2024.07.22 Weekly

A premature sell-off?

Must admit I’m lacking clarity on current market themes of rotations, trump trades, potential for higher yields and how all that can effect the overall market in the near-term.

I do think the recent sell-off to be a somewhat extreme and premature ahead of some key earnings over the coming weeks, and though I’m currently getting killed trying to sniff out these bottoms, I do maintain a constructive risk stance and see this as buying opportunities until the beginning of August.

Beyond that, I see plenty of reflexivity risks and think it could be a very bumpy path into year-end.

Data Review

US retail sales for June beat expectations at 0.0% vs -0.3% expected, and Core retail sales was 0.4% vs 0.1% expected. The non-seasonally adjusted data (chart) shows a different story however — June was in fact quite a weak month vs the prior month and flat over the prior 3-months. Not yet overly concerning, but not as strong as the seasonally adjusted data suggests.

What could be more concerning as the picture develops is the continuous rise in Jobless claims. Initial claims is back to levels seen at the beginning of the year and roughly 35k above the pre-pandemic 5yr average, while continuing claims continues to inch higher but still almost 100k short of the pre-pandemic 5yr average.

The rotation trade

Barclays put out a statistic on the rotation theme which looked immediately suspicious since cutting cycles tend to begin when there is significant economic slowing or even a recession; they note:

“We looked at RTY/SPX performance over the 13 cutting cycles between 1980–2020; the notion that the first cut signals a sustainable uptrend for small caps is not necessarily borne out. RTY tended to underperform SPX before and after the start of cutting cycles over the last 40yrs.”

But it’s quite rare the Fed has eased into a soft-landing, the closest example of that is probably the mid-90s, which Dario Perkins notes:

“this isn’t a cycle; the world economy has been normalizing following a number of big macro distortions. But we will probably end up in something resembling a soft landing. That would put us ‘mid cycle’, sort of like the mid-90s”

The Fed funds rate peaked in Apr’95 with Q/Q real GDP growth loosely averaging about 3% during those years. In the panel below we can the relative performance of RTY/SPX and although there is some truth to Barclays observation that RTY generally underperforms, there has been periods where is has greatly outperformed immediately after the first cut, and in early 1996 when growth was on the rebound.

Suffice to say that I think we can expect market broadening can continue for the forseeable future given the US economy is still in strong shape (good summary here from Brent Donnelly of Torsten Slok’s work).

Further, with Trump likely to become President again, his MAGAonomics has been good for the eonomy initially before his protectionisms seemingly weighed on the economy later on. Looking at the same chart during his 2017–2020 term, RTY/SPX relative performance was fairly steady in the first year and a half of his presidency, but later underpeformed at the height of the Trade wars.

Altogether, I think this supports the theme of laggards catching up via rotations and broadening over the medium term.

That said, I don’t think it’s a smooth path ahead …

Reflexivity thesis revisted

USTs have seen a strong bid via a big bull steepening move with the 2s10s narrowing as much as 30bps over the last month — inflation has been coming down, economic data weakening, and market expectations have turned more dovish, and seemingly more pessimistic on growth also looking at the move in 5 and 10yr yields. But I think these are conditions where the reflexivity thesis can begin to kick in. As my good friend succinctly, and rather perfectly I’d say, phrased it:

“Too much pessimism for slowdown and too much hope for linear disinflation”

‘Too much pessimism for slowdown’ was touched on above noting the Torsten Slok’s ‘economy is still in good shape’ summary. If this ‘economic resilience’ (pivotal to the reflexivity thesis via potential 2nd-order effects) continues for longer, we are likely to see more reluctance from the Fed to ease as swiftly as the market expects.

“Too much hope for linear disinflation” could be observed via the SOFR curve — fully priced for a September cut (-26bps), and 64bps by the end of the year which, another 65bps of cuts in the 1st half of 2025.

For both halves 2H2024 and 1H2025, that to me is looking as dovish as it can get… and this where I see the reflexivity trade starting from.

Bond vol has been on a downtrend since October last year and I think we could see another bout of elevated volatility as a result of overly dovish and pessemistic on growth expectations reverting. In other words, we may see a return of bond vol from a growth rebound similar to what we experienced in Q3 last year.

Looking ahead

PMIs and PCE on deck this week along with some UST auctions.

Tuesday sees the mega TSLA and GOOGL results after the bell.

Earnings expectations continued to climb into July, now 13.21% NTM!

