Friday, February 9, 2018

Gravity & Greed

Besides death and taxes – whose ultimatums we continue to try and cheat - the only two things you can truly depend on showing up on a regular basis are gravity and greed. Over the past week, the two collided in the equity markets in rather spectacular fashion, with gravity taking the day.

Granted, it’s been a while since equity traders felt the strange sensation of gravity. So long has it been, that once pressures arose, there weren’t many on deck even capable of lifting a hand. Cue Mrs. Fletcher’s late 80’s desperate plea into the night, “I’ve fallen, and I can’t get up!” Unfortunately, the markets own LifeCall system also went down, as thousands of volatility shorts were crushed in the scramble, sending the VIX on its largest one-day spike ever.

For some of us, it’s only when gravity starts to take over that we begin to think critically about our bodies. Where did that gut even come from – and more importantly – what might it imply about our underlying health? For stocks, the usual suspects will point out a healthy US economy growing at a decent clip, with blue-chip American companies wielding strengthening market power – essentially, providing outsized earnings in a cheap capital and business friendly market environment. Throw in a healthy dose of global synchronized growth and the appetite to market and consume equities has been enormous.

Never mind that we’ve been feeding heavily from the trough for historically longer than nearly all previous equity cycles, even the typically prudent Jeremy Grantham and Ray Dalio’s of the world have recently suggested a nice finishing course of gluttony awaits us. Dalio’s blunt suggestion merely two days before the rally peaked – “If you’re holding cash, you’re going to feel pretty stupid”, is another way of implying – to hell with regret, come join the party. Of course in classic fashion at pivotal moments the market gods don’t discriminate between maven and monkey. In their eyes – we are all mortal.

Speaking of mortality and reflection, the bitcoin and crypto bandwagon that carried frenzied speculators up a rickety and near vertical ascent last year, now appears to be on the backside of the move, where the dominant hand of god – i.e. gravity, can exert its indiscriminate influence. Considering the elevation and means of transportation taken by these speculative pioneers, the road back may prove treacherous – if not fatal (see XIV “traders”).

For equity investors, the violent breakdown in the crypto market at the end of December was in hindsight (as well in foresight…) the leading speculative wave that broke first. Although equity gains were a mere pittance when compared to various crypto markets last year, the parabolic structures of the moves were quite similar, leading us to believe both markets may have put in their respective highs for some time – regardless of the benevolent economic backdrop that stocks still trade against today.

This is largely because of the inherent nature of parabolic trends, in that once the spell of a buying mania has broken, the unbridled chase that had carried the market without pause beyond more typical expectations, can not rekindle the same degree of momentum required to reestablish the uptrend. Eventually, through the markets subsequent failures to reestablish upside momentum with higher-highs, larger and more sophisticated capital looses trust and sells, thus reinforcing the markets now negative trading dynamics.

From this perspective – and considering our most recent thoughts towards equities long-term prospects (see Here), we will be looking for a lower retracement high and eventually a lower low in the coming weeks and months. We say eventually a lower low, keeping in mind we suspect the current breakdown leg that began just last week has yet to find an interim tradable low. Sizing up the move relative to more recent parabolic breakdowns (e.g. silver, circa 5/2011), gives us a target range in the S&P 500 between 2500 and 2550.

As expected, the 10-year yield continued to climb above the highs from last year, which corresponded with the broader breakdown in equities last week. With the 10-year yield now flirting below our upside target range ~ 3 percent, longer-term Treasuries again have entered an attractive window for longs, as we suspect demand will return as the Fed ultimately defers to equity market weakness – rather than further hawkish leanings tied to potential inflationary concerns. 

Moreover, looking back at our long-term chart of the 30-year Treasury bond, the most recent leg lower, now trades near long-term trend line support – a possible target we have been on the lookout for over the past two years.That said, yields could continue to overshoot over the near-term, before the market becomes more confident that the Fed will restrain from further tightening. 

We would guess that in this scenario, the risk of a swifter break lower below our initial target range in the S&P 500 would increase if yields continue to rise, as it did coming into the fall of 1987 when Treasuries took their final leg lower.

