2022.05.16 Weekly Note

Have we seen peak fear for now?

Some signs we’ve hit peak Fear and have put in a short-term low:

CNN Fear&Greed index got as low as 6 prior to the Friday recovery…

BofA’s Bull Bear Indicator recovering out of Extreme Bearish territory…

Currentmarketvaluation.com is a great website I’ve been looking at recent weeks that provides good perspective on valuations at a macro level. Their Aggregate Index model now sees the market as more Fairly Valued.

However, the equity components of the Aggregate Index model still remains overvalued. Risks of further mean reversion is still very high, but far less so after the recent correction.

The correction also saw the Buffet Indicator (US total market cap over GDP) has made a quick return to the region seen in the late 2010’s from where stock market rally’s have held up reasonably well.

P/E (Cyclically Adjusted PE in this case) also returned to levels seen in the late 2010’s and although high above the longer term average, I would put that average closer to the 1std level on the chart going by more recent ranges and accounting for some form of TINA premium.

S&P500 is now down to trading close to 20 P/E and Nasdaq100 at 26 which isn’t far off it’s P/E in real terms. So assuming the market entertains the idea that the FED will credibly combat inflation and achieve a ‘soft-ish landing’ then it may reasonable to say we are much more reasonably overvalued at current levels than before when equities was some 20% higher. I’m content with giving US equities some premium (for reasons tied to TINA and US exceptionalism) to the longer term averages in the above valuation charts, e.g. the 1std level as being fair.

We’ve also seen near record level inflows into US Treasuries which could cap some upside to rates which have been a key risk to market valuations and holding cost for non-USD currencies, and 2) the 4week average of net Equity outflows has started to level off.

Risks of a deeper correction will remain as the tightening of financial conditions becomes increasingly realised and the focus stays firmly on the recessionary impact. But for now, I think markets have adequately accounted for those risks in the near-term and the sell-off takes a (roughly 4 to 6 week) pause as it awaits more data and next Fed meeting to gauge how persistent and damaging inflation will be.

It’s also OPEX week and I think the Friday bounce will continue to hold up in the following week to sustain the short-term relief from the recent sell-off.

NEWSFLOW

Equity market sell-off, Crypto market crash, Inflation-induced social unrest, Geopolitical tensions around Ukraine, and China’s zero-covid policy tested to the limits dominates headlines.

— MARKETS —

• Investors Stay Put, Because They Can’t Think of Better Options (WSJ) This sell-everything market is confounding big and small investors alike after a string of years when markets seemed to go only straight up. “There’s paralysis, Even as people sell, they don’t know how to reinvest it.” Some investors are holding on to their stocks because they are betting they will eventually be rewarded, and even buying more on down days. Others are holding on because they can’t think of anything better to do.
• Wall Street ‘fear gauge’ offers no silver lining as bear market looms (Reuters) Since 1990, the Cboe Volatility Index (.VIX) has hit an average level of 37 at market bottoms, compared with its most recent level of around 32. “Sentiment is negative out there but there is no real fear, there is no sense of panic,” said Kris Sidial, a co-founder at volatility arbitrage fund The Ambrus Group. “The one thing that you are not seeing is capitulation.”
• The Dollar Is Winning in a Messy Global Economy — and That Matters in the Fight Against Inflation (WSJ) A stronger U.S. currency could help the Federal Reserve hold down the cost of imported goods
• The 10-Year Treasury Yield May Have Peaked. It Makes Stocks Look Better (Barrons)
• They Signed Contracts for Their Dream Homes Last Year. Now Their Borrowing Costs Are Ballooning (WSJ) Many home buyers who signed contracts for new homes in 2021 or early this year calculated monthly payments based on near-record-low mortgage rates of around 3% or less. But average mortgage rates have climbed this spring to 5.3%, according to Freddie Mac, as the Federal Reserve started raising short-term interest rates.
• Oil jumps 4% as U.S. gasoline prices hit record high (Reuters) U.S. gasoline futures, pump prices hit all-time highs, WTI rises for third week, Brent down for first week in three, EU embargo could take 3 mln bpd of Russian oil offline
• Rising Diesel Costs Are Straining U.S. Truckers, Shipping Operations (WSJ) Prices for the fuel powering big rigs have hit record levels, adding to inflation pressures in the U.S. economy
• Saudi Aramco overtakes Apple as world’s most valuable company (FT) Rallying oil prices lift state-backed energy group while tech stock sell-off hits iPhone maker. The Saudi Arabian oil company’s market capitalisation on Wednesday was $2.426tn, exceeding Apple’s $2.415tn by just over $10bn.

