Weekly Note 2022.08.15

We’re still in a bear market, right?

Had a rough few weeks being bearish on the market with losses dwarfing all the small wins. It’s about time I score a decent one and think that time is soon. Also as a result of my bearish views since mid-July, I’ve covered a lot my thoughts already in prior weeks, so diving straight into the weekly review, charts and my ideas this week.

LAST WEEK’S ACTION

Risk on! — Equities and commodities up across the board, Safe-havens lower.

MAJOR HEADLINES

US

• Bull or Bear market?
  Bye-Bye Bear Market. For Now, Signs Point to More Buying — better-than-expected inflation helped lead to a 3.3% gain in the S&P500 index, its fourth consecutive weekly advance (Barrons). Market Surge After US Inflation Data Has Skeptics Warning It’s Overdone — “We were pricing a much more severe slowdown than we’ve seen so now it’s repricing for a different outcome. That doesn’t mean we race back to all-time highs, just means that the worst-case scenario of a hard landing is fading into the rear-view mirror.” (Bloomberg). The Market Is Acting Like Peak Inflation Is Over. Not So Fast — Even if inflation has peaked, it’s likely to remain stubbornly high. “One good print isn’t going to change the Fed’s modus operandi,” “The last thing they want to do is take the foot off the brake and have inflation come ripping back (Barrons). This 20% Nasdaq gain doesn’t mean we’re in a new bull market — On the contrary, there have been a number of occasions during past bear markets in which the Nasdaq Composite index rallied by far more than 20%. There were three such rallies during the bear market that accompanied the bursting of the late 1990s internet bubble, for example. The most explosive of them occurred between early April and late May of 2001, during which this benchmark rallied more than 40% (MarketWatch).
• Inflation…
  U.S. Consumer Sentiment Improved in August From Early Summer Low — UoM Consumer sentiment moved up very slightly to about 5 index points above all-time low reached in June. Inflation expectations also eased but remained elevated (WSJ). Grocery prices in July had largest price increase since 1979 — price of food at home rose 1.3% from June to July, marking a 13.1% increase compared to last year (MarketWatch). Rent Is Climbing Fast —government index measuring cost of shelter jumped by 5.7% and accounted for about 40% of the increase in the core index (Barrons). U.S. Home Prices Jumped to Record High in Second Quarter — Median prices rose by double digits from a year earlier in 80% of 185 metro areas (WSJ). Mortgage Rates Tick Back Up Above 5% (Barrons), Homes Are Staying on the Market Longer: ‘We Finally Hit the Turning Point.’ (Barrons).
• Labour market…
  Rapid Wage Growth Keeps Pressure on U.S. Inflation — Pay increases exceeded an annual 5% every month this year as companies vie for workers in tight job market (WSJ). Labor Shortage Is Vexing Challenge for U.S. Economy — labor force is about 600,000 smaller than in early 2020, several million smaller if adjusted for the increase in population. After approaching prepandemic levels earlier this year, the number of workers has fallen since March by 400,000. Participation rate was 62.1% in July, down from 62.4% in March, and much lower than prepandemic rate of 63.4% (WSJ). U.S. Jobless Claims Rise Slightly to New 2022 High — Initial jobless claims, a proxy for layoffs, increased to a seasonally adjusted 262,000 last week from a revised 248,000 the previous week, the weekly number has been on an upward trend since reaching a 50-year low in March. Continuing claims, a proxy for the number of people receiving government unemployment payments, increased by 8,000 to 1.43 million in the week ended July 30 (WSJ).
• Desperate Democrats…
  FBI Recovered 11 Sets of Classified Documents in Trump Search, Inventory Shows — Including some marked as top secret and meant to be only available in special government facilities (WSJ). US lawmakers draw battle lines over search of Trump home — Democrats want ‘damage assessment’ on seized documents while Republicans question FBI action (FT). Donald Trump backs ‘immediate release’ of documents on FBI search of Mar-a-Lago — “Not only will I not oppose the release of documents related to the unAmerican, unwarranted, and unnecessary raid and break-in of my home in Palm Beach, Florida, Mar-a-Lago, I am going a step further by ENCOURAGING the immediate release of those documents. This unprecedented political weaponisation of law enforcement is inappropriate and highly unethical” (FT). U.S. lawmakers arrive in Taiwan with China tensions simmering — “discuss shared interests including reducing tensions in the Taiwan Strait and expanding economic cooperation, including investments in semiconductors, reaffirm the United States’ support for Taiwan as guided by the Taiwan Relations Act, U.S. — China Joint Communiques, and Six Assurances, and will encourage stability and peace across the Taiwan Strait” (CNBC). US Goes on the Offensive in Its China Tech War — Under former President Donald Trump, the US began extensive deployment of export controls in an effort to cut off Chinese tech champions including Huawei Technologies Co. from key, sophisticated equipment and software. President Joe Biden continued that effort, and even expanded it (Bloomberg).