Peaking around at other markets – a word of caution towards those dip-buyers in oil today. Should yields again trade lower, it’s a decent bet that crude would mimic the trend, as it has over the past year.

Although gold failed to capitalize on equity market weakness and break above its current cycle highs from July 2016, the modest retracement bounce in the dollar was largely at fault. Generally speaking, the cyclical unwind in the dollar continues to make progressively negative momentum (RSI) lows, an indication technically that further weakness is still unfurling, before a more tradable interim low is reached with likely a positive momentum divergence (e.g gold, circa 7/2013). Cyclically, the dollar continues to loosely follow the previous cycle decline, which remains naturally bullish for the euro and gold.

Thursday, January 11, 2018

the Inevitables

In what’s becoming a bit of a New Year’s tradition, the Bond Kings are out with some early ruminations on the prospective end of the three-decade young bond bull. Never one to pull a punch, Bill Gross of Janus Henderson went full-bear (not to be confused – although admittedly, quite similar to – fubar), bluntly stating on Twitter, “Bond bear market confirmed today.”

While definitely less sanctioning, although still glazed with concern, Jeff Gundlach of DoubleLine eyes 2.63% on the 10-year yield as a trigger to sell long-term Treasuries, with a break above the late 2013 highs ~3 percent on the 10-year as the delineating line in the sand for the secular cycle.

If it all rings too familiar, they did issue similar pronouncements last year – practically to the day – calling for the end of the secular rally in bonds.
Jeffrey Gundlach said the 10-year Treasury yield topping 3 percent would signal the end of the three-decade long rally in bonds. 
“Almost for sure we’re going to take a look at 3 percent on the 10-year during 2017,” Gundlach, the chief executive officer of DoubleLine Capital, said Tuesday during his annual “Just Markets” webcast from New York. “And if we take out 3 percent in 2017, it’s bye-bye bond bull market. Rest in peace.” 
Bond manager Bill Gross at Janus Capital Group Inc. has a different threshold. He said in an investment outlook released earlier in the day that benchmark Treasuries above 2.6 percent would spell the end for the bond bull market. 
“The last line in the sand is 3 percent on the 10-year,” Gundlach said. “That will define the end of the bond bull market from a classic-chart perspective, not 2.60.” – January 10th, 2017Bloomberg
Although we do find merit (over a much shorter timeframe) in Gundlach’s “KISS” technical criteria of simply using a higher high to trigger a shift in market posture, as we commented on last January (see below), we view both approaches as broadly misplaced from a historical read of previous long-term cycles, where a trough is formed and largely proportional with the broader cycle (trough to trough). Contrary to the explosive secular peak and reversal in yields in 1981, the trough is a long-term process in-of-itself, inevitably breaking overhead trend line resistance as a range is extended laterally.
This week, markets are knocking on that inevitable door – the question is, secularly speaking: Does it hold any broader significance if and when we walk through it? Considering the massive and overarching size of the secular cycle (see Here) and echoing our thoughts below from last January – we don’t believe so.
While Gundlach and Gross have a semantic squabble over the upside threshold in yields that might delineate the end of the three-decade old bull market in bonds, perhaps they should stop viewing the bond world as round and come to the apparent reality that it’s more flat than circular here in the trough of the long-term cycle. 
In this construct, the unidirectional sovereign yield winds died – or more appropriately – transitioned, years back in 2011 and 2012. Although short-term yields and the dollar have risen in tandem as the US economic expansion led the world out of the financial crisis, long-term yields have taken a more lateral path into the trough with what we suspect will be doldrum conditions blowing east to west at best – rather than the prevailing winds we experienced out of the north for thirty years. How long the journey along this yield equator will take is anyone’s guess, but by our estimation of previous long-term cycles (most recently, Here), likely has further seas to float before the strong updrafts of the Westerlies can bring us to the higher-latitudes of a "New World". - January 19th, 2017 Market Anthropology
That said – and considering our suspicions of a continuing trend of higher realized inflation, we wouldn’t be surprised if the 10-year was squeezed for a spell firmly over Gross’ threshold and up to Gundlach’s line ~ 3 percent. In this scenario – and maintaining our approach since early 2014 (see Here) to a potential troughing range in long-term yields – use the span between 1.5 and 3 percent in the 10-year yield as a guide towards opportunistic trading windows in Treasuries.

