2023.10.03 Weekly Notes

Tactically Bullish

My views have been slowly evolving over the last 2 months and a summary of my prior notes provides a good picture of where I’m currently at:

• 2023.07.24 Market ‘vulnerability’ to be tested
  — noted increasing risk of market getting wrong-footed on the disinflation and strong growth narrative
• 2023.07.31 Bullish, but Vulnerable
  — becoming more convinced market will get wrong-footed
• 2023.08.07 Ope, there goes gravity…
  — inflation risks and weakening earnings trend materialising
• 2023.08.14 Goldilocks and the 3 Bears
  — China Europe US showing cracks
• 2023.08.21 Bond vigilantes and The 5% Canary
  — Looking for the tactical bounce
• 2023.08.28 MonPolVol is here to stay
  — Jackson Hole review
• 2023.09.04 Bad news is Good news, right?
  — “Narrative shift from ‘Growth’ to ‘H4L under deteriorating conditions’”
• 2023.09.11 SPX to 4k?
  — “4100 should be more than reasonable”
• 2023.09.18 Still a challenging September but relief in October?
  — Bearish but thinking strategically ahead
• 2023.09.25 Bearish but Nimble
  — Looking for a tactical bounce

… and now - I’m tactically bullish.

While tactical longs is a tough bet to make as it is difficult to argue for an instant bounceback with inflation reacceleration still a huge risk and the massive bear steepening in the yield curve, there are 2 things I’m counting on — Q3 earnings to be resilient and continued softening of incoming data (to support a consolidation phase in yields as well as repel the notion of another hike by year-end).

Some weeks ago I had the sense that Q3 data was still fairly robust and that there could be the possibility of Q3 earnings to prove resilient against expectations. Looking at the above snippet of data, we can see that has been the case — retail sales, consumer and service sector surveys have been quite positive.

On inflation reacceleration risks, expectations via inflation swaps are coalescing around the 2.5% mark — shorter term 1 and 2year inflation swaps have been rising since mid-year while 5 and 10yr have been mostly flat in recent months.

Cleveland fed nowcast has been overshooting for sometime and with that considered, it’s not looking particularly alarming for the next set of prints. Path of disinflation is on the right track and last week’s PCE report is one the Fed would have liked particularly with respect to the core categories.

So while we are seeing some renewed upward pressure in shorter-term inflation, I don’t think there is any cause for alarm with respect to inflation yet.

NEWSFLOW

MARKETS

• US stocks notch quarterly drop against backdrop of Treasury sell-off (FT). Tech Stocks That Drove Market Rally Are Now Down 10% (BBG). US equity funds see biggest weekly outflow in three months (RTS). Global bond funds saw their biggest weekly outflows in more than a month (RTS). US Junk-Bond Funds Post the Biggest Outflow in Seven Months (BBG). Treasury ‘Term Premium’ Gauge Positive for First Time Since 2021 (BBG). Once Unthinkable Bond Yields Now the New Normal For Markets — Dramatic bond selloff reinforces shift from easy-money era, Larry Fink sees ‘embedded inflation’ pushing US 10-year to 5% (BBG). US Yield Surge Helps Fed on Inflation, But Risks a Harder Landing (BBG). Moody’s warns of ‘systemic risk’ from leveraged lending market — Rating agency says looming ‘race to the bottom’ between banks and private debt funds could erode credit quality (FT).
• Crude climbs above $96 a barrel on US stockpiles concern (FT). Nearby Brent crude spread hits 2023 high on tight supply (RTS). Russian Oil Is Trading Closer to $100 Than the G-7 Price Cap (BBG). Oil Rally at Risk From Swing to Surplus Next Year — Wall Street expects the price frenzy to cool in the first quarter as a flood of fresh supply more than satisfies demand (BBG). Saudis May Ease Oil Cuts Sooner Than Market Thinks, Rapidan Says (BBG).
• Japan Warns Again on Yen After Dollar Breaches 149 Mark (BBG). ‘Mr. Yen’ Says Japan Will Fret If Rate Hits 155, May Intervene — Sakakibara says verbal warnings ineffective if no intervention (BBG). BOJ Former Research Chief Sees 2% Approaching for 10-Year Yield (BBG). Sterling heads for worst month since Liz Truss’s mini-Budget (FT). Hedge Funds Boost Euro Shorts to 11-Month High on Peak ECB Bets — Speculators increased net short positions to 23,306 contracts, Euro set to remain under pressure for six months: AVM Capital (BBG). Canadian dollar extends quarterly decline as economy stalls (RTS). China Gold Prices Plunge the Most Since 2020, Curbing Record Premium — Shanghai premium to international prices falls to $10 an ounce, Beijing’s curbs on gold imports had helped fuel gold rally (BBG).
• Extreme weather hits lovers of sweet treats in the pocket — Prices of sugar and chocolate are rising steeply as heat and reduced rainfall disrupt supply (FT). Wheat Set for Longest Run of Quarterly Declines in 14 Years — Bumper harvests in parts of Northern Hemisphere bolster supply, Black Sea tensions simmer after collapse of safe-passage deal (BBG). Aging Trees Show a Crisis Looms for the World’s Everything Oil — The pandemic and last year’s record palm oil prices have exacerbated delays to replanting efforts, putting future supply at risk (BBG). Poorest Monsoon in Five Years Clouds India Sugar Export Prospect — Rainfall from June to September was 6% below long-term average, Weaker rains increase risk of India continuing export curbs (BBG).
• Global trade falls at fastest pace since pandemic — Trade volumes were down 3.2 per cent in July compared with the same month last year, the steepest drop since the early months of the coronavirus pandemic in August 2020. Latest World Trade Monitor figure followed a 2.4 per cent contraction in June and added to evidence that global growth was slowing (FT). South Korea’s Export Decline Eases Further, Adding to Optimism — South Korea’s exports to China gained for a second month, Shipments to US, Europe also climbed as global demand improves (BBG).