NEWSFLOW

MARKETS

• Dow tumbles more than 370 points, S&P 500 posts worst week since April as investors dump big tech (CNBC). High-Flying Chipmakers See Worst Plunge Since 2020 (BBG). Investors count on earnings to calm $900 billion US tech rout (RTS), Flailing Stock Market to Get a Lifeline From Earnings, Survey Shows (BBG). S&P 500’s Next Leg Up Hinges on Battered Stocks Getting Revenge — Equal-weight S&P posts best two weeks vs cap-weight since 2020, Small caps notch second-biggest inflow ever at $9.9B: EPFR (BBG), Russell 2000 beats tech-heavy Nasdaq 100 by most in decade (BBG), US small-cap funds saw a significant surge in demand as they received $8.67 billion the largest weekly inflow since at least October 2020, Large-cap funds garnered $10.34 billion of inflows (RTS), Russell 2000 notches its best five-session run since 2020, CPI reading launched small cap rally as two-year yield plunged (BBG). Wall Street’s Great Rotation Trade Is Stirring Up Hedging Market — Rising demand to hedge portfolios on political, monetary risk, Bearish bets on tech darlings now outweigh bullish wagers (BBG). Trump Trade Is Back. But Did It Ever Work? — Investors are buying small-cap and ‘old economy’ stocks in a way reminiscent of 2016. It won’t necessarily pan out (WSJ). Trump Trade Sees Investors Snap Up Junk Debt and Industrials (BBG). UK stocks end with weekly losses as commodity-linked stocks weigh (RTS). Europe’s STOXX 600 logs weekly decline as tech, resources shares weigh (RTS).
• Traders Add to Bets on Three Fed Rate Cuts in 2024 — Swaps briefly price in more than 60% of a third move in 2024, Expectations remain short of where they began the year (BBG). Top Fed officials say they are ‘closer’ to cutting interest rates — Waller and Williams both noted shortening horizon toward looser monetary policy, Barkin “very encouraged” that declines in inflation had begun to broaden (RTS), Powell says latest data ‘add somewhat to confidence’ inflation is returning to 2% (RTS), Fed Prepares for September Cut as Powell Shifts Focus to Jobs (BBG), Williams Says Long-Term Trends Still Back Low Neutral Rate (BBG). Donald Trump warns US Fed chair not to cut rates before the election — Ex-president says he would let Jay Powell finish term at central bank if he was ‘doing the right thing’ (FT). IMF: warns of ‘bumps’ on road to lower inflation — Concern comes as FED and BOE consider rate cuts (FT), sees steady global growth, warns of slowing disinflation momentum (RTS).
• Investors revive ‘Trump trade’ in bet on US bonds — Traders backing short-dated debt to outperform longer maturities encouraged by prospect of interest rate cuts (FT). Big US bond managers steer clear of long-dated government debt — they expect fiscal worries to spur periodic bouts of volatility (RTS). Foreign US Treasury holdings rise, Japan’s stockpile shrinks — Foreign holdings of U.S. Treasuries hit a record in May while a decline in Japan’s huge stockpile closely coincided with what appeared to be the start of intervention to support its currency (RTS).
• Dollar climbs for the week, cyber outage unsettles investors (RTS). Gold jumps to record above $2,460 (CNBC). WTI futures backwardation widens to 8-month high as Cushing stocks fall (RTS). US imports of Canadian crude hits record high following TMX startup (RTS). OPEC+ unlikely to change oil output policy at Aug 1 JMMC meeting, sources say (RTS). Copper Set for Worst Week Since 2022 as China Plenum Disappoints (BBG), Hits New Three-Month Low (BBG). Wheat Climbs as Investors Trim Bearish Bets Amid Crop Woes (BBG).

