Hello traders
I hope you’ve all had a good week!
It has been a similar story in the past few days to what I discussed here last Friday. The markets have been concerned about inflation which sparked a sell-off in equities on Tuesday, only for the market to bounce back over the next couple of sessions as fears abated. Whilst there has been a lot of chop with very little direction on the face of things, beneath the surface there have been some pretty interesting moves.
Many of the most speculative corners of the market have come under real pressure in light of a pickup in inflation leading investors to believe that interest rates will rise sooner than previously expected. This ultimately threatens the stretched valuations of growth names and dampens speculation in crowded momentum trades given the prospect of tightening liquidity. This is one area of the market that I have been careful to avoid in my own portfolio ever since the rotation began to gather pace in mid-February, which coincides with the peak in many of these assets as depicted in the chart below from Bloomberg shows.
This chart was produced earlier in the week, before the colossal sell-off (and subsequent rally) in Bitcoin. As arguably the most speculative of the assets mentioned, crypto traders found themselves in the eye of the storm on Wednesday when the currency token collapsed by as much as 30%. Having seen weakening over the previous few days as a result of interest rate anxieties, it didn’t take much to trigger a cascade of selling as China’s government effectively ruled against the use of Bitcoin and other cryptos as a legitimate method of payment after a few tweets by Tesla CEO Elon Musk also spooked investors. Whilst ‘HODLers’ were largely undeterred, it demonstrated for me just how fragile many of these consensus trades really are now.
Whilst we’re on the subject of Bitcoin and Elon Musk, it might also be worth considering the news that famed short-seller Michael Burry (of ‘The Big Short’ fame) this week announced a sizeable short bet against Tesla, putting more pressure on the EV manufacturer’s share price.
Returning to our conventional analysis, another key driver in the markets this week has been the weakening in the US dollar as a result of falling real yields (a product of inflation rising faster than interest rates). The consequences of this can be felt across the investment landscape, and most notably in gold which has been a beneficiary of this trend.
Whilst our Checklist actually had a negative score at the beginning of this month, falling real interest rates have since become the dominant factor as the strength of the rally in gold clearly confirms.
With a lot going on in other assets - and beneath the surface in equities - as a result of this theme, it is worth reminding ourselves of the bigger picture when it comes to the outlook for the US economy and stock market as a whole. Firstly, our Business Cycle Checklist provides an optimistic outlook for stocks, but also gives reason to suggest that higher inflation and interest rates are likely going forward, which may well spur the reflation rotation. The current score of +4 has improved substantially since last month and sets the tone for the long-term trajectory of the US economy.
Similarly, our US Equity Checklist also presents a positive score and suggests that stock investors may look to adopt a bullish bias.
For all the noise this month (following a very good return in April) the S&P 500 is still going strong and is barely 3.5% from setting a new record high. As shown by our process, the fundamentals support the rally and also the rotation which is underpinning it. This is not what a bear market looks like, and investors should in my opinion focus more on the current fundamentals than getting caught up in interest rate speculation.
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Have a great weekend,
James
Disclaimer: For educational purposes only. Even though we do our best to provide reliable data, you should not trade based on this information.
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