In a follow up to my previous post, Trump’s First Stock Market Correction: Coming Soon, I am going to outline a growing list of warning signs that suggest the US equity markets are fast approaching a correction.
Damn do markets love inflation. They say hunger is the best sauce, but wow just wow, after 5 long years of deflation, PMIs around the globe have started to roar.
What is most incredible about this rally is how broad based it has become. Price action in Emerging Markets is incredibly bullish.
Brasil has clearly been eating its proverbial Wheaties as well. To think I wanted to short it last March…
But in the land of the longest running bull market, despite what the Tweeter in Chief, Donald Trump, says the stock market does not reflect reality.
Exactly… we don’t even have a tax plan yet… or a functioning legislative branch for that matter. Jawad Mian of Stray Reflections adds:
“The political uncertainty so apparent in both the US and Europe has not really dented market optimism yet but the global equity rally is extremely stretched, with record levels of speculative long positioning in the Russell 2000 and the S&P 500 pricing-in a staggering 30% earnings growth for 2017.“
Of course S&P 500 earnings have been falling for the past 8 months…
Cognitive dissonance indeed. Although you can’t entirely blame them given the elevated levels of economic surprises.
It’s hard to imagine conditions will continue to surprise to the upside, in the US, especially, where most of the surprise has been in the form of soft data or sentiment.
Further compounding the peak in economic surprises, is the movement in US treasury bonds which typically has a negative impact on the economy.
And yet the move higher in interest rates has not been enough to counteract the rise of inflation.
This has helped fuel the price of gold, as well as has Marine Le Pen’s rise in the polls.
As we approach the French elections which have the most binary outcome of any election, we should expect a pick up in volatility. At the same time, US equity markets have been historically calm.
To put this level of calm into perspective, the chart below shows the number of 1% down days out of the last 200. At just 5, we are at the all time lows last seen in the summer of 2007, when the dollar was about to fall off a cliff, while EM and commodities soared (we’ll get to this bit later).
The indicators only get worse from here… The VIX which has been sold short like never before is starting to mis-behave.
At the same time we are seeing further warning signals from inflation and bonds.
From a liquidity standpoint, the US is also at risk.
This can also be seen in the DXY forming a potential H&S pattern that would take us to the election night lows.
And perhaps this is why EM is behaving so bullishly. If the dollar falls, EM could really rally further. This is further reflected in the momentum divergence in SPY/EEM. We’ve also broken the 4+ year trendline. This is something to watch going forward.
I will caution this last statement with the fact that the reflation trade has thus far been a dollar positive story. As inflation rose, so too have interest rates in the US, which is the only large DM economy that is not undergoing some massive form of QE. This interest rate spread drove dollar strength against other DM countries as well as some EM countries (albeit initially).
We’ve seen currency strength out of places like Mexico, Turkey, South Africa, China, Chile, Brasil and quite a few others. Could the dollar strength be a DM only story going forward? Gold mining companies have begun to prepare for such an event and have liquidated the majority of their RECORD short position.
DISCLAIMER: This blog is the diary of a twenty something millennial who has never stepped foot inside a wall street bank. He has not taken an economic or business course since high school (for which he is immensely proud of) and has been long gold since 2012 (which he is not so proud of). In short his opinions and experiences make him uniquely unqualified to give advice. This blog post is NOT advice to buy or sell securities. He may have positions in the aforementioned trades/securities. He may change his opinion the instant the post is published. In short, what follows is pure fiction based loosely in the reality of the ever shifting narrative of the markets. These posts are meant for enjoyment and self reflection and nothing else. So ENJOY and REFLECT!