— CRYPTO —

• Crypto industry shaken as Tether’s dollar peg snaps (FT) The $1.3tn cryptocurrency industry was on Thursday hit by one of its toughest challenges when stablecoin Tether — a critical cog in the market — failed to maintain its link with the US dollar. Ratings group Fitch said the troubles at Tether and TerraUSD “highlight the fragile nature of private stablecoins, and will accelerate calls for regulation”.
• How a Digital Token Designed to Be Stable Fueled a Crypto Crash (Barrons) TerraUSD relied on a complex mechanism of minting and burning another token, LUNA, to maintain its dollar peg. A cascade of selling in TerraUSD destabilized its peg, however, and crashed prices for LUNA. Crypto entrepreneur Do Kwon, based in Korea, had tried to shore up LUNA and TerraUSD with plans to purchase up to $10 billion worth of Bitcoin as collateral through the “Luna Foundation Guard.” Before the crash, the foundation held $3.5 billion in Bitcoin.
• Coinbase Bonds Are Sinking. Blame the Crypto Crash and Creditors’ Concerns (Barrons) Coinbase Global’s bonds are trading around 60 cents on the dollar amid a broad selloff in cryptocurrencies. Lenders are grappling with the news that they could have an unexpected group of competitors for company assets in case of a bankruptcy: the depositors.
• Crypto Exchanges Are Delisting Terra Tokens After Meltdown (Bloomberg) FTX is delisting LUNA perpetual swaps. Before resuming earlier Friday, Binance, the world’s largest exchange by trading volume, said that it suspended spot trading for LUNA, the native token of Terra blockchain and TerraUSD, or UST, the dollar stablecoin that lost its peg, against Binance’s stablecoin Binance USD. Huobi took similar measures. Crypto.com announced that it has suspended trading of LUNA, Anchor and Mirror. Coinbase, Global Inc. will suspend trading May 27.

— OTHER NEWS —

• Soaring food prices are triggering shortages and protests across the developing world as disruption from the Ukraine war adds to existing strains on global supplies of grains, meat and other foodstuffs. Rising Food Prices Roil Developing World. We’re living in an age of food protectionism: 5 countries that are banning or restricting major exports to safeguard food supplies as inflation soars. Risk Of Destabilization In Africa Escalates As Food And Fuel Prices Rise. Price protests turn political in Iran as rallies spread. Inflation and food prices fuel social tension in Argentina. How Sri Lanka Landed in a Political and Economic Crisis and What It Means.
• From Sneakers to Teslas, China Lockdowns Upend Global Supply Chains (Bloomberg) Supply-chain chaos is expected to worsen as the impact on companies and consumers starts to ripple across the globe.
• Nations Aim to Secure Supply Chains by Turning Offshoring Into ‘Friend-Shoring’ (WSJ) U.S. officials and allies around the world are looking to establish friendly supply routes for key goods amid a war and global pandemic. Companies including Samsung Electronics Co. and Gap Inc. are tapping into this trend.
• Shanghai Lays Out Covid-19 Reopening Plan as China Cancels 2023 Soccer Tournament (WSJ) Residents in China’s financial hub express skepticism about plans to loosen restrictions; China withdraws from hosting next year’s Asian Cup
• China Cuts Mortgage Rates to Counter Collapse in Home Sales (Bloomberg)
• Finland and Sweden Will Seek to Join NATO Alliance (Barrons) Neutral Switzerland leans closer to NATO (Reuters) Switzerland’s fabled neutral status is about to face its biggest test in decades, with the defence ministry tilting closer to Western military powers in response to Russia’s invasion of Ukraine.

LAST WEEK’S ACTION

• Late week bounce along with the bids in Bonds is hinting the reversal could hold up, but still early days until Equity and Bond futures trade through prior week highs.
• Precious metals still under fire while the strong bounce in Energy and elevated Agricultural commodity prices could weigh on sentiment.
• USD and JPY saw higher highs and close, higher beta FX continues to trade heavy with the exception of CAD and MXN.

