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.
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Booger
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May 26, 2016 at 12:50 PM ×

The action of the last week is I think the market anticipating that Yellen will slap down the hawks. Spoos is giving her a free pass to hike in June or July but I think she is too smart to take it. A hike in June or July would be a potentially monumental mistake with the current data.

My prediction (which will probably be wrong):
1. Yellen slapdown of hawks
2. Steepening: backup in U.S long rates
3. Dollar correction and retest of previous lows
4. Spoos flat, unlikely to take out previous highs
5. Oil to mid 50's before rolling over

Am adding to short Spoos position here and initiating long gold position for a punt. Should be an interesting Friday.

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Anonymous
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May 26, 2016 at 2:16 PM ×

agree that spoos are discounting a ( once again) very dovish janet- but if she comes across as remotely hawkish i think we could give back these gains of the last few days very quickly especially with monday holiday and thin markets
on adovish yellen i intend to sell into a spoos spike

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washedup
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May 26, 2016 at 3:25 PM ×

@Boog I think it is quite literally impossible for yellen to be more dovish than she was in march, so there is that. I am also very cynical about their ability to care about (data dependent my ass) anything other than spoos, so if anything I'd argue the opposite of your point 1. Equities are giving her a gift and she is too smart NOT to take it. It follows that the best way to prepare the market would be to advertise it through this speech, but do it with the warning that if financial conditions deteriorate she reserves the right to change her mind. Now whether she is smart enough to realize that one day her relents may stop working is anybody's guess.
Could it be a mistake if they hike? Who knows - I think spoos themselves are torn between the 'higher rates are good, the economy must therefore be good, buy financials etc' and 'higher rates are bad, sell commodities' meme. I am not yet giving up my view that this is a rotational market 80% of the time with people passing hot potatoes, a wrist slashing sky is falling market for 10% of the time, and a 'OMG buy equities before the sky turns fully pink and buybacks leave nothing for us market' for the remaining 10%. In short, still rangebound.

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jbtfd
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May 26, 2016 at 4:02 PM ×

Slightly late posting, but I have closed out all remaining equity longs this US session.

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Mike
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May 26, 2016 at 4:19 PM ×

I was short at SPY 205 but just managed positive beta the past three days.. but now have a big red hole where my risk premium was supposed to be. I worry that commodities, energy and pharma rally, making new highs and push indices up 10%. But am holding this short... Triple top and declining earnings is rare. And the old relationships generally seem to hold; interest rates down stocks and real estate up. Interest rates up ... ?

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abee crombie
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May 26, 2016 at 4:21 PM ×

strong dollar, buy US stocks,
weak dollar, buy US stocks

at some point int't equities (and small caphave to pick up the baton if this is a real turn in eco activity and sentiment. But it doesnt look like its happening. I suspect Spoos make a new high, maybe by 50 or 100 points and put in a double top for a nice October sell off

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Mike
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May 26, 2016 at 4:26 PM ×

It would be nice (while I'm short) to see an intray new high and close below 210.

There must be a few stops up there

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johno
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May 26, 2016 at 5:18 PM ×

Interesting observation on BOBL, MM.
I continue to think that buoyant markets are an opportunity to hike, and agree with washedup that Yellen will likely take it. I'm not so sure Yellen will say much new this Friday. I'd guess she, like Dudley on the 19th, is happy with what STIR markets are now pricing and will try to keep them where they are. After she's seen the early June data, she can steer June odds higher or lower at her speech on June 6.
I can see a scenario where Yellen hikes and equities don't fall or even rise, the narrative becoming, "Fed saw economy strong enough to hike and market says she's right." All these institutions surveyed by BAML who have been selling stocks for some record number of months straight may then run to cover underweights at highs. (I'm not saying I'm bullish, just that I can see either Booger's or this scenario playing out and I don't know which is likelier).
As for gold and its correlation with markets, the correlation now should be negative. When people are panicked about a deflationary accident as they were earlier this year, and the Fed relents, then yes, the correlation will probably be positive (since USD will sell off, although gold is probably most valuable in a deflationary accident scenario, so perhaps gold becomes a sell into the USD-selling-led strength). But if people start thinking the world is OK again, with the Fed hiking into strength and stocks holding up, some of the new gold "investors" (read: tourists) are going to reconsider (read: puke) gold. I think of gold's strength this year as a response to negative interest rates, which are deflationary and hurt the banking system. If central banks have now realized this, then rates shouldn't go more negative. Kuroda might be stupid enough (read: in thrall to some academic viewpoint) to ignore what markets have said so clearly. If Kuroda wants a weaker yen, he should leave rates where they are and massively increase stock ETF buying which drives FX-hedge adjustment flows.
Re oil, there are so many moving pieces ... this year has been a story of unplanned outages and aggressive reserve accumulation by China. I understand completion of DUCs would start adding materially to supply from mid-50s.

