Stocks continued the big bounce today into technical support.
Let’s take an updated look at the S&P 500 chart …
So, we had a 5.5% decline in this benchmark index to start the year, and now we have a sharp bounce of nearly 3% from this big technical trendline, which comes in from the election day lows of November 2020 (an important marker).
We heard from Jay Powell today, in his renomination hearings before the Senate. He did nothing to change the expectations on the Fed’s guidance on the rate path. Whether it be three or four hikes this year, we’ve just finished a year with around 10% nominal growth and over 5% inflation.
The coming year may be more of the same, and yet we have a market and Fed posturing and speculating over how close to 1% the Fed Funds rate might be by year end. That dynamic only adds fuel to the inflation and growth fire.
On that note, we’ve been watching three key spots that should be on the move with this policy outlook: bonds (down), gold (up) and the dollar (down).
Gold was up 1.25% today, making another run at this 1830-50 level. If that level gives way, the move in gold should accelerate. As you can see in the chart, we would get a breakout from this big corrective trend that comes down from the August 2020 all-time highs.
On a related note (dollar down, commodities up), the dollar looks vulnerable to a breakdown technically …
Yesterday we talked about the repricing of the tech giants as the catalyst for the slide in global stocks. That slide continued today.
But the brunt of the punishment is back on the Dow, which was down another 2%. At the lows today, that takes us back to flat on the year for the DJIA … up 1% for the S&P 500. And the Nasdaq, at the lows today, was up just 4.8% on the year.
As they say, stocks go up in an escalator and down in an elevator.
Interestingly, in this slippery slide for stocks, money has NOT been piling into bonds. This is the flight to safety trade we’ve seen throughout the post-financial crisis era. It doesn’t seem to be happening this time. The 10-year yield remains in sniffing distance of 3.25% (closing today at 3.14%).
So, where is the money going? Gold.
Gold is on the move — the top performer in global markets today. And it looks like it’s just getting started. As I said last week, “the set up for a bounce in gold here looks ripe. The level to watch will be 1,214.”
You can see in the chart, the 1214 level gave way today, and we had a break of the downtrend of the past six months.
Now, when we discussed gold last week, we were talking about the potential for China to perhaps try a few shenanigans over the next month, in order to influence the outcome of the November elections.
Here’s an excerpt from that October 3rd note: “China remains the holdout on making a deal with Trump on trade. And it looks likely that they are holding out to see what the Novemberelections look like.
Will Trump retain a Republican led Congress? I suspect we may see China do what it can to influence that outcome. As we know, the Republicans will be promoting the economy as we get closer to voting day.
What can China do to rock that boat?
They can sell Treasuries, in an attempt to ignite a sharper climb in rates. And a fast move in rates (at these levels) has a way of shaking confidence in equity markets–which has a way of shaking confidence in the economy.“
I suspect we may be seeing precisely this above scenario play out.
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Yesterday Trump made good on his promise by announcing another $200 billion in tariffs on China.
To the surprise of many, stocks went up. Why?
Perhaps it’s because reforming the way the world deals with China is a good thing. Remember, China’s currency manipulation over the past two decades led to the credit bubble, which ultimately led to the financial crisis. And as long as the rest of the world continues to allow China to maintain a trade advantage (dictated by their currency manipulation): 1) they will manufacture hot economic growth through exports, 2) the global cycle of booms and bust will continue, and 3) the wealth transfer from the rest of the world to China will continue.
With this in mind, as I’ve said, the trade dispute is all about China – everything else Trump has taken on (Canada, Mexico, Europe) has been to gain leverage on getting movement in China.
With Trump now making it very clear that he won’t back down until major structural change takes place in China, it’s no surprise that one of the biggest winners of the day (following the further economic sanctions on China) was Japan!
The Nikkei was up big today. And it was Japanese stocks that set the tone for global markets on the day. As a signal that China’s days of cornering the world’s export markets may be coming to an end, Japan is in position to be a big winner.
Remember, while much of the world has returned to new record highs following the global financial crisis, Japan remains 40% away from the record highs set nearly 30 years ago.
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Those that look for reasons to pick apart the bull case for the economy and markets were disappointed by the ECB this morning.
As we discussed earlier in the week, the improvements in the U.S. economy and the trajectory of U.S. rates has cleared the path for Europe to finally exit QE. And the ECB confirmed this morning that they remain on that path — to end QE into the year end.
