The rally seen last week was all but labelled a dead cat bounce, as the S&P 500 fell back to the all-important 2750 level on Tuesday, re-testing its lows and falling all the way down to 2700. All stocks -- ranging from Technology to Financials -- were sold down and gave up almost the entire rally seen over the last few days. The U.S. market has pretty much given up all its year-to-date gains -- it is now only up 2.5% for the year. Still a massive outperformer vs. the likes of emerging markets -- and their proxy, the iShares MSCI Emerging Markets (EEM) , which is down 15% -- but the gap is closing.
Even the darlings of the market, like Amazon (AMZN) , Microsoft (MSFT) , and Apple (AAPL) (all Action Alerts Plus holdings), have been ruthlessly sold down over the last few days. Microsoft reports tonight and Amazon tomorrow, which should perhaps alleviate some concerns. On the flip side, U.S. 10-year bond yields are trading at 3.15% (down from the 3.22% number that spooked equities in the first place).
The dollar, other than a short rally last week, is back down and holding the same level vs. most developed market currencies. Commodities like copper have firmly held onto their key $6200/tonne level and has flat over the past week, while copper equities are down between 10%-20%. Iron ore has been rallying over the last few days, yesterday it closed up 2%! So, what do the equities know or expect that the other asset classes are not aware of?
It is all about liquidation and rebalancing flows out of equities into bonds, coupled with panic selling, as key 200-day moving average support levels are being tested. Algos are dominating this market. No one is actually looking at the fundamental drivers across asset classes, but are just fearful of another 2008 collapse -- and reacting first, asking questions later.
Sure, the picture is a bit blurred by the U.S. picking up the pace of harsher talk against China. The Italy/EU saga over the last few days has certainly not been helping, as the EU refuses to accept Italy's budget deficit projection, causing the euro to fall and dollar to rally. Any dollar rally is deemed as negative for the overall market -- especially emerging markets and commodity-oriented stocks, given their inverse correlation.
The higher dollar and potentially higher U.S. interest rates are currently the most important driver of equities across the board. Most economies have their debt denominated in U.S. dollars, so higher interest rates hurt them with higher interest costs. Once this is understood, it is easy to understand why Trump is pointing the finger at Fed Powell, who is really only doing his job to stop the economy from over-heating and causing an inflation spiral.
The GS financial conditions index shows how the environment has tightened over the past few months, in line with even higher interest rates -- without the Fed even raising rates. Yet the Fed maintains its course.
After all, with U.S. S&P 500 at all-time highs, it would not justify a pause in policy, but with the market now threatening the uptrend of the last few years and lower company guidance going forward, talks of recession and aggressive market selloffs, the Fed has an excuse? Investors have become so used to the opioid of central bank monetary accommodation, that they do not know how to function outside of it. It seems Trump is the same. After all, how will his leveraging U.S. debt policies and Presidential campaign be a success if interest rates are high and rising.
Equities are usually the third derivative of all asset classes, they get whipsawed from left to right on the back of other asset classes and their implied dynamics. One thing is certain, bond yields that were the cause for the initial selloff are no longer rallying. Oil is now down 10% from its highs of $86/bbl for Brent, so clearly inflation is also not going to show up in data going forward. Physical markets such as copper, steel and iron-ore are suggesting higher physical premiums, which indicates tight -- not loose -- markets.
At the end of the day, these companies' revenue and earnings are driven by where these commodities trade, not where the market fears it will go down to. Every day with the price averages at these high levels, these companies are generating higher income. It is as simple as that. Something has to give, either the equities are wrong or FX or commodities. My money goes with the former, as equities tend to get over-excited and overly pessimistic during any economic cycle.
There is one danger that is alive and well -- the Chinese yuan. If it does break the key 7 level per dollar, there will be mayhem. Authorities have been stepping in with strong measures to support the markets, including PBOC open market operations. But the market needs some clarity on the U.S./China trade war spat for investors to focus purely on company earnings and valuation.
As the U.S. mid-term elections edge closer, perhaps a resolution or agreement will be realized. Either that, or the Fed holds off on the December rate rise. If that happens, commodities will fly. Especially markets like copper that are flat on the most pessimistic scenarios. One can only imagine what happens in a "positive" tape.