EUROPE

• Rhine to Recede Further as Climate Crisis Adds to Energy Crunch — The Rhine is western Europe’s most important river for the transport of fuel and other industrial goods. Many barges find it uneconomical to transit past Kaub when the water marker there is at 40 centimeters or below, currently at about 35 centimeters (Bloomberg). European electricity prices hit new highs amid power market disruption — Summer heatwave and impact of Russia’s war in Ukraine send prices to record levels (FT). Norway’s unexpected energy crisis — Unusually dry weather has reduced hydropower production, leading to pressure to cut electricity exports (FT).
• Germany Heads for Engineering Pay Showdown Due to Energy Crisis — Employers refuse raises, see companies’ survival at stake (Bloomberg).
• Putin’s War Sends Russian Economy Back to 2018 in Single Quarter (Bloomberg) Considering the lost output, GDP is now roughly equivalent to its size in 2018.
• U.K. Economy Shrank in Second Quarter as Inflation Hit Households (WSJ) Recession is projected as the nation struggles with soaring gas bills and rising interest rates. Johnson admits UK’s cost of living support is not enough — Outgoing PM says there is ‘extra cash’ available to help households through winter (FT). UK’s debt and welfare payments bill set to soar by more than £50bn (FT). Farmers fight to save stunted crops in record UK heat — Livestock and dairy farmers use up winter feedstocks as climate change brings further extreme weather threats (FT).

CHINA / ASIA

• China Crisis Wipes Out $90 Billion of Developer Market Value in stocks and dollar bonds this year, — Builders’ shares weakest since 2012, junk bonds at record low. Sector outlook dim as Beijing prioritizes appeasing homeowners (Bloomberg). China new bank loans tumble more than expected amid property jitters — Chinese banks extended 679 billion yuan ($101 billion) in new yuan loans in July, less than a quarter of June’s amount and falling short of analysts’ expectations (Reuters). China’s Mounting Risks Set Stage for PBOC to Rein In Stimulus — China may be ready to curb some of the excess liquidity sloshing in the banking system as it turns its focus to mitigating risks in the financial industry (Bloomberg).
• China Factory Orders Shrink in Ominous Sign for Global Outlook — Makers of Christmas decorations to clothing and tents say orders from overseas customers are drying up, with some predicting the best they can aim for is flat demand versus last year (Bloomberg). Luxury watch prices plummet on weak Chinese consumer confidence — prices of second-hand luxury goods have fallen rapidly in China over recent months, as even the wealthy cut back on their discretionary spending and sell their Rolex watches and Hermès bags to raise cash (FT). China’s July auto sales extend recovery, jump 30% as COVID curbs ease (Reuters).
• Shanghai Schools to Reopen After Classes Suspended in March — Students and teachers must be in Shanghai for two weeks before schools start on Sept. 1, and take two nucleic acid, or PCR, Covid tests within three days before returning to campuses (Bloomberg). Several cities in China add COVID curbs as millions still under lockdown — Reducing people’s unnecessary movement for a few days — a softer type of lockdown — as soon as dozens of new cases emerge is a key practice of China’s “dynamic COVID-zero” strategy (Reuters).
• Asia Analysts Predict Biggest Profit Drop Since Pandemic Started — Earnings per share for MSCI Asia Pacific Index members slid 16% in the three months through June from a year earlier, the steepest decline in eight quarters (Bloomberg)
• South Korea to Slash National Budget for First Time in 13 Years — “We are tightening our belt. The former administration had a lot of debts, and we can’t do that” (Bloomberg). Samsung heir Lee Jae-yong to win presidential pardon — paving the way for him to retake the helm of South Korea’s biggest company as it confronts slowing demand in the global chip sector (FT). South Korea disputes China’s account of foreign minister talks (FT).
• India could emerge as Asia’s strongest economy in 2022–23, says Morgan Stanley — as it is best-positioned to generate robust domestic demand, helped by economic policy reforms, a young workforce and business investments (Reuters).

EQUITIES

US markets continues to lead global equities, but starting to get relatively overbought as it tends to slow down when the SPX relative to the ACWX extends beyond the weekly 2nd standard deviation band.

Energy made a strong recovery while value and small-cap sectors outperformed with market getting more optimistic about a softer landing.