AMERICAS

• US lawmakers pass short-term deal to avoid government shutdown — Agreement to maintain funding until mid-November leaves out billions of dollars in Ukraine aid (FT). Climate Disasters Drain US Emergency Fund, Adding to Government Shutdown Risk (BBG). Food Insecurity Remains Elevated After Pandemic-Era Benefits End (BBG).
• US inflation outlook brightens as underlying price pressures subside (RTS). Dips in core and “supercore” inflation could bolster a Fed hold — both core and super-core gained 0.1% in August vs 0.2% and 0.5% in July (RTS). US durable goods orders beat expectations in boost to economy in third-quarter (RTS). Durables Look Good From Afar, but Are Far From Good: Wells Fargo (x). US GDP growth unrevised at 2.1% in second quarter as economy shows resilience (RTS). US GDP revised down in every first quarter from 2020 to 2022 (RTS). US Consumer Spending Rose at Weakest Pace in a Year Last Quarter — Second-quarter outlays grew just 0.8%, revised from 1.7% pace, GDP report also showed upward revision to business investment (BBG).
• US Consumer Confidence Drops to a Four-Month Low on Outlook — Expectations index declined in the Conference Board survey, Views on present situation are stable on resilient job market (BBG). US Consumer Spending Is Signaling Pain Ahead: Credit Weekly — There is ‘real concern about weakness in the consumer’: Hunt, Weakness particularly in young people, lower-income households (BBG). Citi Sees Cracks Forming in US Consumers With Low FICO Scores (BBG). Small Business Bankruptcies Rising at Worst Pace Since Pandemic — New signs of economic distress signal no soft landing for many entrepreneurs (WSJ).
• Home Prices in US Hit Record High, Erasing Recent Decline — Buyers are fighting over a limited supply of homes for sale, Prices have gained 5.3% so far this year through July (BBG). US Pending Home Sales Index Slides to Lowest Level Since 2020 (BBG). Average Payments for New Home Loans Rose 46% in 2022, CFPB Finds — Higher rates ‘had profound effects’ on the market, Chopra says, CFPB found evidence of higher denial rates for some minorities (BBG). US Mortgage Rate Climbs to 22-Year High of 7.41%, Curbing Demand — Contract rate on 30-year fixed mortgage at highest since 2000, MBA index of home-purchase applications remained depressed (BBG).
• Rising headwinds threaten US economy’s resilience — Risk of government shutdown adds to concerns that American consumer is about to crack; start of October by the expiry of coronavirus pandemic-era relief for student loan repayments and childcare subsidies for providers; “At a time when incomes are being squeezed again by higher fuel costs, the ongoing increases in borrowing costs and student loans restarting, I am concerned that we will see consumer spending slow rapidly in the fourth quarter”; Once bolstered by a hefty stock of excess savings, Americans are estimated to have fully run down those balances this quarter; Delinquencies are rising again for credit cards and auto loans. Small and medium-sized businesses are also feeling the pressure, a new quarterly survey by Morning Consult showed, with many reporting shrinking sales and little expectation for improvement (FT).
• Canada’s economy stalled in July as previous rate hikes took hold — Growth ground to a halt in July as the manufacturing sector posted its biggest decline in more than two years, but it most likely ticked up 0.1% in August (RTS). Canada Economic Growth Misses Forecasts, Backing Rate Pause — Bonds rally after numbers show economy is nearly a stall, Most economists believe BOC is done raising interest rates (BBG).

