Oh How The Market Turns

*Disclaimer: I am really bad at putting out posts in a timely manner - I first started drafting this one Sunday night*

Back from vacation and a break from the financial markets. The world seems drastically different than where I left it two weeks ago. Still in a vacation mood, I wanted to take a break from the macro aspect of things and view the recent developments from a trader's perspective.


A few quick hit points this post will explore (looking at both market and economic stuff): 

-Have a hunch that this market is topping out

-Seems like the Fed is hiking into a recession...

-Are we at a reversal for the rates move?

-There has been a divergence of gold and nominal rates

-Some portfolio house cleaning stuff


Let's get to it.


Have a hunch that this market is topping out

I think most of us would agree - maybe even with Harry H included - that speculation and overvaluation have become pretty rampant in some assets in the last year or so, especially in recent months: FANG, cryptocurrencies, Canadian real estate, subprime auto loans, etc.

Cryptocurrencies, a form of speculation IMO, have clearly made a top for at least the time being.

FANG stocks had led the market on the way up. They will lead the market on the way done; and at this point, it's possible that the process has started.

Vehicle sales had been fueled by easy credit via the form of auto loans for years. However, recent prints show that this has started to peak.

As a result, it felt to me that equities are getting a bit toppy to me - when futures opened gap down this past Sunday night. After Monday's  price action by the close, I felt enough conviction to build a punt from the short side.

I already have sizable negative oil delta in the portfolio - the fact that it's worked out thus far is yet another conviction in favor of recessionary pressures that might be just beyond the horizon. 

To make things work, I covered a little bit of that short oil delta. Additionally, I was a receiver of the US long-end of the curve - exited that to make room for the short equities punt.

Call it trader instinct. Call it a blind shot in the dark. Just a hunch.

Seems like the Fed is hiking into a recession...

Okay, so auto sales seem to be topping out - we've seen it in the chart above.

Commercial paper growth and credit, in general, seem to reflect that as well. 

Anyways, all this seems to be occurring as Yellen along with other central banks around the world (Draghi on Tuesday) are stepping up the rhetoric of tightening faster whether via hikes, balance sheet reduction or asset purchase tapering.

Taking a look at US consumer credit, we've started to see a contraction - it is yet to be seen whether this contraction is an aberration or the beginning of a trend. However, with equity valuation where it is (current PE of 21+ and PB over 3), and the Fed tightening, we might finally have enough driving factors to push the stock market to the precipice. 

We talked about potential drivers keeping down the VIX via indexing and beta funds that are vol targeted. Is today's move in equities and the VIX enough to start the process of an unwind? We shall soon see.... 

On Tuesday, we saw long end duration get slammed. Which leads to the next two points.

Are we at a reversal for the rates move? and There has been a divergence of gold and nominal rates

Gold is more of a currency than a commodity. It trades off real rates of the specific currency that it's denominated in - so gold in US dollar terms usually trade off US real rates. 

It was interesting that nominal rates and gold decoupled for a little while there. I no longer have a Bloomberg terminal handy, so I had to wait a couple of days before I had a chance to see this:

Gold and real yield have been reacting to tighter financial conditions from Fed action and Fed talk as well as similar things from other central banks. Initially, nominals seem like they did not get the memo. 

There was a notable/tradeable divergence between nominals and gold that started to close this week. Long end duration finally got the clue and sold off sharply this week, starting Tuesday - so sharply in fact that 2s10s actually steepened!

Another point of interest here is that the inverse correlation between US govie returns vs equity returns moved sharply positive this week. I know enough market history to know that back in the Paul Tudor Jones' Trader movie days, bonds and equities traded together in positive correlation instead of the current risk on/risk off regime we are in now. 

Could this change in correlation lend credence to the idea that the Fed is tightening is hurting the equities market at a time of economic vulnerability? 

True, the yield curve has flattened tremendously over the last couple of years but is still far from being inverted. But do keep in mind that an inverted yield curve is not necessary for a recession, and definitely not needed to spark a meaningful sell-off in spoos.

Some portfolio house cleaning stuff

- The large negative oil delta I have in my portfolio has worked out well until this week. I still maintain my thesis that oil can go markedly lower from purely a production and OPEC market share view. Now that market participants might start anticipating for a recession, we can get a move from the demand concern side of things too. More conviction.

- US duration trade - closed the trade at the beginning of the week - saw this sell off coming. No strong convictions here but gun to my head, the curve continues to flatten but we get higher rates via an overall sell off along the whole curve.

- Took the money from US duration and some of the short oil profits and built a short tech equities punt at the EOD Monday. As you could've guessed, I'm feeling like Johnny Hekker today, aka LA Rams' pro bowl punter.

If we are indeed heading for a large correction/bear market, I expect another few percent lower here before a sharp rally in equities that will make a lower high. Then the real fun can begin. 

Even if I'm wrong and we haven't top ticked, I feel like we are pretty damn close. (Believe it or not, I don't punt on Spoos often - I've actually been a Harry H type of passive investor from 2011 to 2016)

- CAD has been a mess for me. Fellow contributor Shawn made some really good points regarding Canada - check it out here. I conceded the point in my own CAD post that the currency definitely looks undervalued in real terms, which was a concern. 

The bubble is largely concentrated in a few cities and Poloz is stuck between a rock (letting the bubble run) and a hard place (raising rates which would hurt the economy). But the economy there is doing okay, so I'm going to take my losses and wait to see how Poloz reacts if and when the bubble pop. Maybe CAD depreciation would occur after he raises rates to pop the bubble first...

As far as HCG goes, apparently they did have Buffett on their Batphone speed-dial! Eh. Buffett is still a market participant - he can easily be wrong like any of us - he just gets some unbelievably good deals whenever he buys something. 

Buffett essentially borrows at 0% and lends it out at 9% (fully secured I might add) and garners shares at $10/share when the stock was trading 50% higher. In one fell swoop, Buffett basically destroys any chance HCG has to be profitable by choking off their future cash flow. If I was a shareholder, I would fade this pop, because this investment isn't exactly bullish for the company going forward.

- EUR and GBP ripping - rate differentials had to catch up and we are seeing it now. Europe has been chronically underinvested over the past decade. We talked about this before too: here and here. If and when equities sell off meaningfully, I would be a buyer of Europe and in EM as well.

- Wheat! Don't say I didn't warn ya. Wheat soybean ratio up 16%+ since March...Ripping almost as if there has been massive overplanting of beans and underplanting of wheat for years...oh wait. Wheat itself up 5% outright since March.

That's all I got for now. Can you believe the NYC business library only allow 1 hour sessions on the terminal? What a travesty!

Happy summer and 4th of July weekend! Good luck out there folks.