Tuesday, April 15, 2014

A Simple Plan

A simple question deserves a simple answer. 

Are 10-year yields headed higher or lower through the balance of this year?
  • If you believe long-term interest rates are headed higher, sell precious metals and the broader commodity complex and buy the dip in equities - especially the banks.
  • If you believe long-term interest rates are headed lower, sell the banks and the SPX and buy the dip in commodities - especially precious metals.
Our chorused refrain throughout 2014 has been that 10-year yields became stretched to a relative extreme last year - despite their low disposition - and were poised to retrace. 

As the precious metals sector takes it on the chin on yet another tax day, we urge participants to appraise the bigger picture. While the equity markets should bounce over the short term, we expect they will once again roll-over with long-term interest rates. 

Click to enlarge images

Friday, April 11, 2014

Yield to Yields

10-year yields slid into their skipped-stone support from the breakout range they have meandered in since last summer. They then broke through mid-morning, accelerating the downside reversal in the equity markets and a strengthening bid beneath the yen. 

Clearly depicted in the chart below, the strong inverse relationship between these two risk proxies have tightened considerably as our own domestic equity fronts have collided with several different pressure systems. Namely, the trap door we have expected would open in Japan - and participants beginning to come to terms with the end of QE. As the markets flounder further and volatility creeps higher, we suspect that the discussion surrounding QE and its impact to the market will only grow louder and more confusing.  
What we do know is that while correlations may be strengthening in some corners of the market, the indiscriminate tightness we witnessed across assets in 2011 as the Fed last attempted to step away, or 2008 as the Fed rushed to the accident scene - are not present. It really has become a market-picker's market in 2014. 

A snapshot of this weeks performance through Thursday's close tells the story. 

                  SPX  -1.75%                                       US Dollar Index -1.35%
                  IBEX -3.19%                                      Euro +1.33%
                  Japan   -4.49%                                   Yen +1.72%
                  EEM +1.28%                                      Australian Dollar +1.34   
                  CRB +1.78%                                     Gold +1.21%
                  FXI +2.98% (SSEC + 4.43%) 

As the banks (already down ~ 4.0% for the week) get hit once again this morning on the back of considerably weaker then expected quarterly profits from JP Morgan, the downside catalyst will only reinforce the trend and negative divergence that long-term yields had pointed towards in the financial sector over the past few weeks.

An inverse to last years sentiment and structure, participants need to yield their considerably misgiven perspectives to yields. Those that have followed our work over the past four months (see Here) will know that this has been a major theme and imbalance that we have positioned off of.  

Closing out an important and powerful week, we updated several different ongoing series.  

Wednesday, April 9, 2014

a Dead Cat Bounce

The SPX fell into a bounce zone in yesterday morning's session and found support around last month's lows. This begs the question for both traders attempting to paint the edges or investors looking to hedge their portfolios - will it hold, how strong of a bounce to expect and for how long? Taking into account our comparative sensibilities, a follow-up query might provide greater perspective. If the equity markets have indeed exhausted, what kind of top was it? Short-term, intermediate, long-term - cyclical, secular? 

For those that have followed our logic in recent weeks these are rhetorical questions. However, it should be understood that our assumption of a top with just a few weeks (much less with the SPX) of daylight between those highs, is that it is a market posture and not an ideology. Keep in mind that in our experience the bear wool goes on much easier than comes off. Considering the SPX's relative strength and proximity to its high water mark, versus its more volatile and higher beta cousins, Mr. Russell and Ms. Nasdaq - we should know soon if it's just whimsical fashion or trend setting. 

Our suspicions, based on our peripheral studies is that it was an intermediate to long-term top and of the cyclical variety. And while the nomenclature likely just muddles the water with regards to future expectations, the takeaway for us is that we would handicap a higher probability that the SPX revalues expectations swifter - then churns indefinitely, rather than a slow motion and eroding correction that rewards perennial bearish leanings (i.e 2000 & 2007). 

These expectations are based on a variety of factors, but in general fall at the foot of the broader interest rate cycle and monetary policy. If past is prologue - both recent and historical, the SPX takes an expedited path lower as the Fed steps away, rather than the long and winding road characteristic of its two previous long-term tops. Look no further than the end of QE1 and QE2 for examples of this market dynamic that some might call obvious to the point of spurious. All cynicism aside, we view causation between the market and the Fed as blurred, thick and gray between structural - psychological and back again. Hindsight 20/20, the 1940's are our closest parallel. A time when the Fed was active, obvious and some might say rather magnanimous to the markets. And while a price was certainly paid when they stepped away, by comparison to its then more contemporary anxieties of the Great Depression - a discounted expense.  

Circling back to the initial question - we do think the equity markets will firm over the next several sessions, but expect it will be shallow and brief. In essence - a dead cat bounce. Bonds and the yen look poised to break higher and the Nikkei looks ready to shoot the retracement hole below 14,000.