Morning Note: The Elephant in the Boat

 Asset prices, the world over, are swimming in a sea of red as we start the week.

All but 2 of the 16 Asian markets we track closed notably lower overnight. Same so far this morning for all but 3 of the 19 European bourses we follow. And no better for U.S. major averages: Dow down 339 points (1.13%), S&P 500 down 0.81%, Nasdaq down 0.92%, Russell 2000 down 1.72%.

The VIX (SP500 implied volatility) is up 6%. VXN (Nasdaq vol) is up 7.73%.

Oil futures are down 0.86%, Gold’s down 0.87%, Silver’s down 1.52%, copper futures are up 1.33% and the ag complex is down 0.67%.

The 10-year treasury is appropriately up (yield down) and the dollar is down 0.06%.

Our only core position in the green this morning is base metals (read copper). Otherwise, energy, emerging market equities, Asia-Pac equities, silver and banks are notable drags. All in, our core portfolio is down 0.87% to start the morning. 

While not as whacky as Friday, this morning’s asset correlations are a bit out of whack nevertheless. Conventional thinking would indeed have bonds higher, given the global selling across most asset classes, but it would also have gold higher, and it certainly wouldn’t have copper rallying.

So what’s it mean? Well, conventional thinking, in the short-run can appear faulty every bit as often (if not more) as it appears accurate. 

As for gold, the conventional wisdom that it’s your quintessential port in the storm, well… it all depends on what type of storm you’re hedging against. 

If you’re hedging the prospects for money printing and interest rate suppression as far as the eye can see, then any hint that either of those are due to subside amid the potential for robust economic growth will have folks selling their shiny metal. Which, along with a bit of rotation to bitcoin I suspect, has them taking some off the table of late. 

The thing they’re missing, however, is the debt bomb that ultimately gets ignited if indeed interest rates are allowed to rise to any historically-meaningful degree… 

Remember, the Fed fully intends to allow inflation to run hotter going forward; now you know why (they’ve no stomach for raising their benchmark rate to ward it off. Quite the opposite in fact, I fully expect them to actively buy down the longer end of the curve if indeed consequentially higher rates begin to threaten).

As for what has markets on edge this morning; well, there’s increased tension between the U.S. and China, as the Administration is looking to blacklist more Chinese companies, there’s of course the latest COVID numbers, there’s the pending passive fund quarterly rotation I mentioned last week that may already have traders on edge, then there’s the fact that, as I stated on Friday, up until this morning hardly anyone’s been on edge lately:

“Suffice to say that, based on the aggregate reading of our barometer (-80 [-100 is max greed]), there’s a tremendous amount of optimism baked into the present price of your average share of stock!

And that, believe it or not, is not necessarily a good thing; as the following from Investor Intelligence explains:

“The bull-bear spread is again in the danger zone, at +41.4%, up from +39.8% last issue. That exceeds the +40.4% reading three weeks ago.

Late Aug the difference hit +45.1%, the widest spread since Jan-2018 when it exceeded 50%! Above +30% counts show more risk the higher they get, with defensive measures appropriate above 40%.

Prior to +41.5% difference in Jan this year we saw a +43.2% spread late Sep-18, just before the S&P 500 corrected 19.7% to its Christmas Eve low that year.”

Here I placed a red circle on an S&P 500 graph at each of the highlighted +40% bull/bear spread dates referenced above:

Of course this doesn’t guarantee that the market’s about to roll over, it just says to us that, along with the present overall reading of our fear/greed barometer, positioning is at the moment precarious. A little bad news could be met with an oversized reaction…”

So, again, it’s been standing room only on the bull side of the boat… 

And, lastly, on the elephant in the boat:

In their insightful 2015 book The House of Debt, economists Atif Mian (Princeton) and Amir Sufi (University of Chicago) teamed up to teach us what one might think the world should already know, but, alas, clearly doesn’t.

Here’s a snippet:

“The conclusion drawn by Jorda, Schularick, and Taylor from their analysis of a huge sample of recessions is direct:

We document, to our knowledge for the first time, that throughout a century or more of modern economic history in advanced countries a close relationship has existed between the build-up of credit during an expansion and the severity of the subsequent recession. . . . [W]e show that the economic costs of financial crises can vary considerably depending on the leverage incurred during the previous expansion phase [our emphasis].”

Have a great day!


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