As is normal volatility continues to rise and instruments are starting their Autumn move, lead by the US$ but now bringing in many key levels across instruments.
The Swiss team set out their deflationary case in their report below.
Its a very familiar, one might say classic, corrective bounces aside, model of lower inflation, lower risk asset prices from commodities to equities with bonds and the US$ rising.
Near term all sorts of technical indicators have been flashing at red for sometime. Likely weakness has been very well flagged to participants for much of 2014. We have always lacked classic price signals to support leveraged short entries but this is close to confirming and has confirmed on some sectors and indexes so the moment for a decent correction does now appear very close.
Should we critique these technical signals as being inadequate? In my view its more a question of instrument selection. To have been short this market purely on sentiment surveys and weak internals and breadth would have been wrong. For aggressive traders occasional leveraged futures attacks are fine but without a swift reversal 2014 would thus far have been a very poor year for those traders involved in this approach. A far better approach was occasional put options on weak indexes. Puts expiring worthless are much less costly than it getting directionally wrong with futures!
If you are uncomfortable with this “classic” risk off model Fitzpatrick offers us a different model of higher rates alongside an improving US economy lead by an uptick in consumption and Capex (from prior reports). Its a deflationary world with weakness in commodity prices, short term rates rising and real rates rising even more rapidly as deflation increases. Corrective sell offs aside Fitzpatrick now presents us a Goldilocks US scenario which suggests long US equities fully funded by $s. The world back drop may be weak but the US is set to boom, according to Fitzpatrick. If he is correct then US equities as a share of world asset prices is set to soar as their US$ trade weighted value will rise alongside a continuation of their bull US$ price charts. The long awaited capital recycle out of bonds and into equities may yet occur in this scenario.
Here Fitzpatrick’s two most recent reports:
For Fitzpatrick to be proved right on his model the US consumer needs to increase his spending once again.
There are a few shreds of evidence for this but its not strong as yet.
US consumer’s major assets are houses. If US house prices can rise more rapidly.
Here WF on that subject:
JP sits at present between the two camps regarding US equities, at least. They recognize that price is shifting into a more volatile period but they doubt getting short this market yet and are still leaning to higher highs on the medium term.
And here the 2014 AG bear camp. Early bears on risk but events starting to turn their way.
(Worth mentioning that market sentiment via the put call average is not extremes here). If we have had a multi year bull market top for risk its the first time in a while that’s occurred at such a damp sentiment level. Make of this what you will.
Here finally, for now, GS.
For my own perspective I don’t expect this bull market to roll over immediately but the correction writing is on the wall. A mid to late October time frame appears more reasonable to me. I think the surprise wildcard on all the above is the US$ which has become a very very crowded trade. If the US economy significantly stuttered here due to weakening world growth or the stronger US$ etc then the reversal would be immense and the weak technical picture in risk would lead a spike in volatility, as she is set up for this, to the downside. The safe heavens of bonds & gold would saw as the rate rises get pushed back. That is the non consensus trade at present, if historic volatility allows worth playing for with out of money options to hedge the consensus allocation. For my own book i’v reduced the commodity exposure back to a very low level having stepped it up earlier in the summer playing for an end cycle commodity bull run. It didn’t play out. There was a profit on the allocation but much of this wiped out in the last few weeks as the crb has broken down. Ive significantly reduced on the pm allocation. Rightly or wrongly we have US$ resurgent here alongside deflation and an apparently improving economy and the Fed jaw boning higher rates. The scenario can kill the paper pms, at least in the short run until these various bluffs are called. I’m purely concerned to monetize events here. I am not a gold bug ahead of my economic interest. My long term physical allocation to bullion remains untouched and on great weakness i may indeed to this physical store.I have held SLY (US small cap600 etf short) for the last few months and its currently 4% in profit countering a QQQ short which is around -7% in profit at present. I’ve taken many longs off the table where they are cyclical and at higher ratio levels. Im still holding quite a few yielding defensives inc high quality low debt commercial reits. If Fitzpatrick is correct reits will not be the place to be in the coming years but i lean myself towards the Swiss and AG view that risk off will likely lead to lower rates high bond prices in spite of the ending of QE to infinity. Finally, I’m watching the nikkei225 with great interest. She has scored a higher high and the jpy is in free fall. The Japanese monetary experiment continues to be fascinating.
Over and out for now. I’m still catching up after my summer floating around. Ill update on FX in the next few days.
Good to be back on dry land.
All the best
Rich