Schrodinger's market

While this week has been a solemn one thus far for your author, equity markets have been in full on party mode.  Although the reason for the buy-a-thon isn't immediately obvious, in explaining short-term price action there doesn't always need to be.   Sometimes there really are more buyers than sellers (at a given price, at least) regardless of their motivation.

In a way, stocks (or at least the SPX) last week were like Schrodinger's market; both the head and shoulders pattern and the potentially bullish channel breakout were equally valid states of interpretation as discussed here.  For a while it looked like the price action would resolve in favor of the H&S, but after what was a false break we've now (perhaps unsurprisingly) seen the channel give way to the upside.

If we project the channel width as a measuring target it gives us 2110, which is also close enough to the year's high to make it an obvious objective.   Of course, that's less than a percent away, so from Macro Man's perspective there is little to do but keep his topside stops in place and see what happens.  It's certainly not enticing to go long here.

If one were looking for reasons to be skeptical, the weakness in gold could be used as a reason for caution.  After all, both the SPX and gold rose sharply in late winter/early spring thanks to the Fed capitulation trade that has evidently now run its course.  (Though not without a bit of self-congratulation.)   Insofar as gold led the rally in risk risk assets, might its weakness now augur a rollover in the coming weeks?

Perhaps...but perhaps not.  In fact, over the last 120 trading sessions the daily returns of the SPX and gold have been negatively correlated, and while this may be somewhat unusual in the monetary policy-dominated post crisis era it's far from an anomaly on an historical basis.  Indeed, as with so many financial market indicators (or just use Spooz 'n' Blues for short), the performance of the last seven years or so is out of step with historical norms.

The evidence would suggest, therefore, that weakness in gold offers little structural reason to be worried about equities, though of course on a short run basis narratives can take on a life of their own.   (And all of this leaves aside whether there are other reasons to be concerned about equities, which there almost certainly are.)

Moreover, oil isn't exactly confirming the message from gold (though indications from copper have been less positive); even if the price of the bubblin' crude is being driven by idiosyncratic supply factors, the transmission mechanism to financial assets via high yield is still a positive one in the short run.

Again, how markets might react if crude prices encouraged a change in the perceived inflation trajectory (and central bank reactions to it) is another question.  Bobl yields, for example, remain anchored near their lows despite the rise in crude and the recent solid ifo reading.  Of course, some of this is down to the simple anchor of the negative deposit rate; even with this, however, there's nothing to suggest that yields couldn't rally 10-15 bps from current levels  (with a stop 4-5 bps below).  There's little near term chance of a home run, but there's nothing wrong with the occasional single.

 

Of course, NIRP is the most quantum of monetary policies, a regime wherein classical finance ceases to function along the lines to which we are accustomed.   However if, as seems likely, policymakers have acquired an understanding that the good achieved by such policies is alloyed with a rich vein of uncertainty and unintended consequences, perhaps we can hope for a day in the not-too-distant future when we can put away the Heisenberg and Dirac and take the Newton and Maxwell back off the shelf.