With the release of the December CPI report tomorrow morning, markets will have fresh catalyst to work through as they skate towards the first Fed meeting of the year at the end of this month. Despite this mornings PPI report coming in weaker than expected, year-over-year performance in the US dollar hit an over 6-year low coming into 2018, which as we have shown in the past leads the trend in real yields (shown below through 10-year less CPI/year-over-year).
Although the threat of inflation appears to be receiving wider attention in the financial media these days (see Barron’s coverDecember 30th, 2017) – and pundits have cited the risk as impetus for the recent rise in yields, a broader impact to underlying market psychology has yet to take place, one we suspect will eventually adversely affect the lofty and ebullient sentiments currently entrenched in equities.

Moreover – and getting back to Gundlach’s initial trigger of 2.63 percent on the 10-year yield, we would look for that break above last years highs to coincide with broader market weakness in equities and potentially an upside breakout in gold. While gold would likely benefit from the more typical safe haven demand, we would also expect real yields to continue to decline as inflation outstrips the reach of nominal yields. 

Sunday, December 10, 2017

Instant Gratification's Gonna Get You

Sans the ever wilder world of bitcoin – more of the same since last month’s note, as spreads between short and long-term Treasuries continue to narrow, with 2’s and 10’s earlier last week at their tightest levels since the previous equity market peak in October 2007.

That said – and contrary to the market environment in Q4 2007 where spreads had been widening for several months as both short and long-term Treasury yields fell, but shorter-term yields fell faster – the curve today has continued to flatten as shorter-term yields have climbed and “outperformed” the long-end, greatly buoyed by staunch confidence of another rate hike by the Fed this week and tepid expectations towards rising inflationary pressures next year.

The cyclical disinflationary gravy train that began in Q4 2011 as the US dollar and real yields carved out their respective cyclical lows, has handsomely rewarded both equity and credit investors alike, at the expense of more inflationary driven assets – like commodities. And while there are many that believe that a secular move higher in equities began in 2013 as indexes broke out above their previous 2007 cycle highs, that observation appears mostly biased by simple technical disposition and ignorant of a wider historical perspective and understanding of the long-term yield/growth cycle – we believe essential to even considering more lasting secular persuasions.

The long and short of things – which appears entirely personified in the speculative microcosm of bitcoin mania these days: trade it while it lasts, but don’t be fooled by price alone. Valuations anchor all returns in the long run, and that rope between expectations and reality is exceptionally long and extraordinarily taut today.

Besides the unconventional and extraordinary monetary policy approaches applied in the markets since the global financial crisis, expectations continue to be muddled by the massive scale of the long-term yield and growth supercycle that we believe ultimately exerts the greatest influence on the respective equity and commodity sub-cycles over the long-term. Simply put, investors need to balance expectations by also viewing the overarching cycle through a market historian’s wide-angle lens, rather than just a weatherman’s radar display of current market conditions.

Granted, much easier said than done, as prudence typically takes a back seat to the ever pressing consequence of the fear of missing out. Heck, what’s a measly 20 percent return, when your kid’s teacher bought some crypto last week and doubled his “investment” – just because his nephew bought a bitcoin financed Bimmer on a cheap ticket punched in June? As if Millennials weren’t disliked enough already, returns in their preferred investment vehicle over the past year rival equities over the entirety of the more than 35+ year secular bull market. From a speculative point of view, there’s never been anything like it – and it’s happening right now. Chew on that.