AMERICAS

• Joe Biden drops out of US election and endorses Kamala Harris (FT). Trump taps Ohio Sen. J.D. Vance to be his vice president (Politico). What would a Trump-Vance economic agenda look like? — Maganomics promises a radical break from Republican laissez-faire dogma (FT). JD Vance Pick Hardens GOP Swing to Protectionist Trade Stance — Trump plans for huge tariffs reverses decades of orthodoxy, Nominating Vance positions a successor to entrench trade views (BBG). ‘I Don’t Like China:’ What JD Vance Has Said About Beijing — Trump’s VP pick has suggested US military focus on China, Vance has backed cutting access to US financial system (BBG). For JD Vance, It’s Always Been Them Against Us — If you were surprised at the vice presidential candidate’s conversion to Trumpism, you didn’t read his book (BBG).
• Initial Jobless Claims in US Increase by Most Since Early May — rose by 20,000 last week to 243,000, Continuing jobless claims climbed to highest since late 2021 (BBG). US retail sales report showcases consumer, economic resilience — Retail sales unchanged in June, May retail sales gain revised up to 0.3% from 0.1%, Core retail sales surge 0.9%; May data unrevised (RTS), US Retail Sales Excluding Autos Rise by Most in Three Months — Advance suggests consumers regained footing at end of quarter, Drop at auto dealers due to cyberattack restrained total sales (BBG). Fed’s Beige Book Shows Slight Economic Growth, Cooling Inflation — Nearly half of districts reported flat or declining activity, Price gains modest as consumers buy essentials, trade down (BBG). US Mortgage Rates Fall for Second Week, Easing Strain on Buyers — Average for 30-year loans drops to 6.77%, lowest since March, Homebuyers have yet to respond to lower costs (BBG). US firms point to slowing activity and softer labor market, Fed survey shows (RTS). US import prices flat in June (RTS). US Homebuilder Sentiment Declines for a Third Straight Month — NAHB index eased 1 point to 42, the lowest level this year, 31% of builders cut prices in July, up from 29% in prior month (BBG). US Housing Starts Increase on Pickup in Multifamily Construction — New construction rose 3% in June, building permits up 3.4% (BBG). US single-family housing starts hit eight-month low; green shoots in manufacturing — Single-family housing starts fall 2.2% in June, Single-family building permits drop 2.3%, Manufacturing production increases 0.4% more than expected (RTS).
• Bank of Canada to cut rates on July 24, then twice more in 2024: Reuters poll (RTS). Canada Inflation Decelerates to 2.7%, Core Measures Sticky — Sixth straight month that headline CPI in BoC target range, Traders boosted bets for a second rate cut next week to 90% (BBG). Canada retail sales fall in May, boosting interest rate cut calls (RTS). Canadian dollar hits 2-week low as potential rate cut looms (RTS). Supply in Canada’s property market surges as mortgage renewals loom (RTS).

EUROPE

• Starmer Plans Law Change to Simplify UK Alignment With EU Rules — King’s Speech quietly announces product regulation law change, New Labour government wants to ease trade friction with bloc (BBG). Europe Resets Relationship With UK After Years of Strained Ties (BBG). UK Faces Stark Choice as Public Service Pay Hikes Loom — Chancellor Reeves fears worker shortages if wages are kept low, Research group warns more borrowing or taxes may be needed (BBG). UK finance minister hints at above-inflation pay rises for public sector workers — Reeves said she will consider giving inflation-busting pay increases for almost 2 million government employees later this month to avoid crippling public sector strikes (RTS). UK borrowing overshoot underscores task for new government — Borrowing 14.5 bln pounds in June vs Reuters poll 11.5 bln, Borrowing 2.9 bln pounds more than OBR forecast, New government has ruled out major tax increases, Net debt 99.5% of GDP, highest since early 1960s (RTS).
• Rate Cut or No, the UK Economy Is in Good Shape — latest wages data doesn’t make an August rate cut any more likely. But that doesn’t matter (BBG). UK inflation pressures stay hot, reducing chance of August rate cut — UK consumer price inflation 2% in 12 months to June above the 1.9% expected, Services inflation holds at 5.7%, Investors pare bets on Aug. 1 BoE rate cut, Taylor Swift tour might have fuelled inflation (RTS). London Rental Inflation Eases in Relief for Squeezed Tenants — Annual price gain is below 10% for first time since January, however tenants pay record £2,100 per month for private rents (BBG). UK inflation expectations ebb before BoE meeting, Citi/YouGov survey shows (RTS). Cooler UK weather chills retail sales in June (RTS). England and Wales record second-highest company insolvencies since 2009 (RTS).
• Von der Leyen Reelected to EU Top Job in Push for Stability — Commission chief vows to keep climate, emissions targets, Platform centers on boosting competitiveness versus US, China (BBG). ECB keeps interest rate at 3.75% — Christine Lagarde says September rate cut decision is ‘wide open’ (FT). ECB policymakers back more rate cuts as inflation heads back to goal (RTS). ECB’s Villeroy Says Market Views on Rate Path Are Reasonable — Investors are leaning toward two quarter-point cuts this year (BBG). Euro zone inflation will continue easing, may fall below 2% in 2026, ECB survey shows (RTS). German property sector cracks show as new building starts tumble (RTS). Fall in German home building permits picks up pace (RTS).

