Term Treasury Rates: Long rates are rising and that will reduce the attraction of equities while cooling the housing and auto industries to the detriment of economic growth.
High Yield Credit Spreads: The cost of borrowing is rising for lower-rated firms compared to their AAA siblings, a portent of potential defaults to come.
Emerging Market FOREX / $US: Nations like India, South Korea, the Philippines and Mexico are getting weaker against the dollar, and that’s bad for global growth since many key imports are priced in $.
Tin Prices: Tin is broadly used across goods and industry and falling prices typically signal worsening growth prospects.
S&P 500 Technicals: The top 40 in the S&P 500 look set to move the market lower.
Russell 2000 Technicals: Small stocks are breaking down and reflect declining confidence in economic growth.
Gold Prices: Falling gold prices reflect higher potential interest rates, which is on net bad for equities.
Copper Prices: Copper makes the energy transition happen but is also a barometer of global growth, and falling prices signal growth may be worse than expected.
Practically nothing is working in the market’s favor at the moment, which is typically a sign that the bottom is in sight. Based on the action yesterday and overnight the two bullish factors that will eventually gird the bulls are:
Volatility Risk Premium: The VRP signals significant upside in the near term as the rate of change in the VIX remains subdued relative to actual volatility.
Aluminum Prices: Aluminium is a critical input for consumer and industrial goods and rising prices signal better than expected global demand, which is usually good for equities.
My current positions reflect my intermediate-term bullish forecast, and include 3M (MMM), Pfizer (PFE), and a large position in UPRO that is largely hedged by an offsetting position in SPXU, which nets out to a long position in equities.