The Axis Of Evil Comes Together But The Bulls Just Want To Be Free: The Action For Wednesday, September 6, 2023

Reverberations of the Russian assault on Ukraine continue to destroy global comity but this is far from the minds of investors, who are focused solely on the interest rate — equity valuation relationship. The bulls believe the US consumer will spend no matter what the geopolitical situation, since they were exhorted to do so back in the aftermath of 9/11. But the dollar’s recent strength reflects both economic relations and geopolitical fears, and these fears will periodically get a fillip like Kim Jong-Un is providing this week. I see the market zig-zagging for a period as it rachets higher but eventually reality will fell the bulls and send markets down to last October’s lows, driven by some combination of economics and geopolitics.

For now the S&P 500 likely falls over the near term, then reverses course and rises by the end of this week and over the next few weeks as momentum and bullish sentiment continues to be dominant. The bears have control for the moment as several indicators reveal pessimism on interest rates and the macro environment. These include:

  • Long-Term Treasury Rates: Long rates are rising and that will reduce the attraction of equities while cooling the housing and auto industries to the detriment of economic growth.

  • Developed Market FOREX / $US: The dollar is getting stronger against most major currencies (€, ¥ and Renmimbi) and that’s usually bad for global growth.

  • Emerging Market FOREX / $US: Nations like India, South Korea, the Philippines and Mexico are getting weaker against the dollar, and that’s bad for global growth since many key imports are priced in $.

  • WTI Crude Prices: Oil and by extension gasoline is getting more expensive and that in itself hurts consumers and the global economy.

  • Liquidity Metrics: Measures of money flow across the globe are trending downwards lately, which hurts equities.

But based on the action yesterday and overnight there remain several factors that likely flip the markets by the end of this week, including:

  • Volatility Risk Premium: The VRP signals significant upside in the near term as the VIX has declined relative to actual volatility.

  • EPS Estimates: In the last week Wall Street analysts raised profit forecasts for many firms in the S&P 500.

  • MOVE Index Of Bond Volatility: Fixed income volatility is steady and implies modest inflation expectations and stable interest rates to come, potentially bullish for equities and the global economy.

  • BTP-Bund Spread Of Italian & German Bonds: Italian default risk and a corresponding crisis for the Euro are muted, which is critical for European stability and is good for global growth.

My current positions reflect my intermediate-term bullish forecast, and include 3M (MMM), Pfizer (PFE), and a large position in UPRO that is largely hedged by an offsetting position in SPXU, which nets out to a long position in equities.

Warmth Is Wealth