“Investing illusions can continue for a surprisingly long time”, Warren Buffett

Since 2009, the Fed has focused on financial markets, hoping to impact jobs and growth. But Powell’s testimony last week suggests it now wants higher interest and inflation rates to confirm a recovery in the real economy.


Oil

Brent moved higher early in the week on news that 30mb of Texas output would likely be lost due to the freeze. It then fell back to close at $64.63/bbl. Geopolitics are likely to be key to the outlook.

✦  HIGHLIGHTS

  • Market prices are now back at pre-pandemic highs – but only because of major OPEC+/shale cutbacks
  • They are also within touching distance of the technical resistance level established since the 2014 price collapse
  • Biden’s release of the CIA report suggesting Saudi’s Crown Prince approved Khashoggi’s murder confirms the end of MbS’ cosy relationship with Trump
  • It also means Saudi has lost its veto over Biden’s planned re-start of Iran talks, which could lead to a quick end to oil sanctions
  • Saudi has only limited options when it comes to increasing its exports, as Iran already has a major deal with China, and US imports are now relatively low
  • Biden’s actions also mean the Crown Prince’s position may start to be questioned by other Saudi royals

WATCH FOR

Saudi’s leadership of OPEC+ to come under pressure if it tries to monopolise any increase in output


S&P 500

Despit a bright start, the S&P fell 2.4% to 3811, whilst the VIX volatility index jumped to 28

✦  HIGHLIGHTS

  • Investors have seen themselves in a perfect world, with talk of stimulus further boosting market sentiment
  • But pressure is clearly mounting on the equities bubble
  • ‘Buy on the rumour, sell on the news’ is always a sign of a weak market – and news that Biden’s $1.9tn stimulus has passed the House brings that moment closer
  • The major bubble stocks led the downturn, with Tesla down 14% and the Nasdaq down 5%
  • Retail ‘investors’ haven’t yet got the message, though, with Gamestop doubling in a few hours on Wednesday/Thursday

WATCH FOR

Rising interest rates to continue weighing on equities.


Interest rates

The rate moved up again to 1.46%, whilst the MOVE volatility index jumped 25% to 76.

✦  HIGHLIGHTS

  • The rate is now at a key technical resistance point, with any move higher likely to take it rapidly towards the 2% level
  • Buffett is on the side of the bears, suggesting “Fixed-income investors worldwide – whether pension funds, insurance, companies or retirees – face a bleak future”
  • Thursday was a bad day, with confidence hit by an “extraordinarily weak” $62bn auction of 7yr Treasury notes.
  • At the same time, the US 5yr bond rose from 0.61% to 0.80% in a single session
  • Investors are starting to realise that the Fed would now like inflation to move well beyond its target 2% level, to support its growth narrative

WATCH FOR

The Fed’s tacit support to encourage investors to push rates higher


Global liquidity

A weakening dollar increases liquidity, and generally supports rising stock markets. The chart suggests we may be close to a peak.

✦  HIGHLIGHTS

  • The US$ has moved in a regular cycle over the past 40 years versus the Euro (the world’s second most important currency) and its predecessor the Deutschmark
  • A rising dollar tends to decrease global liquidity, as prices become more expensive for those outside the dollar zone; and liquidity rises as the dollar weakens
  • Rising liquidity is also good news for stock markets as it makes it easier for investors to obtain cash
  • As the chart shows, there has been a reasonable correlation between rises/falls in the annual change in (a) the Euro’s rate versus the US$ and (b) rises/falls in the S&P500
  • The cycle tends to reverse when the Euro has risen 18%, or fallen by 12%
  • The Euro is currently up around 11%, so liquidity could have further to grow. But rising US interest rates would likely lead to a reversal as investors bought the US$ again

WATCH FOR

Consensus thinking is usually wrong at turning points. It currently expects a new decline in the US% to boost global stock markets.


Summary

Investors prefer a simple story and dislike uncertainty. Geopolitical developments in the Middle East, and the Fed’s support for higher interest rates, may therefore start to impact confidence.

Oil

S&P 500

Interest rates

Market view today

Some concerns

Some concerns

Expecting inflation

Our current view

Negative

Reversion to mean inevitable

Expect long-term deflation

Positioning began

December 2020

December 2020

December 2020

Confidence level
Initial
Today

.

.

.

Relevant positioning

Waiting for reality to dawn

Waiting for reality to dawn

Expecting higher rates for the 10-year and longer-dated Treasuries

Confidence level: = 100%,  = 75%, = 50%, = 25%


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This Research Note has been prepared by New Normal Consulting GmbH for general circulation. The information contained in this Research Note may be retained. It has not been prepared for the benefit of any particular company or client and may not be relied upon by any company or client or other third party. New Normal Consulting GmbH do not give investment advice and are not regulated under the UK Financial Services Act. If, notwithstanding the foregoing, this Research Note is relied upon by any person, New Normal Consulting GmbH does not accept, and disclaims, all liability for loss and damage suffered as a result. The pH Report and pH Outlook are published by New Normal Consulting GmbH.
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