WEEKLY MACRO NOTE - Irrational Exuberance

As a reminder, the extreme valuations of the past 15 years were in no small part predicated on ZIRP and QE infinity. I think it should be becoming increasingly clear that the QE tool has been removed from the toolbox, and ZIRP is not coming back anytime soon.

The chart below should help contextualize the big picture.

For an even longer-dated view, please see below the ratio of the DOW to GDP

Of course, it is important to stress that none of the above has any predictive power in the short term, but by definition, can only be looked at to help one contextualize the bigger picture.

That said, if you are reading this and are long equities, buying protection right now has become quite cheap, and may be an idea worth entertaining.

WEEKLY RECAP

As anticipated, this week we saw positive action in equity markets on the back of a declining CPI.

The New York Stock Exchange Composite was up 2.35%, Europe was up 3.85%, the FTSE 2.02%, the KOSPI 4% and so on. Pretty much all global markets rose except for the Nikkei, which was flat WoW, and is still catching a breather after this year’s massive rally.

The Dollar meanwhile crashed and was down -2.26%. The move was quite an extreme one-way auction south, and Wed, Thur & Frid were all spent 3 standard deviations away from the 50-day moving average.

This meant that the Long USDNOK trade shared by me last week did very well, and was up 5.67%, and so did the EURNOK short which I have been talking about for a while now, which was down -3%.

The NOK was of course buoyed by the rise in OIL, up for the third week in a row, and closing up 8% from where I shared Oil as a long idea just three weeks ago.

As it stands, if OIl can hold the $72 area, I remain bullish and it may want to make a trip towards $80, otherwise, forget about it.

A similar trade to OIL, which may be shaping up, is in NAT GAS. Now this is an asset with volatility comparable to that of BTC, so you want to keep it on a tight leash and size your position appropriately.

In Nat Gas can hold $2.4, and UNG $6.5, I could see a break out towards $3.5 and $9-10 respectively.

Briefly returning to the FX market, a trade I mentioned a few weeks ago, short the EURAUD, is becoming increasingly attractive. At the same time, if the Dollar were to remain under pressure, the AUDUSD is the only major pair left to break out and if it clears 0.7 it might very well do so.

The declining dollar resulted in commodities rising. In fact, the CRB index was up 2.4% this week.

Which brings me to inflation. A down dollar may be quite good for disinflation in Europe and other countries, but it has the opposite effect on inflation in the US.

Now, after this 3% headline CPI, the deflation crew has gotten quite loud again.
This is quite curious if you consider that prices are still rising, and have not yet stopped doing so. See CPI seasonally adjusted below.

But the increases are clearly no longer as staggering as they were, if you set foot out of your house, it is quite obvious that prices are normalizing at a higher plateau.

But the key question we should ask, is where will headline CPI go from here? Even I with some very crude methods and calculations was able to estimate that CPI would print around 3% for June.

Going forwards, assuming a 0.2% MoM increase, CPI will print at about 3.3% in July and similarly again in August. But watch out for OIL, because this is where most of the disinflation has come from so far. Energy base effects are now no longer favourable, so if OIL starts climbing above $80, then you could get monthly increases of 0.3% or above, which would really surprise a few folks. Another point that I have raised before is that healthcare costs are projected to rise in the back half of the year, also a positive contribution which may offset some of the negative contributions from the shelter or rent component, which are about to kick in.

I think this graph from the BofA helps. Unless we get outright deflation, CPI will still be around 3% by Jan 2024.

The only reason it is worth mentioning this is that it pretty much guarantees that there will be no rate cuts coming any time soon.

This brings me to the final point of our weekly recap, Bond yields.

After marching higher over the past few months, Yields took a breather, and depending on which part of the curve you look at they were down -10 to -30bps.

I personally have no idea where they could trade from here, I could make an argument for either direction, so I shall make it for neither. But if I look at the US 10Y this 3.7%-3.8% area seems quite important and could act as support.

It would be a worrying sign I think if they started to trade back above 4%!

What yields and the dollar do should impact GOLD, although this has become a little less correlated of late.

We have traded Gold very well, and as it stands, as long as it holds $1930, the trend should continue upwards.

On the back of this, some of the GOLD miners I shared 2 weeks ago have had monstrous moves. NEM +6%, FNV +5%, GOLD +6%, these are some of the bigger ticket miners, but if you pushed yourself out on the speculative curve a little more, the junior miners were up about 10% a piece.