Strong bullish impulse is pointing to an extension of last week’s rally, but doesn’t appear to much room left with a confluence of technical resistance above while overbought. 4350 on SPX and 2050 on RUT would be the levels to watch but I suspect it could even come up short should US data stunt the momentum, and…

the Value Line Arithmetic Index (essentially an Equal-weighted index of all stocks) has highly confluent technical levels within touching distance — 50wma, 1sd-band and 61.8fib. Also 2/3rds or more of stocks are above the 20, 50 and 100 day moving averages which tends to increase the risks of pullbacks (assuming we are still in a bear market of sorts).

Coming into August, price action was looking increasingly exhausted until the post-CPI squeeze caused hedge funds a good deal of pain, and it probably shouldn’t come as a surprise that hedge funds had once again built up a large short exposure given the trajectory of the US growth and liquidity.

According to GS Prime, this rally has now become the 3rd biggest hedge fund short covering event in the last decade. The last time being early 2021 when we had Meme stocks mooning 1000%+ causing hedge funds (most notably Melvin Capital) to get burned. What’s interesting is the heavy selling flow that ensued from each of those spikes, in particular the one in early 2021 which had flipped over immediately with SPX seeing some choppy trading in the following months.

Why wouldn’t it be? The forward path of financial conditions and earnings growth is the polar opposite to early 2021 and it would make little sense to me that we rally back to ATH’s.

COMMODITIES

Prices paid and PPI has continued lower in recent months but with the Bloomberg commodities index roughly +10% from July lows, August data points could be interesting, especially as the severe weather conditions on top of ongoing geopolitical risks is impacting crop yields and disruptions in supply routes.

WTI Crude is looking particularly weak trading below the moving averages. A firm test of the lows and support at 85.00 looks in order. No view, but I would consider longs depending on how markets/sentiment is around those levels.

US gasoline prices have come down significantly from the highs, but as the Energy market remains very tight, it would seem reasonable to expect prices stay somewhat elevated.

On a side-note, while the fall in gas prices has helped to ease inflation, I think this could be double-edged for the overall inflation outlook as it eases pressure on real disposable incomes while the tight labour market continues to support wage growth. Just a thought.

WTI Crude is looking particularly weak trading below the moving averages. A firm test of the lows and support at 85.00 looks in order. No view, but I would consider longs depending on how markets/sentiment is around those levels.

Metals appear to be showing bearish consolidation/continuation patterns — rising wedge structure into resistance on Gold, and ascending channel in Copper.

RATES

UST bond yields finished the week largely unchanged with the 20 and 30yr yields moving no higher than 6–7bps, reflecting more the more optimistic sentiment around a softer landing than thought.

Fed fund futures pricing have moved away from 75bps after the softer than expected CPI report…

but stickier components such as Shelter costs have continued to rise, while Food prices saw record increases in some items.

Further out, Eurodollar Dec’22 contract is inching back to pre-CPI levels, Mar’23 is back to pre-CPI lows while Jun’23 is trading lower. Market now appears to expecting a more gradual and slower pace of rate hikes with H1'23 cuts being priced out, reflecting the increased probabilities of a softer landing with headline inflation finally showing signs of slowing.

The selling of inflation expectations is dragging up 10yr yields and the optimism towards a more ‘softish’ landing should keep both the 10yr nominal and real rate up. I therefore expect USD to maintain support, particularly against JPY and EUR, while precious metals to underperform.

CURRENCIES

USD traded back to the lows of prior week, while most higher-beta FX traded to new highs on index basis. I think the trade is to find the levels to fade last week’s action with US equity markets getting stretched to the upside.

• USD longs preferred against JPY (positive US real rates), while JPY longs is starting to be attractive as yield curves invert deeper and bond yields rollover. Add to that the weak Chinese data earlier today and the potential for risk aversion to come back, AUDJPY short, a popular trade among traders I speak with regularly, is now looking very attractive.

• EUR and GBP shorts are one of the more obvious themes due to the huge stagflation risks (sharp contraction and extremely high inflation) facing both economies. EUR would be my preferred funder against the higher-beta FX when conditions are suited, and German DAX would be the preferred European indices due to being the most impacted by the Energy crisis.

• Of the antipodes I lean towards AUD downside due to exports unlikely to get a lift from China demand anytime soon, while NZD exports could benefit from the tightness in global food trade. I’ve been in out of AUDNZD over the past few weeks, and still like the idea — chart looks ready to resolve lower, pair is rich on yield differentials, and I would consider RBA likely to be the more cautious of the central banks. RBA minutes and RBNZ rate decision to finally kick it lower?

Currently short AUDNZD and Gold, long USDJPY and will be switching my focus on rebuilding short risk positions to hold into next week, anticipating OPEX to clear the floor for a pullback in US equities:

Long USD vs EUR and GBP; Short AUDJPY; Short US equities.

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