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Hotairmail
admin
May 26, 2016 at 5:46 PM ×

Bring back the Phillips Machine: https://www.youtube.com/watch?v=k_-uGHWz_k0

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Leftback
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May 26, 2016 at 6:16 PM ×

Dovish Janet cooing softly in Mr Market's ear has surely been thoroughly priced in this week, yet we think that @washedup is correct. Surely even La Paloma Blanca cannot manage to appear more dovish than her ridiculously easy March posture amid a performance that was appropriately described herein by MM as "fluffing the Spoos".

We think that she says little if anything about monetary policy tomorrow, or anything else of substance, other than to note that the economy is doing fine, thank you very much, and that might be enough to get some dollar shorts to run for cover. The June 6 Philadelphia speech is clearly being prepared for the Chair to move the goalposts a little, and before that event, there will be the jobs number on June 3 to help guide Mr Market in his expectations.

We also agree with johno that this lull in the global crisis, and the low volatility in the markets, together with the timing (May/June/July seasonal weakness is normal) really affords the Fed an absolutely ideal opportunity to move towards another rate hike, one that they would be very unwise to miss. The interesting question then becomes whether September is in play for an additional move, with another to follow perhaps in December. Imagine 1% rates on checking.... the thrill of it.

Just FYI we added to our CAD short again today, and will add more tomorrow if the opportunity arises. We also sold some more REIT common shares, that group is vulnerable here on technical and fundamental grounds.

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Anonymous
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May 26, 2016 at 6:52 PM ×

Month to Date corporate bonds sales at $205B. Today's deals should make it the largest issuance month in 3 years

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abee crombie
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May 26, 2016 at 7:58 PM ×

jono, I think a lot of the gold tourists are in bitcoin or eth/tao today. Etherium is getting too much press for my liking but i do like it better than bitcoin. The more I learn about crypto currencies the more I think they will be part of the post CB solution. But i have no way to value them and still think a massive washout is likely. but ignore them at your peril, CB are making a mockery of 'money'. PPL flock to gold bc they know the rules. Bitcoin etc is the modern day version.

Re oil, DUC are an interesting question. apparently not as many left as some thought. Also the ability of shale to turn on a dime and start drilling isnt going to be so easy according to some bc a lot of labor has left for good. Lots of talk of non US, non opec as the one whose supplies are going to really drop and not come back. but to me whats more interesting is the demand side. US, India and CHina all growing quite nicely.

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Leftback
admin
May 26, 2016 at 8:30 PM ×

Spot VIX is under 14 again. We are steaming into a long holiday weekend and now here is your market weather forecast and a note on the assessment of market risk, as follows:

Sunny. All day and night. For ever.

Yellen - No Risk
China - No Risk
NIRP - No Risk
Rate Hike - No Risk
Commodity Demand - No Risk
Inflation - No Risk
Credit - No Risk
OPEC Supply Glut - No Risk
Trump - No Risk
Brexit - No Risk
Grefault - No Risk
Pricofault - No Risk

Good, that's settled everything, then. If there is a dip, there is still no risk, so Jbtfd.

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Anonymous
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May 27, 2016 at 12:53 AM ×

This meme is certainly catching on, like a virus and this particular virus will "kill" us all...it's the end game:

"Japan’s a pretty good picture for the rest of the world, maybe five or 10 years ahead. I have a sense that that’s the route central banks will pursue. They’ll keep on buying debt, keep interest rates low and then ultimately the treasury doesn’t owe them anything.” Bill Gross

David Rosenberg on Bloomberg: US Treasury should issue a trillion dollar bond. The Fed buys it and the money used for "infrastructure". ( This will lead to more looting, of course, with friends and family getting the bulk of the money and whats left, used to purchase more red light cameras and speed cameras )

Hedge Fund Guy ( John Thomas ): The Fed returns all the Treasuries on it's books to the government. Voila, trillions in debt erased, gone, wiped out.

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Anonymous
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May 27, 2016 at 2:37 AM ×

Pandora's Box.

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