Gold surges with Marine Le Pen

Advertisement

Friday night saw the USD stable:

tvc_0e8d23aef4a067fad4d5dd2598587f7f

Commodity currencies were hit:

tvc_987481d04f2b8cfb5159c32f00fee045

Gold surged again:

tvc_1634b4f21ce9c9ea5ac4f7d6a9e07995

Oil is stuck:

Advertisement
tvc_e01632a3b2b016141f9fc8097cff1678

Base metals rebounded:

tvc_860b5c501d8cf45e86e1ddcb4d06731a

Big miners did not:

tvc_97e8b4a7e5eabe1a9a576d43231d5808

EM stocks tried but failed to rally:

Advertisement
tvc_21bc681be80c09e9ff46376b88fbecc9

High yield was firm:

tvc_2cc56bfb73c049cb4a7e193c899aa05e

US bonds were bid hard:

tvc_f941d1bf48ddec5d06553e933a2047f9

Which helped stocks hit record highs:

Advertisement
tvc_dedb0a0110d1bb903feca1f5d91b52a8

Goldman is increasingly cautious on the rally:

“August in February” describes both the weather and trading activity this week. As temperatures in Manhattan climbed into the high 60s (20º C), equity volatility continued to fall. S&P 500 realized 3-month volatility now ranks in the 1st percentile of the last 50 years. It has been more than two months since S&P 500 moved more than 1% intraday. Earlier this month marked a full calendar year since the last 10% US equity market drawdown. The S&P 500 declined by 14% in February 2016. It has been more than seven months since the last 5% drawdown (6% in June 2016), and 93 trading days – more than four calendar months – since the S&P 500 last experienced a daily decline of 1% in early October. The last time the market exceeded that stretch was 94 days in 2006.

Long periods of market stability are not good indicators of drawdown risk. Since 1980, there have been only six instances of the S&P 500 trading for 80 or more consecutive days without a 1% decline. Following the end of these stable market periods, the S&P 500 actually registered a positive three-month return in five of six episodes, with a median 6-month return of 9% and a 12-month return of 15% (Exhibits 2). In short, following previous periods of market stability, the S&P 500 usually continued to march higher.

Extreme positioning of US equity investors is generally a contrarian indicator, but the market has continued to climb amid widespread bullishness. Our Hedge Fund Trend Monitor published this week showed that hedge funds currently carry their highest net long exposure since 2015. Similarly, our Sentiment Indicator based on S&P 500 futures positions reads a 100 this week on a scale of 0 to 100.

Although the indicator is more useful in signaling market upside following low values, readings above 90 have been statistically significant indicators of modest downside risk during the subsequent month. The S&P 500 has continued to reach new record highs despite SI readings above 90 for nine of the last 10 weeks.

The clearest potential tailwinds for S&P 500 upside include government policy and acceleration in US economic data, but neither catalyst looks likely. Investor optimism in recent months has been driven in large part by hopes for lower corporate tax rates. However, our Washington, D.C. analyst believes the political climate suggests that tax reform likely will not go into effect in 2017. Meanwhile, recent economic data have been strong, but the high level of our economists’ MAP index of data surprises as well as the 3.6% pace of US economic growth signaled by their Current Activity Indicator place a high bar for upcoming data releases to maintain the current pace of economic acceleration and drive further share price appreciation.

The distribution of market outcomes appears asymmetrical in our view, but the market will likely continue to grind higher until a catalyst sparks a drawdown. Upcoming weeks include a number of major risks:

  1. US government policy: Next Tuesday, Feb. 28, President Trump will present his State of the Union to Congress. Trade with China has been notably absent from recent headlines despite constituting a central pillar of his campaign. Protectionist trade policy is a risk lurking under the surface.
  2. US monetary policy: Although most investors expect two or three FOMC rate hikes this year, the market prices just a 22% likelihood of a hike at the FOMC meeting on March 15. PCE inflation data released on March 1, Chair Yellen’s planned speech on March 3, and/or the monthly jobs report on March 10 could raise the odds of a hike sooner than is currently expected.
  3. European elections. In a busy calendar of European elections, the first round of the French presidential election will occur on April 23, with a potential run-off scheduled for May 7.

Fund managers are currently caught between a long list of risks and a market climbing steadily to new record levels.

Our 2017 outlook remains that S&P 500 will peak in 1Q at 2400 and then fade to 2300 by year-end. Firms will not benefit from lower tax rates until 2018 and the Fed’s bias is to tighten. But following years of watching cash and hedges drag on returns, it is difficult for investors to miss out on potential upside or spend premium for protection in a market that continues to grind higher. Although European implied volatility shows a “kink” around the French elections, US equities reflect little to no implied risk from the events listed above. Unfortunately, drawdowns rarely announce themselves to investors in advance.

Investors seeking to own US stocks while protecting against upcoming risks can take advantage of extremely low volatility by replacing cash equity holdings with calls. Call options offer unlimited upside participation but risk just the cost of the option if the market falls or stops rising. Investors who are already long but find themselves concerned with the asymmetric risk profile can sell unlikely upside to protect against drawdown risk. An investor can sell a 2410 (+2%) S&P call with a June 30 expiry and use the premium to buy a 2240 (-5%) put. This strategy protects investors from a drawdown of 5% or more during the next four months while allowing participation to our upside forecast level of 2400. June 30 expiry captures the potential event risks listed above as well as the June 14 FOMC meeting. Our economists assign a 90% probability of at least one Fed hike by then while futures imply a much lower 67% likelihood.

It’s risk three that has us taking profits. The French election is pure asymmetry and Marine Le Pen is still improving in the second round polls:

waegfq
Advertisement

Moreover, the Macron policy platform is taking shape and it does not inspire confidence in this environment, via the FT:

Emmanuel Macron has outlined a Nordic-style economic programme mixing fiscal discipline and public spending, amid mounting pressure to clarify his policies two months before France’s presidential election. The election hopeful said in an interview with Les Echos that he would target €60bn in savings over five years and cut up to 120,000 civil service jobs, while vowing at the same time to reinject €50bn into the eurozone’s second-largest economy. “We need to invent a new growth model,” Mr Macron was quoted as saying in the French business daily late on Thursday. “To be fair and sustainable, it must be environmentally friendly and increase social mobility.”

Under his plan, France would keep budget deficit below the EU-required threshold of 3 per cent of gross domestic product — a target Mr Macron estimates will be met this year. He would reform the labour market to give companies more flexibility to negotiate working hours and pay, but he would also extend the welfare state, allowing entrepreneurs and self-employed to be eligible to unemployment benefits. He would lower companies and households’ tax bill by €20bn. Mr Macron, who set up his party En Marche! 10 months ago, has become a serious contender by promising policies that are “neither on the right nor on the left”.

…Mr Macron’s economic measures do not herald a big break from policies he inspired and helped implement as economy minister under Socialist president François Hollande. In the past three years of his presidential term, the deeply unpopular leader made a pro-business U-turn with €40bn in tax breaks for companies in the hope of reigniting the economy and cut unemployment from nearly 10 per cent.

These are the precise policies that much of the developing world polities are revolting against. MB allocations remain:

Advertisement
  • but the dips on S&P500, though we have taken profits;
  • buy the dips on short end Aussie bonds;
  • sell rallies on commodities and the AUD;
  • buy gold miners on the dips for portfolio protection;
  • sell property.
About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.