We're Loading Up The Shorts

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.

 Global equity indices have rolled over in stark fashion. From top to bottom, the S&P 500 index still remains the strongest of the DMs, and is one o the only few indexes to still trade above its August 2015  'Black Monday'  lows. We are watching 1800 specifically, a daily close beneath this level will make us bearish on the longer term. The Nikkei 225 index has tumbled despite negative interest rates from the BoJ almost 2 weeks ago, trading almost in perfect tandem with USDJPY (and other yen crosses). The EuroStoxx 50 in Europe is the weakest of the DMs, with financials being offered hard as contagion risk has started to spread once again. Peripheral yields are surging while CDS spreads are widening. Lastly, Hong Kong's Hang Seng 33 index sits below its August 2015  'Black Monday'  lows. While most of Asia will remain shut for the first 2 days of the week (Chinese New Year), expect selling to continue once they reopen later in the week. 

Global equity indices have rolled over in stark fashion. From top to bottom, the S&P 500 index still remains the strongest of the DMs, and is one o the only few indexes to still trade above its August 2015 'Black Monday' lows. We are watching 1800 specifically, a daily close beneath this level will make us bearish on the longer term. The Nikkei 225 index has tumbled despite negative interest rates from the BoJ almost 2 weeks ago, trading almost in perfect tandem with USDJPY (and other yen crosses). The EuroStoxx 50 in Europe is the weakest of the DMs, with financials being offered hard as contagion risk has started to spread once again. Peripheral yields are surging while CDS spreads are widening. Lastly, Hong Kong's Hang Seng 33 index sits below its August 2015 'Black Monday' lows. While most of Asia will remain shut for the first 2 days of the week (Chinese New Year), expect selling to continue once they reopen later in the week. 

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.

 Gold has been the best performing (beta adjusted) asset YTD, up a whopping 14.5% since the start of 2016. In fact, the entire precious metals group (gold, silver, platinum, palladium et al) have seen incredible strength lately. Gold has broken through a key technical bearish trend line on our charts and will now have to tackle $1,200. A daily close above this level will lead us to be long term bullish the yellow metal. We are already both short and medium term bullish, and have never been more so in the last 3 years. Seasoned traders will take the important cue gold is giving as to the implied probably of future central bank activity.

Gold has been the best performing (beta adjusted) asset YTD, up a whopping 14.5% since the start of 2016. In fact, the entire precious metals group (gold, silver, platinum, palladium et al) have seen incredible strength lately. Gold has broken through a key technical bearish trend line on our charts and will now have to tackle $1,200. A daily close above this level will lead us to be long term bullish the yellow metal. We are already both short and medium term bullish, and have never been more so in the last 3 years. Seasoned traders will take the important cue gold is giving as to the implied probably of future central bank activity.

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 entire yield curve on U.S. treasuries has shifted much lower following December's Fed rate hike to 0.5%. Shown here is the yield on the 5-year note trading inside a range from (1.18% to 1.8%) for most the past 3 years. Of good mention is the CFTC reported futures positioning on the 5-year note by large speculators, which at last print was at a record short interest of 300,000 contracts. Synchronizing the 2 (yield/price & net positioning) we are inclined to believe that treasury yields will likely head lower, breaking under 1.77% on the 5-year. This translates into continued risk aversion (risk being sold and safety/liquidity being sought).

The entire yield curve on U.S. treasuries has shifted much lower following December's Fed rate hike to 0.5%. Shown here is the yield on the 5-year note trading inside a range from (1.18% to 1.8%) for most the past 3 years. Of good mention is the CFTC reported futures positioning on the 5-year note by large speculators, which at last print was at a record short interest of 300,000 contracts. Synchronizing the 2 (yield/price & net positioning) we are inclined to believe that treasury yields will likely head lower, breaking under 1.77% on the 5-year. This translates into continued risk aversion (risk being sold and safety/liquidity being sought).

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.

 As we wrote in  last week's snippet , the U.S. dollar index (TWI DXY) remains at an important technical juncture as it now challenges a key long term trend line buffer that has supported a volatile bull trend for almost an entire year. Based on last week's reactive price action, we believe that more downside is likely for the medium to long term. For this to happen, the index has to clear specific technical support areas. In the broader sense, this technical take ties in with our overall view on the greenback.

As we wrote in last week's snippet, the U.S. dollar index (TWI DXY) remains at an important technical juncture as it now challenges a key long term trend line buffer that has supported a volatile bull trend for almost an entire year. Based on last week's reactive price action, we believe that more downside is likely for the medium to long term. For this to happen, the index has to clear specific technical support areas. In the broader sense, this technical take ties in with our overall view on the greenback.

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!