EUROPE

• Euro zone inflation falls to lowest in 2 years as economy slows — Inflation falls across the board, ECB’s rate hikes take toll on economy (RTS). French inflation unexpectedly slows in September as food price rises ease (RTS). German inflation falls to lowest level since start of Ukraine war (RTS).
• Euro-Area Loans to Firms Grow by Least Since 2015 on ECB Hikes (BBG). German business sentiment worsens in September -Ifo (RTS). German GDP expected to contract 0.6% this year, economic institutes predict (RTS). Swedish Consumers Turn Gloomier as Labor Market Weakening Looms (BBG).
• SNB done with rate hikes, end-2024 level a mystery (RTS). Swiss Central Bank Stepped Up FX Sales in Bid to Tame Inflation — Swiss National Bank sold equivalent of 40.3 billion francs, Officials announced further sales after surprising rate pause (BBG).
• UK’s Money Supply Falls for First Time in Recession Signal — Monetarist economists warn money supply data suggest downturn (BBG). Revisions show UK economy no longer the post-pandemic laggard — UK economy 1.8% bigger than in Q4 2019, Previous data had showed economy 0.2% smaller than pre-pandemic, Growth outstrips Germany and France, slower than rest of G7 (RTS).
• UK Mortgage Approvals Hit Six-Month Low After Rate Rises (BBG). UK Homeowners Say Jump in Interest Rates Will Force More to Sell — Soaring interest rates are straining mortgage holders, Analysts anticipate house price declines will accelerate (BBG). London Pushes UK Home Price Cuts to Biggest Since 2019 — Discount to asking price biggest in London, southeast England, BOE hikes, cost-of-living crunch are straining would-be buyers (BBG). UK Loses Tax-Registered Businesses for the First Time Since 2011 (BBG).

ASIA

• China’s economy stabilises, factory activity returns to expansion — “The manufacturing PMI, plus the good industrial profit figures, suggest that the economy is gradually bottoming out” (RTS). China hopes Golden Week holiday will deliver economic boost — Surge in consumer spending could spill over into fourth quarter and help ailing property sector (FT). China Home Sales Saw Mild Recovery in September Amid Policy Push (BBG). Hong Kong Finance Chief Hints at Easing Property Market Curbs (BBG).
• Bank of Japan dispels view that risk of loss will impede easy-policy exit — “still a distance to go”, “A central bank’s ability to conduct monetary policy is not impaired by a temporary decrease in its profits and capital, provided that it conducts appropriate monetary policy”. Some academics have warned the BOJ’s huge balance sheet will make an exit from ultra-loose policy difficult by exposing it to massive losses that could put its credibility on the line (RTS).
• Souring Global Office Bets Raise Risk of Korean Liquidity Crunch — Korean brokers have $10 billion of overseas property exposure, Analysts see bigger losses ahead as loans start to mature (BBG).
• Australian Inflation Quickens, Keeping Rate Hike in Play — Measures of core inflation still well above RBA’s 2–3% target, RBA is still expected to stand pat for a fourth straight month (BBG). Australian Housing Prices Stay Strong as RBA Seen Standing Pat (BBG). RBA to Hold Rate as Pimco Sees Hikes Already Hitting Households (BBG).

EQUITIES

Equity value funds observed $4.37 billion worth of outflows, the most since December 2022. Growth funds witnessed about $1.95 billion worth of net outgo

All Countries World Index some support into Quarter-end which probably shouldn’t come as a surprise given how extremely short the market was at Index and Single stock level and via options. Weekly trend is still still very bearish the MACD expanding negatively against the signal line but has printed a reversal bar off the 91.50 handle and 100ema. Daily timeframe is very short-term stretched with MFI oversold and Friday’s low tagged the 200dma with a Demark daily 9 countdown.

