Friday, May 31, 2013

Macro Analysis 5/31/2013

This will be the shortest weekly commentary in awhile.

Stocks are churning as a number of crosscurrents are confusing market participants on the future direction of equities.  All the major averages finished down on the week after equities tanked on Friday afternoon due to a rebalancing in MSCI indexes. 

The big story this week was the rise in interest rates and the debate on why they are moving higher.  Here's a daily chart of the Ten Year Treasury Note yield:

(click on chart for larger image)
 
Interest rates are going parabolic!  There are three theses on the street as to why this is occurring:
 
 
1. Treasuries are starting to price in better economic times.
 
2.  Participants are front running the Fed before the central bank tapers its asset purchases.
 
3.  Treasuries are pricing in inflationary expectations.

Who's right?  Before Friday I was willing to actually start considering thesis #3 as Gold has been showing some stealth strength this week.  But Friday the yellow metal took another dive after the SPDR Gold Trust Shares ETF (GLD) bounced off Fibonacci resistance on Thursday.  Here's the daily chart of GLD.  I circled the last two days price action:

 
(click on chart for larger image)
 
I think the answer is a combination of theses one and two.  Economic data is certainly nothing to get excited about but it has been consistent and on balance positive.  And stocks have  traditionally been an accurate predictor of economic conditions six to nine months out.  As such, they are pricing in a significant rebound in the economy.  Stocks are acting accordingly.
 
I also believe investors are front running the Fed by unloading treasury notes and bonds. My concern here is that if there's a rush for the exits in the US Treasury market it will destabilize all financial markets, especially debt markets.  Corporate and high yield (junk) debt will also be significantly impacted.   
 
Last week I addressed the skittish Japanese bond market and the BoJ intervention.  Since that time many have come forward stating that the Japanese market is largely insulated and there is no historical correlation with the US market.  My rejoinder is that the Japanese have never before embarked on such a massive and unprecedented quantitative easing.  I honestly have not gotten my arms around the implications of a sell off in JGBs but I'm having a challenging time believing it would end well.  Watch the Yen carry trade.  It unwound a bit on Friday afternoon and US equities took a nose dive.
 
To sum up, the US is definitely on the road to economic recovery and stocks will move significantly higher in the coming months.  And I do believe, as I stated earlier in the year (see my January commentaries), that we are entering a secular bull market similar to the beginning of the last great "bull" in 1982.  However, central bank distortions will have to be unwound and investors are getting nervous about that prospect.  The problem here is that you really don't want nervousness in the bond market.  The bond market is the biggest and "smartest" of all asset classes and it is the dog that wags the tail of all other asset classes.  A volatile US bond market will send reverberations across the planet!
 
I don't think the Fed will taper purchases after their June meeting but if we get more signs that this economy is strengthening in July, I believe it's a real possibility.  Admittedly, there's a lot more in attempting to figure out this equation than what I've presented here.  We're still in a disinflationary environment which actually means the Fed could pump more liquidity in the system (not likely but a possibility).  In any case, the Fed needs to communicate its plans more clearly and soon because if interest rates continue higher at the same pace as the past three weeks all financial markets are heading for trouble.
 
In the very short term, all eyes will be on Asia (specifically Japan and the Nikkei) on Sunday evening after the sell off in our markets on Friday.  Focus will be on the Chinese PMI number due out at 9:45PM EST that evening. 
 
In our country we have a busy economic calendar next week culminating with Friday's monthly employment report. 
 
It's going to be a volatile trading week. 
 
Enjoy!

NOTHING IN THIS COMMENTARY SHOULD BE CONSTRUED AS AN OFFER OR ADVICE TO BUY OR SELL ANY SECURITIES, OPTIONS, FUTURES OR COMMODITIES. THE OPINIONS ARTICULATED ARE ONLY THIS AUTHOR'S WHO IS NOT A REGISTERED INVESTMENT ADVISOR OR BROKER.