Your corresponding blogger has spent most of his time this week recovering from Covid, which has ruined some otherwise carefully laid plans for this week’s missive. I thought that I’d start slowly then, by dissecting the topic on everyone’s minds this week; the inverted U.S. yield curve. Albert Edwards is absolutely right when he says that: "Once inversion occurs a whole new industry emerges, devoted to dismissing the relevance of the signal.” Albert quotes Juliette Declercq of JDI Research for the argument that this time is indeed different for the 2s10s, mainly because the real yield curve—here the 5s30s TIPS vs the nominal 5s30s—is still upward sloping, even steepening. Albert looks to the Macro Compass—penned by Macro Alf—for the contrasting point that if you use forward 2y yields, the real yield curve is in fact very flat. Albert concludes, perhaps not surprisingly for the ice-age perma-bear that the "Fed funds won’t need to rise much before the Fed crashes the economy and the markets. It is as they say “déjà vu all over again”.
Read MoreEquities seem to be in the throes of the death of a thousand cuts at the moment. The rebound towards the end of January, from the initial swoon, was reversed last week, and at this point a new low is all but certain. There are a number of things troubling equities. Geopolitics are a fickle catalyst for anything, but it has certainly added to the misery in the past few weeks. A Russian incursion in Ukraine remains a distinct risk, an event which would force markets to discount the risk of a more sustained military conflict on the European continent, not to mention a further leap in energy prices. The latter would intensify inflation fears, which are already weighing on markets in the context of the surge in bond yields, and the significant repricing in expectations for monetary policy, for both rates and QE. Investors could do with relief from these headwinds, but I doubt they’ll get it, at least not in Q1.
Read MoreFinancial markets have a tendency to gravitate towards the same narratives over and over, a bit like a good script writer who knows, obviously, that the hero always has to save the cat in the first scene. Core and headline Inflation have soared, and the Fed, as the perennial first mover among the major central banks—curiously flanked by its trusty squire the BOE—is now determined to kill it with rate hikes and QT, having recently abandoned all hope it being ‘transitory’. Cue new scene, and we are witnessing a torrent of forecasters tripping over each other to proclaim that they now think the federales will lift the Fed funds rate by five, six, or even seven, times this year, not to mention shrink its balance sheet by $1T. Markets have been blissfully ignoring the threat of monetary policy tightening, until now. As I type global equities are down 5-to-10% month-to-date in January, and the yield curve is flatter. What comes next?
Read MoreInvestors remain locked in discussion about the same issues they were mulling before the holidays. The rollout of the vaccine—however frustratingly slow in some countries—means that the light at the end of the tunnel for the economy is probably not an oncoming train. That’s great news, but the counterpoint is that markets have long since priced-in such an outcome, leaving investors vulnerable to the famous adage that if they’re buying the rumour, they’re also likely to sell the fact. In that vein, I am happy to double down on my comments at the end of last year that you should now be looking to stash away profits rather than putting new money to work. On that occasion I showed two charts to warn about incoming multiple contraction in equities, proxied by valuations on the S&P 500, and my in-house valuation score, which is also headed for the basement. The first chart on the next page shows that the six-month stock-to-bond return ratio in the U.S. remains pinned close to cyclical highs, also hinting that equities are about to give up some of their recent gains, with bonds rallying in appreciation. The second chart shows what happened the last time stock-to-bond returns were this stretched. It occurred in the run-up to the Flash Crash in 2010, before the swoon in the summer of 2011, ahead of the drawdown in May 2012, not to mention during the Taper Tantrum in 2013. Based on this albeit short sample, investors should brace for volatility in H1.
Read More