The Bulls Are Opening New Vistas Of Optimism As China Reopens Its Economy — What Fixed Income, Currency & Commodity Markets Are Telling Us
The earlier global cross-currents of Asian growth and Western deterioration have flattened as investors now see the entire world robustly growing as a result of China’s reopening, the warmer than expected winter and the redoubtable American consumer. Equity bulls are discarding the potential for higher for longer interest rates crushing both earnings and valuations, and completely oblivious to the cultural and political changes wrought since the pandemic which threaten to erode the work ethic and productivity. It’s only a matter of time before these negative factors overwhelm irrational exuberance, but for now the volatility risk premium points to a higher market over the next few days while my technical reading of key stocks in the S&P 500 is neutral. There are several negative factors across global asset classes. The action in currencies signifies $US strength. 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 heading lower as February draws to a close.
Equity derivatives are firmly bullish while the MOVE index of bond market volatility is modestly bullish since it hasn’t risen in lockstep with the large moves in the yield markets. While bond prices may soon bottom out and remain above late 2022 levels I still see yields eventually retesting last year’s highs as both Fed policy and economic reality point to higher for longer interest rates due to persistent inflation and robust nominal GDP growth.
The labor market is the chief culprit in keeping inflation high, since commodity prices have been well-behaved ever since the $US hit a bottom earlier in the year. Fossil fuels are range-bound but with downside risk, likely reflecting the warm winter. This may reverse however if China’s reopening galvanizes other Asian markets and Russian supplies trail off, leading to deficits in various products. Industrial metals have been falling with further downside possible while precious metals are in profound downtrends after peaking earlier in the year. Real interest rates and a strong $US are pushing against the reopening story to pull metals lower. Foods, meats and softs are generally in trading ranges but with considerable upside risk as global nominal GDP looks robust due to the reopening. Disinflation is simply too slow from all sides and may even halt in the goods market, leading to persistently high interest rates and a declining asset values across the board.
My current positions include a significant cash position, 3M (MMM), Pfizer (PFE) and the inverse levered ETF SPXU, which nets out to a significant short position.