Getting back to a more stodgy and puritan landscape… When you look back at the span of the broader long-term yield cycle, you'll find it was a period in history that encompasses 70+ years of remarkable growth, the last 35+ of which were traveled with increasingly benevolent credit conditions, in which the US has enjoyed elevated equity market valuations on the back of a proportionately massive secular downdraft in yields. Historically speaking, the significant investments and advancements in the world economy that took place directly after World War II, helped drive growth, inflation and eventually yields to such Icarus heights – that countries, central banks, corporations and individuals have enjoyed the voluminous book-end benefits of a declining rate environment for well over 35 years. This in a nutshell built the long road to the top of the equity market cycle on the back of ever cheapening credit and ever more accommodative monetary policy.

Interestingly, the relative symmetry represented in the current yield cycle is not unusual and quite characteristic when you look back at several hundred years of market history. 
* Click to enlarge images
The previous cycle (from trough to trough) spanned 40 years to the month; a period in which yields rose for 20 years – followed by a 20 year decline. Unlike the current downtrend in yields that has trended to the trough with increasingly more symmetry with the mirrored rise in yields from 1941 to 1981, the previous cycle exhibited an asymmetric return below the 1901 lows, as economies pushed up against the limits and unbalances exposed and magnified during the great depression - and markets stumbled their way across the transitional divide to the next major growth cycle.

Comparatively, the secular peak in yields in 1981 was over three times as steep as the previous secular peak in 1921 – and the broader span from trough to trough of the current move (1941 - today) will likely be over twice the previous cycles length (1901-1941'). Consequently, the massive range and structure of the current long-term yield/growth cycle represents the enormous scale that market participants should balance their more long-term and secular expectations within. 
Believing that the broader system will normalize and reboot to the next long-term cycle without a prolonged period of transition (i.e. secular stagnation - we like transitional divide) – even proportional and commensurate with the previous trough – is unfounded even along the irrational continuum markets often walk out on. In this respect – and as was the case across the previous transitional divide in the 1930’s and 1940’s, look for alternating periods of outperformance between equities and commodities extending well into the next decade, before a more secular move higher begins beneath growth, yields and equities.
The main takeaway for us, is that although equity markets have extended far offshore to relative valuation extremes today, the anchor of the broader long-term yield and growth supercycle will eventually pull returns lower as economies move further away from the easy credit conditions and accommodative monetary policy approaches that have greatly defined the current disinflationary sub-cycle since 2011. Considering the major influences of US dollar strength and extraordinary monetary policy accommodations that have gradually receded over the past few years, the disinflationary tradewinds that have greatly supported equities – but were headwinds for commodities, will eventually dissipate entirely in the current doldrums (i.e. goldilocks conditions) the markets remain in. Filling the void will be either rising inflation – deflation, or relatively brief cycles of both. We suspect we’ll see the former stretch its legs further, before the latter threatens yet another return. That said, we’re reminded this isn’t the summit of the yield/growth cycle of the 1970’s were inflation had ample fuel to burn – but likely the middle of the trough, where outbreaks of inflation burn fast and bright before exhausting whatever oxygen remains in the economy.


With November’s CPI report coinciding for release with the December Fed meeting announcement Wednesday afternoon, markets will be provided ample catalyst and reaction to trade between. Gold, which has remained mostly under pressure since its late summer high, has found major tradable lows shortly after the two previous December rate hikes in 2015 and 2016. It traded out of a bear market cycle low in December 2015 – directly after the Fed’s initial rate hike off ZIRP; and successfully defended that low the following December as the Fed hiked once more. Should the CPI report come in hotter than expected, look for gold to test underlying trend line support ~ 1215, before reversing course into the end of the year.

Generally speaking, gold has continued to trade higher – even as the Fed has raised rates four times over the past two years, predominantly because real yields have continued to fall as the dollar’s cyclical bull market turns down. In this regard, the dollar’s year-over-year performance trend has continued to decline this month, which would indicate that real yields should follow suit, largely supporting the cyclical uptrend in gold that began two years ago.

Overall, we continue to watch the slow battleship turn in the US dollar, with the fundamental belief that similar to the trend in long-term yields, the dollar will also work its way back down to the trough of its long-term range, coinciding with another cyclical move higher for gold and commodities in general.