US Stock market is down, Gold dropped down to $1885 and it is recovering now to $1920s, Bitcoin is down, Oil also dropped -8% from the recent highs and now it is recovering +3%. EURUSD is down, VIX have some mild higher highs and higher lows.
Starting this article with an update on the liquidity conditions makes sense since this is an indicator I have kept a close eye on this for quite some time and sharing updates regularly here, in the VIP channel and my XM Live sessions.
The US Domestic liquidity continues to be relatively flat, with no significant change since our last discussion about it. I created a chart update on US liquidity vs S&P 500. The S&P 500 index widened the gap significantly for the last couple of months since the debt ceiling issue was solved and the Fed started to use Reverse Repo money (which was not my base case, but it was the second scenario as we have discussed multiple times).
The same is true for the global liquidity. It is currently moving lower, but it is overall flat.
Liquidity isn’t the only variable that affects broad stock index performance but it’s one of the big ones.
One of the biggest challenges to global liquidity right now is the U.S. Treasury market. Record high ongoing supply of Treasuries are flooding the market, while the Fed is also letting Treasuries mature off of their balance sheet rather than reinvesting them (quantitative tightening). And as yields go up, that contributes to higher interest expense, and thus larger deficits, and thus more Treasury issuance.
As a result, Treasury market volatility is high, Treasury market liquidity is low, and Treasury yields broke out slightly over their autumn 2022 highs:
The biggest foreign holders of Treasuries are Japan and China. Japan has been getting more hawkish around the margins, which can repatriate some capital out of the U.S. and back to Japan’s domestic markets.
China, meanwhile, has very weak economic results and is selling dollar-denominated assets to backstop their weakening yuan. If they end up selling a lot of Treasuries, that can render the Treasury market illiquid (similar to September 2019, March 2020, and September 2022 to varying degrees) and result in a spike in yields.
None of this is particularly good for risk assets (particularly growth stocks or anti-dollar trades like gold and bitcoin) until it reverses toward a better liquidity situation. And that answer the questions that I received regularly why I don’t have any long-duration Treasuries in my portfolio. It’s not that I’m particularly bearish on them; I have low conviction either way because it’s largely up to the Treasury Department and the Federal Reserve how they are priced. Instead, I stick to short-duration Treasuries for my defensive capital, which so far has been the right move.
As a tendency, I update again that most economic indicators has been decelerating over the past year and a half and many YoY indicators are negative in real terms.
The interesting update here is probably the AtlantaFed that recently had an unusual spike up in its estimate for this quarter’s annualized GDP growth:
And as also discussed in my XM Live sessions last week (especially on Friday, 3pm gmt+3 session), most of that spike was due to the recent consumer spending numbers. Consumers in aggregate are absolutely on fire, although it’s not evenly spread around.
This is interesting because the venture capital industry is generally dried up, bank lending continues to tighten on small and medium-sized businesses, commercial real estate has major issues, and manufacturing activity is sitting at borderline-recessionary levels:
In some of my debates and livestream sessions, I have explained and also mentioned multiple times that monetary policy is putting downward pressure on interest rate-sensitive parts of the economy, while huge federal deficits are continuing to stimulate other parts of the economy.
Homeowners with long-duration fixed-rate mortgages, large investment-grade corporations with long-duration fixed-rate bonds, and senior citizens who are receiving large swaths of what has become a top-heavy stimulative pattern (Social Security and Medicare in an ageing society)- these groups broadly are doing more than fine.
Exxon Mobil (XOM) for example has around $30 billion in cash and cash equivalents, and $37 billion in long-term debt, most of which is at low-interest rates that they locked in years ago. So their net debt is low, and importantly, they’re earning higher interest rates on their cash equivalents than they are paying on their debt. That’s historically uncommon.
And for a company like Alphabet (GOOG) it is even more extreme. They have $114 billion in cash, cash equivalents, and short-term marketable securities, offset by around $14 billion in long-term debt. With a net positive of $100 billion or so, higher rates mean more income for them, not less.
In other words, if the Federal Reserve wants to stimulate companies like Exxon Mobil and Alphabet, then raising rates is one of the ways to do that.
So, we have a tale of two economies. Entities with a lot of short-duration debt that is getting refinanced quarter after quarter at these high rates, or that are unprofitable and rely on the persistent issuance of very high-valued equity (venture capital or unprofitable publicly-traded companies), are generally not doing well. On the other hand, profitable cash-rich entities with long-duration fixed-rate debt are doing just fine.
Japan’s impact on Global Assets
Japan’s Yield Curve Control Update
The argument for lower U.S. Treasury bond yields ahead is that when the U.S. enters a recession, long-duration bonds will be a source of defence as they normally are. The argument for higher bond yields ahead is that huge fiscal deficits and re-accelerating energy inflation will put pressure on bond yields even in a recession, much like what happens to many emerging markets.
At these prices, I don’t like the risk/reward of long-duration bonds, either with a short view or a long view. For the low volatility part of my portfolio, I prefer T-bills or short-duration notes (roughly 5 years or less), as well as defensive value stocks and gold. For the higher volatility part of my portfolio, I prefer commodity producers, select growth stocks, and bitcoin. Long bonds just aren’t very compelling to me here.
To get a detailed analysis of the Japanese equity outlook, join the VIP Channel and the latest updates on stocks, bonds, currencies and commodities.
The recent GDP report out of Japan was on fire, with a 6% annualized real growth number. Outside of the post-pandemic rebound, that’s the hottest GDP print in a very long time.
