Wednesday, November 30, 2016

Connecting the Dots - 11/30/16

Despite the enduring enthusiasm in equities since the US presidential election, we continue to follow the proxy pivots in gold that has broadly led the trend in equities by approximately 4 weeks over the past 2 years. Should the relationship persist, we would guesstimate a pivot lower in equities approaches over the coming week. And while the S&P 500 has fully benefited from the unbridled capital outflows from Treasuries and safe haven assets that helped inspire fresh all-time highs across most indexes over the past 2 weeks, emerging market equities remain in lock step with gold’s leading structure that points towards another leg down after the current retracement rally exhausts. 
 
That said, it would not surprise us to see US equities underperform (on a relative performance basis to EEM) on the downside, as we expect similar to last year’s dynamics going into and after the December Fed meeting, another sell-the-news reaction in the dollar manifests. A good leading indication that the dollar rally has run its course would be for gold and silver to find their respective lows over the coming week or so as the equity markets begin to turn down. We indicated below the two previous examples over the past two years of where a similar dynamic had developed. 
 

The US dollar index has again broken above 100 for the fourth time in the past two years, which has closely correlated with cresting rate hike expectations of the Fed. The last time the CME Group’s Fed Fund Futures probability for this December meeting rose above 90 percent was the first week in January of this year – before global market pressures significantly reduced expectations, which very likely had a negative feedback effect on the near-term outlook for growth and hence the economic data downstream in the following months. Despite participants mood in yields and rate hikes pivoting 180 degrees since the lows in July and some marquee money managers becoming increasingly more bullish on US economic growth in the wake of a Trump victory, US markets are still at the mercy of a fragile global equilibrium that is invariably adversely affected by a much stronger US dollar and tighter financial conditions worldwide – not to mention a domestic economic expansion already historically long in the tooth. 

Consequently, we tend to defer to much longer-term perspectives on yields and growth that despite what the interim rally might suggest, continues to point towards a lower-for-longer market environment well into the next decade. 
While we do expect the current weakness in Treasuries to extend into early next year and that yields would be more supported than the dollar over the coming years as we foresee the uptrend in inflation continuing, both markets are confined by a much broader construct that we believe is not yet under a more secular persuasion or has digested and crossed the transitional divide to the next major growth cycle. This long-term outlook remains for equities as well, as 2200 on the S&P 500 was our secondary target back in January, if the market found support at the Meridian – as it did a few weeks later. And although it wasn't our base case scenario back then, we still hold the respective extremes (both bullish and bearish) as outlier probabilities, with now considerable less upside opportunity today from a long-term historical perspective.
Expecting US growth will now resume a trajectory last seen during the halcyon days of the 1990’s, or that yields on the 10-year will again rise above 4 percent, is putting the cart well out in front of this horse, regardless of whether it was the Fed – or now Trump, holding out the carrot or waiving a large stick. Less we forget, we've been whacked plenty and have eaten trillions of bushels of carrots over the past decade with little to show for it in terms of growth. Sticks and carrots may have helped repair it, but only time will heal these wounds.

Although the US equity markets have enjoyed recent strength since the election, the honeymoon appears to be ending and we expect the new members of the bull brigade to have their gilded growth thesis tested as the equity markets could again become the sharp tip of the sword prodding at the sides of the Fed next year.

Monday, November 14, 2016

Clear & Present Danger

While the list of US money managers pivoting bullish last week on the US economy and equity markets reads like a who's who list of hedge fund titans, the broader reflationary trend that had displayed cracks in its foundation last month (see Here), once again began to quake and break down.

The main forces at work cleaving performance within the markets were longer-term Treasury yields and the US dollar, the impacts of which were mostly absorbed by US equities to date while emerging market stocks, precious metals and commodities took the full impact of a much stronger dollar and surging Treasury yields. 

What's interesting and perhaps lost or largely ignored over the short-term, is that although many strategists and managers now see an intermediate-term catalyst for US equities and a rejuvenation of inflationary forces here in the US  emerging market stocks that had significantly outperformed within the wider reflationary trend this year, now face a clear and present danger as yields break materially higher and as the dollar targets its highs from last year. 

Our comparative with the 1987 breakdown in long-term Treasuries would indicate a near-term low is imminent of a first leg down within a broader ABC corrective decline. We estimate this pattern would work out to an eventual target for the 30-year Treasury bond of around 140 next year.
Considering the recent intermarket developments, we continue to like the protection of a short position in EEM, that is still loosely following the breakdown of the reflationary outperformance of US equities in late 1987. For more on our thought process behind this position, see Here. While we never expect history to repeat in perfect cadence or proportion, intermediate-term support was broken last week that from our perspective points to further declines.
This negative outlook also applies to oil, that continues to follow the inverse performance of the dollar, which is now targeting its highs from last year. 
Although US equities came up a bit short in open market trading of our corrective decline target of around 2050-2060 in the S&P 500, we still think it warrants following the leading pivots in gold that now suggests another leg lower is approaching. 

Wednesday, November 2, 2016

Connecting the Dots - 11/2/16

Notwithstanding the fluid polling data of the approaching US presidential election – or the outcome of today’s less-anticipated November Fed meeting, the equity markets continue to wilt lower and follow gold’s leading footprints, left roughly four weeks back. Should the relationship continue to prove prescient towards stocks, we would guesstimate an initial target for the move in the S&P 500 of around 2050-2060.
That said, there are potentially short-term positive developments working against a broader market dislocation that had raised concerns a few weeks back (see Here), as gold has nearly retraced the entire decline from last month; long-term Treasuries have found a bid within the current equity market weakness and the breakdown in the US dollar rally this week. As described in that note, from our perspective the magnified risk of negative feedback pressures building across asset markets would be greatly heighted with a restrengthening US dollar and higher yields. As such, should the equity markets take another leg down as we suspect they will and upside momentum continue to bleed from the dollar, the utility of maintaining a reflationary hedge  such as the aforementioned EEM short, would diminish considerably in the wake of further equity market weakness. Long story short, a window to cover approaches. 

Overall, while it wouldn't surprise us to see the recovery rally in gold cool a bit if and when the equity markets stabilize, we're encouraged by the recent break in the US dollar and action in the silver:gold ratio that continues to bode bullish towards higher prices in the precious metals sector. Moreover, drawing on the historical parallels in real yields and the dollar from the mid to late 1970's, gold continues to walk the line – regardless of the buildup to the US presidential election.