Clashing Markets Foretell Future Downside — What Fixed Income, Currency & Commodity Markets Are Telling Us

Yesterday’s hawkish Fed hike and softly-hawkish press conference nailed the equity market while boosting the bond market, setting up a clash of views that needs resolution soon. Lower interest rates help long duration assets but low growth hurts nearly everything else, so I expect the mega-cap stocks driving the S&P 500 to crater soon. For now, however, the volatility risk premium 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 neutral. 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. But there were also several negative factors across global asset classes. Gold is trading as a risk-off asset. Oil is pointing to declining global GDP expectations. Expect the S&P 500 to rise modestly over the next few days to test resistance at 4200.

The clash between fixed income and equity markets plays out viscerally in the divergence of volatility between these two asset classes. Bond volatility is again elevated, while equity volatility in the cash market (i.e., S&P 500) is low but in the options market (VIX) relatively high. Options traders skew to the bearish side while equity investors have pushed the index to the upper segment of the trading range. Compounding this confusion is the poor performance of the Russell 2000 but the relatively benign performance of high yield credit spreads. The markets are essentially resurrecting the Nifty 50 trade of the 1973-74 bear market, believing both in recession for the masses and resilience for the mighty.

But elevated bond market volatility suggests that yields will rise and valuations fall sooner rather than later, as the Fed pushes hard against inflation despite creating tumult in the regional banking system. The effects of central bank tightening across the West combined with a less-than-stellar reopening in China and fears of leftist overreach by Xi Jinping is pushing commodity prices down as global growth optimism fades. Precious metals are maintaining strong uptrends but industrials are generally falling, suggesting a profound risk-off mood. Fossil fuels and related energy commodities are falling into new lows and most foods and softs are following them. As equities make a final stand to test resistance expect valuations to subsequently follow commodities down to new lows.

My current positions include a very large cash position, 3M (MMM), Pfizer (PFE), the levered ETF UPRO and inverse levered ETF SPXU, all of which net out to a modestly long position in large-cap equities.