The idea that Europe can exit QE is a huge positive for both the European economy and the global economy – a confidence signal.
With that, German stocks are a big buy here. As you can see in the chart below, while the S&P 500 is on record highs, the DAX has been well underwater on the year (down more than 6%).
The index also trades well under the 200 day moving average (the purple line). To close the performance gap in this chart, German stocks could be in the early stages of a 13%-15% run.
And stocks in Europe should be supported by a strengthening euro.
Remember, as the global economy improves, the dollar should get weaker. The growth and rate gap (between the U.S. and the rest of the world) will be narrowing from here, which will promote foreign capital to flow into currencies like the euro. But most importantly, the exit of QE means Europe has escaped the dangerous crisis era, which means money will flow “back home“ out of/from the world’s safe-haven asset (dollar-denominated U.S. Treasury market).
I suspect the euro will trade closer to 1.30 by this time next year, as the ECB will begin raising rates in 2019, and likely follow the U.S. lead on fiscal stimulus to drive growth.
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The momentum is building for a big run for markets and the economy into the year end. And there are a ton of opportunities.
We have the Dow, which has massively lagged performance of the Nasdaq throughout this post-correction recovery. And even as the S&P 500 has regained new record highs, the Dow remained about 900 points from the January highs. That gap is quickly closing. This makes blue-chip stocks a buy.
Commodities are in the early stages of a bull market, but have been stalled by trade uncertainty and a stronger dollar. Both have now cleared. Trump is winning on trade. And he now appears to have successfully influenced a turning point in the dollar. Both are fuel for commodities prices that have every fundamental reason to be soaring (including a hot economy and a big infrastructure spend coming). This makes commodities stocks a buy.
On the interest rate front, as we discussed Friday, the Fed Chair’s recent comments indicate that the current level of rates could be appropriate, given they don’t see risk of inflation accelerating over their target nor do they see an elevated risk that the economy may overheat. That has turned the tide in the dollar (lower). And it may actually be the catalyst to steepen the yield curve, as the interest rate market starts pricing OUT the risk of overtightening on the economy. Remember, the skittish crowd has been pointing to the flattening yield curve as an indicator that recession is brewing for the economy. A steepening yield curve would take that debate off the table, and would be very good for financial stocks.
And the calming on trade and rates make emerging market stocks very interesting. Remember, when the news hit that China would make concessions on trade, we looked at this chart in Chinese stocks and said the bottom is probably in. Chinese stocks are up 5% already, and have a lot of room to run.
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We’ve talked this week about the pressure that rising U.S. market interest rates are putting on emerging markets.
The fear surrounding the big 3% marker for U.S. 10-year yields is that 3% may quickly become 4%. And a 4% yield, much less a quick adjustment in this key benchmark interest rate, would cause some problems.
Not only does it create capital flight out of areas of the world where rates are low, and monetary policy is heading the opposite direction of the Fed, but a quick move to a 4% yield on the 10-year would certainly cloud the U.S. economic growth picture, as higher mortgage and consumer borrowing rates would start chipping away at economic activity.
With that said, we may have a reprieve with the action today in the bond market.
As we head into the weekend, today we get a softening in the rates market. And that came with a big technical reversal pattern (an outside day).
You can see in the chart above, the engulfing range of the day. This technical phenomenon, when closing near the lows, is a very good predictor of tops and bottoms in markets, especially with long sustained trends.
I suspect we may have seen some global central bank buyers of our Treasurys today (which puts downward pressure on yields) to take a bite out of the momentum. We will see if this quiets the rate market next week, for a drift back down to 3%. That would calm some of the nerves in global currencies, and global markets in general.
We talked yesterday about the building pressure in emerging markets, driven by weakening currencies and rising dollar-denominated oil prices.
With that bubbling up as a potential shock risk, gold hasn’t exactly been telling the story of elevated risks.
You can see in this chart above, since the tax cuts were passed in late 2017, rates have been rising (the purple line). This is a hotter economy, pick-up in inflation story. And, as it should, gold stepped higher with rates all along–until the last few weeks. You can see the divergence in the chart above.
I suspect we’ll see gold snap back to reflect some increasing market risks, and especially to reflect a world where central banks are beginning to finally see inflation pressures build. The gold bugs loved gold when inflation was dead. And now that it’s building, they are surprisingly very quiet.