Japan is even further into fiscal dominance than the United States is. Higher rates may be stimulative for them, especially when combined with quantitative easing. This is because their fiscal deficits are much larger than their rate of new bank loans per year, and with so much public debt-to-GDP, higher interest rates increase the interest expense and thus the deficit (which is stimulative) at a bigger magnitude than it affects bank lending.
China Business Cycle
When it comes to China they have been a major drag on the global economy in 2023, in large part because they’re running the opposite playbook of the United States and Japan right now. China has low fiscal deficits and is easing monetary policy.
As Reuters reported:
HONG KONG, Aug 15 (Reuters) – China’s economic activity data for July, including retail sales, industrial output and investment failed to match expectations, fueling concern over a deeper, longer-lasting slowdown in growth.
It has become so bad that China announced it would stop reporting its youth unemployment metric after it reached record highs, saying they need to review the methodology. If the data gets bad, they can just stop sharing it. Overall, China’s economy continues to languish.
In addition, one of China’s largest property developers, Evergrande, just filed for bankruptcy. The CCP ironically has been letting market forces play out more than much of the West has as they try to deflate their property bubble, with falling property prices, bankrupt property developers, and so forth.
The Chinese economy is in a debt-laden deflationary spiral. House prices have fallen, which has impaired household balance sheets. Household balance sheets, having gotten through three years of strict rolling lockdowns with little fiscal stimulus to support them (unlike the United States), are not in great shape to begin with. And so there is stagnation in domestic consumption patterns.
I suspect the eventual result here will be similar to how they got out of near-endless lockdowns: after a certain point the people will get angry and demand a new direction, and the political calculus of the administrators will change in response. In late 2022, an unusually large number of protests in China against the ongoing pandemic lockdowns caused the CCP to change course and begin re-opening. If that happens again, or signs of it begin to grow on social media, there could be some serious fiscal stimulus out of Beijing.
But in the meantime, the direction is stagnant. Since China is the world’s largest commodity importer, that continues to be a drag on otherwise tight commodity markets. This is also why I continue to generally avoid the copper market despite being bullish on copper in the long run until there is a clear change in global liquidity and economic re-acceleration. The copper-to-gold ratio historically tracks with the U.S. and global purchasing manager’s index rather well, and continues to point down:
The main area of the Chinese economy that continues to do well is the export sector. In particular, their auto export sector has massively ramped up, and that’s a topic I have been mentioning in my live stream session for months. And there’s no sign of that slowing down.
One of the economies that I have been quite bearish is the European economy. I am also talking about that on XM Pannel discussions lately and often mentioning it on the XM Live Rooms.
Europe, like China, has been broadly struggling. During the first half of the year, Germany and some other countries were confirmed to be in a technical recession due in part to their energy crisis, and now they’re more in a period of stagnation. Some energy-intensive companies like chemical producers have reduced their activity in the country and shifted elsewhere.
Germany’s auto exports are coming in below expectations, in part because China has become a major auto export rival to them. China exports more cars than Germany now and is rivalling Japan as the world’s largest auto exporter.
In addition to the rise of China’s auto industry, if Germany and other European companies have higher average energy costs than North America or China or elsewhere due to the energy-related policy choices they have made, it’s hard to remain competitive in manufacturing.
The euro lost around -4.50% against the USD recently. We traded that “bearish wave” down and now some signs of a local bottom may occur. If so, I will liquidate my short positions here and might look for some short-term buy trade. In case the bottoming signal is not convincing me enough I might wait until the price bounces off and maybe go short again next week or two. More about EURUSD you can find in the VIP Channel or join XM Live with Dzhuneyt Vahid.
Bitcoin price action was in a near record-low volatility regime for a while but broke down on Thursday nearly at the same time as the Evergrande bankruptcy news came out and SpaceX selling rumours. This liquidated a lot of traders and washed out a lot of leveraged longs and open interest out of the market.
The price has dropped to $25,183 and it is still holding it. The $25,000 level is the major technical support level for the BTC and discussed level from me for quite some time. Way before the “bad press” news hit the BTC price we were selling due to purely technical reasons and that was the first major target along the way. The two scenarios we’ve discussed here are still valid:
- Basic Chart Pattern View: It is support and the price may bounce back to correct the formed due to fear bearish impulse and form the right shoulder of the potential “Head & Shoulders” pattern. This means that the expected bullish bounce will be the beginning of the following even bigger bearish drop and lower low in BTC price.
- Advance Price Action Outlook: After the bottom formed from October to December 2022, the price completed the bull-motive wave cycle and it started the corrective wave cycle on April 14. The beginning of the corrective wave cycle was signalling an upcoming flat pattern. Then the price bounced to higher highs which confirmed the flat pattern type to be irregular (my major bearish case since the beginning of July). To complete the pattern’s last wave, the price must “crack and snap” below the previous support level ($24,740). That scenario would be complete with a good local bullish price action to buy BTC between $24,740 and $26,000, depending on the forming bullish local pattern.
Price action analysis aligns with my fundamental view on Oil. As I commented before, the short-term picture is difficult to forecast due to big uncertainty. Price held its volatility in the sideways $85 – $65 trading range. Based on technical cycle analysis the price anticipates the end of its 4th local wave and it is preparing to shoot up to complete the 5th wave. Completing the 5th “local wave” will open profit-taking opportunities that may decrease the price to trap short sellers down to the $75 area, which will be a great technical zone for long positions.
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