We've turned intermittently bearish again. Yes, you might be wondering why the flip flopping. That's because price action has been doing exactly that, flip flopping. It wasn't until late last week, specifically after Friday's release of the January NFP report that turned the tables for us.
We're going to keep this snippet really short as it's meant as an update to our short term views on the markets. We're in the midst of our Chinese New Year celebrations and related festivities but we can't simply turn a blind eye to the development that have occurred in the past 2 weeks.
Conclusively, the picture has become clearer for us, and we're really starting to get convicted on one direction. However, caveat to the reader as we mentioned in one of last week's snippets, the current environment still remains extremely volatile and brutal intraday swings can and will decimate the accounts of reckless traders.
About last week's NFP
The BLS reported that the U.S. economy added 151,000 jobs in January on expectations of a ~200,000 print. The U3 unemployment rate ticked down to 4.9% against expectations of 5% (unchanged from December). Wage inflation as represented by the change in average hourly earnings rose to 0.5% MoM on expectations of 0.3%, and up from December's 0%.
So the headline figure missed big time, but wage inflation and unemployment rate beat, the former by a huge margin. Quite an important statistical development in our opinion.
Why? Followers on our social media accounts know that we have been covering the U.S. jobs market pretty closely. We previously reported that jobs growth has slowed with more low quality jobs increasingly being added each month. The slowing of jobs growth has been reflected in rising initial claims, of which the 4-week average has risen above 200,000 (8-month highs).
January's NFP report confirms this and solidifies our thesis that the U.S. economy is very close to what the Fed deems as 'full employment'. Were we surprised about the surge in wage inflation? Somewhat. Taken as a panacea, a 0.5% monthly increase in wages is mostly a positive development. But when taken in the context of the overall economy and state of the financial markets, strong wage inflation is in totality, not a good thing.
We won't go into our train of thought for why we think this way, but just know that U.S. corporations have mostly peaked in terms of their profitability and the last thing they wish to see is higher labor costs.
All about the Fed
Make no mistake. The Fed has committed a policy error when it hiked in December. We've also covered this narrative on these pages and shalln't repeat. Each passing day, both the financial markets and actual economy continue to support this case. The latest FOMC statement also hints of apprehension within the Fed, and markets haven't taken this positively at all.
While we abstain from making outright calls on a binary outcome, we are very inclined to say that we believe the chance of a rate cut outweighs the chance of another rate hike above 0.5% on the FF target rate. The chance of rates being stuck at 0.5% for an extended period of time far outweighs anything else. There is also a heightened chance that the Fed launches another around of asset purchases. We aren't ruling this out.
With renewed uncertainty as to the path of future Fed policy, volatility in the financial markets is to be expected and properly managed. This is a given.
Other Central Banks don't really matter
In the past, dovish jawboning or action from other major central banks such as the BoJ and ECB have sparked bullish moves in risk assets. Not anymore. For whatever reason, they seem to have lost their once revered mojo for pump priming asset prices to the stratosphere.
Remember that just 2 weeks ago, the BoJ went subzero with negative interest rates. The yen tumbled brutally, in the process spuring a buying frenzy in risk assets. But that only lasted for a day. Yes, one day.
The yen proceeded to erase all of its losses it saw that Friday and is now trading much richer than before the BoJ event. Risk assets have likewise fallen way below their pre-BoJ levels. This is despite recent rhetoric by BoJ Governor Kuroda that the bank is ready to push rates deeper into negative and increase the size of its QQE program.
None of that worked to support risk assets. That's pretty telling. The market only cares about the Fed for now.
And the U.S. dollar
We believe the U.S. dollar is the ultimate transmission between the Fed, the economy, and risk assets in general. As we wrote in last week's snippet, the dollar was and still remains at a critical technical area where we expected bulls and bears to battle it out. The U.S. dollar index has since staged a minor bounce from the area we marked out.
We have a feeling that this bounce is only momentary but will wait for further price action to validate our view. It is safe to say we are slightly bearish the greenback relative to a defined set of major currencies.
Clients of our Premium Signals Service have already gotten live updates on how we plan to play this emerging theme of a potential down cycle in the greenback. We have a few specific positions open and they reflect our current view of the dollar.
The short end of long
We're bearish. Bearish enough to have loaded up a few shorts on risk. Bearish enough to lever up slightly on safety and closing all our longs on individual equity names.
1800 is the level to clear on the SPX (S&P 500) before we turn long term bearish. For the record, we're already bearish on the short and medium term and are actively building our portfolio-specific exposure to reflect this view.
Assuming risk continues to sell off, The cleanest plays according to our analysis would be to go short higher beta risk proxies (we can't reveal what), go long safety (U.S. treasuries), and long volatility.
Another trade that we really like is to be long gold. The price action in the yellow metal screams of something major that is to happen.
Until then, we're loading up the shorts and playing it as things unfold. Happy trading during this Lunar New Year!