Controlled Confusion Is The Financial Order Of The Day — What Fixed Income, Currency & Commodity Markets Are Telling Us
Cross-currents in financial markets have created the most polemical market in modern memory. The bulls and bears have rarely been more starkly opposed, with as many major brokerages calling for a retest of the October lows as those proclaiming a new secular bull market. Fixed income, commodity and currency trends are just as hard to discern. For now the volatility risk premium points to a higher market over the next few days, but 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 stagflationary conditions. 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 tries retesting the 4200 level.
The Fed sounds confused as well as it touts higher rates for longer while simultaneously proclaiming the virtues of current disinflation. The reason for their united voice of caution is that inflation is likely to be bumpy because lower wage workers are spending increasingly on services and services inflation is elevated according to the data. What the bulls are keying off of is goods disinflation, which they argue is permanent, supplemented by moderation in basic commodities like energy, foods and metals. The former is debatable as the China reopening likely translates into more demand faster than more supply, since the spread of the virus keeps people at home instead of working. Worse than Xi Jinping’s abrupt and ill-planned COVID flip-flop is his increasing talk of China returning to her anti-Western marxist roots. Just as wealthy Chinese are increasingly looking to get out of the country so too middle-class and working-poor Chinese will likely seek an escape but in their case it will be materialism and more spending, especially while capitalism is still pulsing in communist-run China.
Notwithstanding the confusion on where China is headed and what the Fed will do, the bulls will likely take the S&P back to a retest of 4200 since the $US isn’t rallying strongly, bond yields are up but have stabilized, and commodities are moderating. The equity and bond volatility indices are both low and that augurs well for business confidence too. But fossil fuels are in the process of bottoming and that would have huge implications for the persistence of disinflation. If oil and gasoline continue rising then disinflation becomes bumpier rather than smooth. Foods and softs are generally well-behaved with some flamboyant exceptions like lumber and orange juice, which are offset by declines in key items like poultry and pork. Both precious and industrial metals have moderated and point more to downside risk than upside. Expect this bear market rally to play out a little longer but an upsurge in volatility as the month progresses.
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.