A few weeks ago, the markets were skittish about elevated oil prices and 3% yields. Now we have oil above $70 and yields comfortably hanging around 3%, yet stocks appear to be in a solid post-correction recovery, now up 8% from the February lows.
Meanwhile the VIX has fallen back to pre-correction levels.
What about gold, another proxy on risk? Gold has been quiet, despite the correction in stocks. But that has a lot to do with bitcoin. Bitcoin has become the gold substitute.
Let’s take a look at the behavior of bitcoin, and the bitcoin/gold relationship.
You can see here, when the bitcoin frenzy was running hot late last year, gold was moving lower, as bitcoin was climbing to record highs.
The bitcoin mania peaked almost to the day they launched bitcoin futures, which allowed hedge funds to begin shorting it. And since, we’ve had this chart …
Bottom line: If we look at the rise in bitcoin as the proxy on risk-aversion (as a gold substitute), then this downtrend of the past five months supports the VIX chart and the stock market recovery. That said, given the mass speculation in bitcoin, if we were to get a sharp collapse, it would likely trigger risk aversion in global markets.
On Friday, stocks bottomed into two big technical levels: 1) the two-year rising trendline that represented the recovery from the lows of 2016, which were induced by the oil price crash, and 2) the 200-day moving average.
We’ve since seen a 5.5% bounce off of the bottom.
Interestingly, the market that has had so many people concerned over the past two weeks–interest rates–were tame and lower on the day. But only after printing a new high (at 2.90%, which is the highest since January of 2014).
That climb in rates, of course, has had everyone uptight about the inflation outlook. But the market you would expect to reflect inflation fears hasn’t been telling the inflation story at all. I’m talking about the price of gold. And gold has been lower, not higher, since stocks have fallen.
Here’s a look at that chart …
With this in mind, the psychology always changes when stocks go down. People search for stories to fit the price–for trouble to fit the price. Even some of the more rational market practitioners were succumbing to this over the weekend, trying to conjure up a negative scenario unfolding for markets.
Having been involved in markets for 20 years, I’ve seen, within both short- and long-term cycles, thousands of turning points, trend changes, phases of a cycles, trends and corrections of trends. Markets can and do have technical corrections. And they can and do correct for no reason, other than price.
So, for perspective, things are good. We will have the hottest economy this year that we’ve seen in a decade. The benchmark 10-year yield, at 2.90%, remains very low relative to history. That means, although borrowing costs are ticking higher, money is still cheap. Gas is cheap. Consumer and corporate balance sheets are as good as they’ve been in a long time. And we’ve just gotten a blue light special on stocks–marking down prices from 18 times to something closer to 16 times earnings. And with the prospects for earnings to come in better than expected, given influence of tax cuts, we are probably looking at a P/E on the S&P 500 forward earnings closer to 15.
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Stocks have now opened the year up 4%. Global interest rates are on the move, with the U.S. 2-year Treasury trading above 2% for the first time since 2008. Oil is trading in the mid $60s. And base metals are trading toward the highest levels of the young, two-year bull market in commodities.
This all looks like a market that’s beginning to confirm a real, sustainable economic recovery – anticipating much better growth than what we’ve experienced over the past decade.
If that’s the case, we should expect a big adjustment coming in inflation readings. And with that, we should expect a big adjustment coming for global interest rates. We’ll likely have a 10-year yield with a “3” in front of it before long. And that will have a meaningful impact on key consumer borrowing rates (especially mortgages).
On the inflation note, we’ve talked this week about the impact of higher oil prices on inflation and the impact it may have on the path of central bank policies (most importantly, the speed at which QE may be coming to an end in Europe and Japan).
You can see in this chart, the very tight relationship of oil prices and inflation expectations.
Now remember, one of the best research-driven commodities investors (Leigh Goehring) thinks we may see triple-digit oil prices — this year! This has been a very contrarian viewpoint, but beginning to look more and more likely. He predicted a surge in global oil demand (which has happened) and a drawdown on supplies (which has been happening at “the fastest rate ever experienced”). He says, with the OPEC production cuts (from November 2016), we’re “traveling down the same road” as 2006, which drove oil prices to $147 barrel by 2008.
Bottom line, this is an inflationary tale. If we had to search for a market that might be telling us this story (i.e. inflation is finally leaving the station), the first place people might look is the price of gold. What has gold been doing? It has been on a tear. Gold is up 8.3% over the past month.
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On a related note (dollar down, commodities up), the dollar looks vulnerable to a breakdown technically …
