Rising Volatility Bodes Ill For Business Confidence And Future Earnings — What Fixed Income, Currency & Commodity Markets Are Telling Us
Exuberance over AI is once again powering markets as select sectors bounce back from the malaise of 2022 while others warn that the profit recession is just beginning. Prudence dictates that one follow the more sober prediction and the recent rise in expected volatility mirrors that sentiment. The VIX is higher even as actual volatility remains normal, leading the volatility risk premium to point to a higher market over the next few days while my technical reading of key stocks in the S&P 500 is neutral. Yesterday's cross-asset action brought one positive factor for US stocks. The US yield curve is falling and in the current context that is bullish. But there were also several negative factors across global asset classes. Oil is pointing to declining global GDP expectations. The action in currencies signifies $US strength. Inflation expectations are rising based on measures of Treasuries and TIPS. Expect the S&P 500 to be range-bound over the next few days as it once again tries to scale 4200 and fails.
Bullish investors continue to trumpet snippets of good news but equity prices have been declining of late because the macro environment is getting riskier as liquidity starts reversing course from late 2022. High equity prices can only be justified by belief in profound disinflation that brings the US rate to 2% by 2024. But this can only happen with no adverse impact on profit margins if wages and other input costs decline proportionately. Asset classes besides equities aren’t painting this rosy picture.
Commodity prices are diverging and thus neutral for inflation, as fossil fuels are rolling over, metals consolidating with downside risk, but foods and softs are generally well-behaved but with upside risk. This doesn’t help the disinflation case much, and the Fed needs to see disinflation now since services prices are sticky and low unemployment logically predicts sticky wages. The $US is similarly neutral, with several EM currencies rallying and the majors approaching oversold territory. A weaker $ and solid commodity prices means the Fed will keep interest rates higher for longer, which can only hurt asset prices. Equity volatility is starting to ratchet higher as is bond volatility, reflecting this high-risk macro environment.
Yesterday I exited the remaining portion of my short position in the markets via the inverse levered ETF SPXU. Consequently my current positions include a large cash position, 3M (MMM), Pfizer (PFE) and a significant short-term bullish position in UPRO.