Developed and Emerging market charts showing similar signs of a short-term reversal — lower-low bullish divergence on the oscillators after a firm retest of the pivot level seen last Dec and Q1 this year and a daily Demark 9 countdown on EEM.

US benchmarks somewhat less convincing to me technically even though they are showing a similar complexion to the above charts. While the Demark 9 countdown observed last Wednesday holds however, I do think a 50%+ retracement of the last leg is in order which is only about a further 2–3% from last week’s close.

Refinitiv’s US most-shorted-stocks index is showing signs of accumulation above a key pivot level with bullish divergence where I think just a touch of fresh momentum to the upside could help the recovery in broader sentiment..

AAII Sentiment has gone bearish with the bull bear spread at -13.2%. The last time sentiment had been this bearish was back in May.

Equity volatility is picking up as sentiment has turned negative with ATM IV around the April-May peaks. Downside protection premiums were far more elevated then and this could be the area to keep an eye on in the weeks ahead for directional clues, also with Put/Call ratios having come off their extreme highs in the last week of the Q3.

I like longs looking for a 2–3% bounce while we await for incoming data and further developments to assess the potential for a year-end rally, of which I remain skeptical of.

COMMODITIES

Commodity prices have broadly eased off owing to the sharp sell off in Precious metals and slump in Agriculturals while Energy rally has eased off.

I’ve gone short Crude given the extreme positioning and the idea that OPEC+ will loosen up production as to not exacerbate the global growth slowdown which is of mutual interest of producers and consumers alike. We are already seeing some chatter of OPEC relaxing their tightening production plans as well as fresh supply coming into the market next year.

Industrial metals was the bright spot in Commodities, making a big comeback last week and breaking trend. Although it has been mostly a counter-cyclical indicator in this cycle, it does suggest there is some moderate demand and bodes well that global demand hasn’t fell apart.

The so-called Dr. Copper produced a false break after some Demark signals but the bounce has been capped by moving averages overhead. Another one to keep an eye on.

RATES

As of end of September (Orange), end of August (Purple) and end of July (Green).

We’ve seen some tremendous moves in the US yield curve with the longer-end rising ~50bps in the last month and real yields rising more than 30bps.

Real yields have been rising at an electric pace against breakevens which signals a massive tightening in financial conditions which largely explains the sudden acceleration in the S&P500 sell off.

I do wonder if may have hit a point where this move does start to consolidate however e.g. in and around big levels historically, weekly and monthly RSI oversold and bullish divergences showing. Beyond the charts, November hike is looking far less likely though we would need to see the next CPI and PCE reports where we could see the effects of rising Energy prices feed through further, and economic data stagnating progressively. As the driver of broad market weakness — this is likely to be one of the most relevant questions to whether the strong Q4 seasonalities can play out this year.

CURRENCIES

In FX, weekly charts are suggesting the slump in EUR and GBP is stalling for the moment; Antipodeans AUD and NZD are bouncing back (likely on a short-squeeze) while CAD sold off aggressively from it’s fib extension as growth stagnates and Crude Oil pulls back; USD and JPY attempts to extend their trends but at short-term extremes and CHF continues breaking down after SNB signaled the end to tightening,

It’s difficult to read into the Quarter-end price action, but if to be believed — G8 FX charts shows hints of possible relief for broader markets.

Further to long AUDUSD EURUSD and AUDCAD noted last week…

Back into GBPUSD on the extreme oversold signals which is occurring at the key pivot level seen earlier this year. As it turns out, we saw some big revisions to growth data suggesting the UK may not be as in a rough shape as was suggested. Should the broader market sell-off base out, I can see a rebound back towards the 1.24 handle. I also have my eye on EURGBP shorts with growth prospects looking gloomier and inflation coming down faster on the southern side of the channel.

AUDNZD longs is now looking attractive being quite stretched from their daily moving averages with a Demark 9 countdown likely to print today. Industrial metals have been breaking out while NZ dairy auctions, although picking up in recent weeks has been in a long slump.

That’s all for now, good luck trading!