SENTIMENT

If we look at sentiment we remain in extreme greed territory. While there is little short-term predictive power to tracking this metric, over a 2-3 month time horizon it has generally been a very good contrarian signal. Equities are stretched, and animal spirits are running wild, but you don’t need me to tell you that, it is quite obvious for all to see.

Investors remain incredibly bullish

While asset allocators are at their 90th percentile of exposure to equities, as compared to 20% just 10 months ago. The result has been an epic chase from underperforming managers. Note that CTAs are also similarly overexposed.

From a positioning standpoint, not much has changed over the past few weeks, other than a historic long that has built up in the GBP. As a reminder this data is collected at the close on Monday, so is lagging. I would not be surprised to find out that a lot more SPX covering went on in the last 4 days of the week, during this latest gamma squeeze.

The last two times positioning was this stretched in the GBP was in June 2014 and April 2018, in both occasions these levels market multi-year highs in the Pound, and it proceeded to decline >10% in the following 12 months.

This is particularly curious in the context of a Dollar which has broken down this week.

The Pound now finds itself quite overbought, at a multi-year trend line resistance, with a very weak central bank, in the face of significant macro headwinds and persistent inflation.

That said, the focus for trades in the GBPUSD trade at the moment seems to be the rate spread.

While there may be some time left on the clock before the trend reverses convincingly, if ever there was a contrarian play, this may well be it. I think over the next month or so one could start building a position that goes against the crowd. A position which can be easily counterbalanced by going long the AUD as mentioned earlier.

ECONOMIC CALENDAR

A few things worth paying attention to this week.

Monday we have a fair bit of data out of CHINA, including GDP, this will be quite telling on the back of some very weak export numbers printed last week, down -12% YoY.

We also get a bit of retail sales data from across the globe, as well as the all-feared UK inflation data, which we hope should so some welcome signs of slowing.

I will be watching the US Redbook data, which is an index that tracks year-over-year same-store sales growth. This declined on a YoY basis for the first time since 2020 last week, and this is not inflation adjusted - in other words, nominal sales were down…

As we enter Q2 earnings season, the above Redbook data can be useful to estimate where Q3 earnings might land.

EARNINGS CALENDAR

We have a lot of bank earnings this week, and I would imagine that JPM was likely to be the best of the bunch. An interesting data point is that JPM reported earnings of $4.75, ahead of the Street's expectations of $3.97. But without $FRC, earnings were $3.95. Good old Jamie got a really sweet deal there.

One thing I think may become apparent is that banks are likely to be at peak net interest margin. This is really quite intuitive; as time passes, banks will be increasingly forced to pass on some of the profits they are getting from the high-interest rates on their deposits to the actual customers. So far few have done this. *Anectodally, in the UK, the Chancellor has been quite vocal and pushing for local banks to do exactly this, and I suspect other countries will follow.

We also get a few tech names, like Netflix, TSM and Tesla, although the big chunk of the tech space reports the following week.

THE WEEK AHEAD

This coming week is MOPEX, so it could mark an interim top/ turning point. Friday we saw a bit of a reversal and sold off into the close, but I would still watch out for another push higher into Wednesday, which is Vixpiry.

Looking beyond this coming week, there are a couple of things which will have a bearing on how the end of July plays out.

Firstly, you have the special rebalancing in the Nasdaq scheduled for July 24th. This will mean that a number of ETFs which track the index, such as the QQQs, will have to sell down some of their mega-cap names and buy some of the smaller caps.

This is to address overconcentration in the index, you can find more details on the Nasdaq website https://www.nasdaq.com/press-release/the-nasdaq-100-index-special-rebalance-to-be-effective-july-24-2023-2023-07-07

At the same time, that week you will have GOOG, META and MSFT who all publish earnings.

The rebalancing will certainly be a negative catalyst for these big-ticket stocks, but if they put up good numbers, that might well counterbalance the negative effect.
I will share more views on these names and their earnings next week.

The other event is the Fed rate hike on July 26th, and remarkably another 25bps is pretty much set in stone.

I think if I zoom out, while the next few weeks are clearly quite tricky, between MOPEX, the rebalancing, the FOMC and tech earnings, on a bigger picture time horizon, I do think that Aug/Sept becomes a time frame within which we could see a larger pullback in markets, and given the level of underlying complacency, this could be associated with a meaningful spike in Volatility. If folks are forced to start chasing hedges, the VIX could go bananas.

Animal spirits are running wild, and the irrational exuberance is self-evident. We are clearly at the “wild swings” part of the rally, whether it is a blow of top or not, only history will tell, but I suspect that over the next few weeks we could see a very wide dispersion of moves, first upwards and then downwards.

Have a great week,

Antonio