ASIA

• Highlights of China CPC Third Plenum’s Resolution on Reforms (BBG). China tries to hit more birds with one stone in property rescue push — Beijing ordered Chinese cities to buy newly-completed apartments and turn them into affordable housing (RTS). Xi Jinping’s Great Economic Rewiring Is Cushioning China’s Slowdown — Advances in electric vehicles, solar and semiconductors are helping the nation navigate its property slump (BBG). China’s economy falters, raises pressure for more stimulus — China’s Q2 GDP grows less than forecast, Factory output and retail sales growth slows (RTS). China to hasten work on redrawing model for real estate industry (RTS). China’s stubborn savers ignore inducements to spend as growth slows (RTS).
• Japan core inflation perks up in June, keeps BOJ rate hike hopes alive — June core consumer prices rise 2.6% yr/yr vs forecast +2.7%, Index excluding fuel rises 2.2% yr/yr in June, BOJ to forgo July hike, over three-quarters say in Reuters poll (RTS). Japan cuts growth forecast, prime minister warns of weak-yen pain (RTS). Japan’s mixed business sentiment highlights patchy economic outlook — Manufacturers sentiment index +11 in July vs +6 in June, Service-sector mood +26 down from prior month +31 (RTS). Japan attracts record 3.14 mln June visitors as weak yen draws travellers (RTS).
• New Zealand Inflation Slows More Than Expected to 3-Year Low — Annual CPI rate falls to 3.3% from 4% in previous quarter, Three main banks now see RBNZ rate cuts starting sooner (BBG). New Zealand Inflation Report May Pave Way for RBNZ Rate Cuts — Statistics NZ to release second-quarter CPI data Wednesday, Inflation seen slowing more than central bank has forecast (BBG).

EQUITIES

Starting with the SPX, I posted on twitter that we could be seeing quite the setup for a ‘Turnaround Tuesday’ but it’s already beginning to look like a mistimed call, and the turnaround may already be in…

Not that it bothers me as I’ve been buying deep into this NDX dip. Key level around the 19750 handle which coincides with the trendline running from the May-June lows.

Russell vs NDX spread has recaptured the range seen earlier in the year. Perhaps there isn’t as much relative value in small-caps from here on and if mega-cap earnings delivers?

Volatility has got more elevated into Friday OPEX but is beginning to roll off now. Market seemed to have been long vol and with much of that weight presumably behind us, the market may be able to find some relief from the recent sell off.

European stocks have started the week with a nice recovery which helps to clear the sour mood left from last week’s sell off and IT outage of which the worst is now far behind us:

Asian equities also looks in decent shape to me — China equities appears to be finding a footing at these levels, Japan and Korea stocks has seen a sharp pullback but in the natural fib retracement zone.

COMMODITIES

Bloomberg commodities index is now looking stretched below the 30-mark on Friday and key support area over the last year. Hope for sweeping reforms out of the China 3rd Plenum came up empty, while Trump/Vance protectionist leaning seems to have weighed in.

Aside Agriculturals, we are back to some key support levels in the sub-indices which makes me interested in long ideas, particularly in Energy and Precious metals.

Crude almost came within touching distance of the 77.5 handle and has put in a decent rebound so far today, NatGas is beginning to break higher with a solid bull candle today — both look very promising for a retracement higher. Silver is show signs of demand at these levels which has been an important pivot over the last few months.

RATES

Trump trade steepener — front-end yields were lower by almost 20bps last week, while the longer-end finished higher.

10yr notes is on the turn with momentum increasing. If commodities are to muster a bounce along with some better data this week, we could see the 10yr return the 4.26–4.29 levels.

CURRENCIES

DXY had a flush of the 104 handle last week and looks have been the short-term lows. This ties in with the idea that US yields are recovering higher from their recent slump. FX has been somewhat confusing lately however, especially for a trader like me that relies on cross-asset feedback to get a sense of how the overall market is trading and the direction of travel for certain asset groups.

Given my constructive risk stance, I do expect USD strength to be limited, but I’m also conflicted by the Trump/Vance protectionist risks which would support the USD. I can only wildly speculate on the latter and therefore lean towards limited USD strength as a result of a recovery in risk.

2 trades in FX that has my attention for this week:

There isn’t much reason to be long Kiwi, but I do find it tactically appealing given its one of the weakest fundamentally and the view that risk sell-off is done and could find relief from here. Similar to the Loonie especially if the BoC doesn’t deliver on the rate cut this week.

Brief one for today… Still in pain from my birthday weekend drinking but think I’ve covered the gist of my thoughts for the week ahead.

Good luck trading.