EQUITIES

Sell-off in equity markets continued last week but charts are showing tentative signs of a bounce with a bullish divergence on most of them…

World ex-USA bounced off the 50fib producing a bullish reversal bar;

Emerging Markets index also printed a reversal bar bouncing of the 127.20fib extension of the Mar-Apr swing;

Chinese Equities dragging down the Emerging Markets index and appearing to be in consolidation below the 2018/19/20 lows;

European equities finding support for the 2nd time in this region above the 50fib retracement and 61.8 extension;

SPX printed a weekly reversal bar off the 3sd band and naturally a bullish divergence from that kind of price action. What is particularly interesting is the recovery patterns after a 90% Down-Volume week:

• Red horizontal lines indicates the weeks where SPX had 90% DVOL,
• Blue is the pickup in UVOL in the following week,

and in recent years, relief followed in the weeks after under those conditions.

As noted above, OPEX is one of the key reasons I think the market has put in a local low. After the Friday bounce, we have closed above the large block of put/call gamma at 4k on SPX, 400 on SPY, and 300 on QQQ.

As long as we hover above those levels as we approach expiry on Friday, I expect some bullish price pressures from the unwinding of hedges and put gamma, as well as from some potential dealer buying in the underlying as the call side of that gamma block goes further into-the-money.

I continue to look long high beta beaten down stocks.

I’ve missed out on another at least 5% move covering all my Nasdaq shorts the prior week, most of which I’ve been holding since the beginning of the year on my core book. In fact I’ve been loading up on some risk and have been nursing my longs over past week or two. I had my reasons for squaring up as outlined in previous journal entries and bagged a decent 2.5k-ish move, but with 20/20 hindsight and reflection, I should have given myself better exit signals than doing so on a ‘thesis’ or for ‘speculative’ reasons.

RATES

US treasuries have been on a bull-flattening trend last week. To quote investopedia:

A bull flattener is a yield-rate environment in which long-term rates are decreasing more quickly than short-term rates.

In the short term, a bull flattener is a bullish sign that is usually followed by higher stock prices and economic prosperity.

In the long run, a bull flattener often leads to lower returns for bonds and stocks.

Bond markets are reacting to the scenario that is consistent with short-term relief for markets, but longer-term pessimism.

COMMODITIES

Commodities index recovered to the dip early in the week and continues to be driven by Food (2nd panel down) and Energy (3rd), while Metals continues to trade heavily since the March peak.

The ongoing shortages, food export bans, sanctions on Russian energy and soaring Gasoline prices points to that trend continuing; Metals are starting to look oversold as they’ve been weighed by higher real yields and stalled production in China. As we see are likely to see more flattening in the yield curve from here, Gold longs could be an attractive trade around current levels as the focus shifts to inflation and policy tightening-induced recession risks — somewhere between a ‘soft-ish’ and ‘hard-landing’.

Silver and Gold starting to reach compelling levels (while taking a wider price range view) to go long — risk assets to stabilize, bond rout looks done, and inflation/policy-induced recessionary risks should begin to put precious metals in favour again but I still feel it is too early and the next 50–100bp hikes or data pointing to strong recession odds needs to realised for stronger conviction. One longer-term trade idea on my radar.

CURRENCIES

USD (DJ FXCM equal weighted index against the 4 most traded currencies) has gone parabolic this year and is beginning to look very stretched and ripe for some consolidation. If Bonds and Risk does find some relief, so should this USD rally also.

EURUSD found support last week at the Jan’17 low and now hovering above the lows in the preceding Dec. It is very oversold and while fundamentals continues to favour shorts below 1.06, short-term market relief for this cyclical currency makes shorter-term long ideas particularly attractive at these levels. ECB is sounding increasingly hawkish as the weeks go by and another comment or two could easily send the pair back to 1.06.

Cable is also look very stretched on this leg as the weekly trading ranges are contracting while attempting to find support in the early 2020 consolidation range between 1.20 and 1.25. But a much more pessimistic BOE than the ECB makes it difficult to go tactically long. I therefore like GBPNZD (or GBPAUD) short with bearish momentum divergence and stochastics on the turn of the long-term moving averages.

USDJPY and USDCHF also showing great potential for the anti-USD trade with stochastics rolling/crossing over against the 130 and parity levels.

AUD is looking fairly oversold now. I was trailed out of AUDCAD on the RBA meeting spike at 0.92 and got back in on the following days in the 0.9100/50 region. China’s ongoing struggle with zero-Covid, Canada’s red hot stream of economic data continues and USD strength continues to be favourable for this RV trade.

I think short-term carry trades are attractive particularly USDZAR where I think we will some moderate consolidation lower from here towards ~15.60. There is some bullish momentum behind USDMXN and shorts below 20.30 for a run at the April lows looks appealing.

Have a good week trading!