Mining GFC simmers as folks fight the Fed

As Janet Yellen hawked up a bit and US data was solid, the US dollar rocketed Friday night:

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Yen and euro hit new lows:

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Gold was pole-axed and if the US dollar really gets going then I’d be a buyer as it falls:

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Commodity currencies were hammered:

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Brent oil went sideways:

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Base metals were mixed:

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Big miners fell:

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US and EM high yield too:

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The S&P500 rose another percent as continues to fight the Fed rather stupidly:

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We’re only 30 points shy of a record high. BofAML nicely summarises the tension:

  • 2016 total returns YTD are gold 15.0%, commodities 14.0%, bonds 5.9%, stocks 1.7%, and for the US dollar -3.3%.
  • Note how a “barbell” of inflation assets (e.g. commodities, energy, Petrobras) and deflation assets (e.g. bonds, utilities, Facebook) simultaneously outperforming.
  • We believe “positioning” & “policy” are driving “grind higher”: in a world full of bearish investors & desperate central bankers “pain trade” for risk assets is up.
  • But cyclical upside modest in a world where deflation from tech disruption, aging demographics, excess debt thwarting stimulus of astonishingly low interest rates.
  • And excess asset valuations (driven by ZIRP & NIRP) mean GDP/EPS upgrades required for big upside; we don’t see it, but cautious positioning limits downside.
  • Our AA thus continues to anticipate volatile, single-digit asset returns, and remains skewed toward long volatility, long gold, long stocks>bonds, long DM>EM, long IG>HY, long Main Street, short Wall Street.
  • And barbell strategies recommended (e.g. long Best of Breed stocks & long EM debt) in anticipation of inflationary policy shifts to fight a War on Inequality.
  • In the run-up to June, financial markets continue to be trapped within multi-month trading ranges: GT5 1.2-1.8%, DXY 92-100, ACWI 380-440, SPX 1850-2100, VIX 12-20. So what are the catalysts & “trades of the unexpected” should risk assets finally breakout or breakdown?

Breakout bull catalysts:

  • Bear capitulation: consensus is bearish, FMS cash levels high, our Global Flow Trading Rule once again super-close to a “buy-signal” (and unlike in January, this time we are closer to “ceiling” rather than “floor” of the trading range in risk).
  • Strong macro: if recovery in credit & commodity markets (oil>$50b, US & European high-yield bonds close to all-time highs) & stonking April US new home sales followed by rising PMI’s (e.g. US ISM>53) & retail sales, then investors can return to bullish narrative of “higher rates & rising EPS” (Chart 2).
  • Helicopters: BoJ in Japan, Riksbank in Sweden, SNB in Switzerland hint at future use of “helicopter money”.

Bull Trades of the Unexpected:

New highs in S&P500 and, more important, US high yield (H0A0) best played via selling calls on gold or shorting VIX futures; best contrarian risk-on trades (based on FMS) are long UK, Japan, banks (see Chart 3), tech & industrial

Should Japan go “all-in” by announcing a permanent increase in the money stock to finance fiscal stimulus traders should play the weaker Japanese yen via long TPX, short KOSPI, long inflation assets e.g. TIPS but not EM given likely resumption of China renminbi depreciation fears (and CNH depreciating once again – Chart 4).

Breakout bear catalysts:

  • China: renewed renminbi depreciation validated by sub-50 China May PMI indicating that China’s Q1 stimulus has failed (note BofAML’s China-ACT index, our gauge of Chinese activity decelerated in April).
  • Fed hates Profits: Fed in June is more hawkish than expected despite weak global profit growth (trailing 12m = -8% YoY); overvalued asset prices forced to correct.
  • Politics: rising political risk premia as electorates demand more extremist policies cause volatility tremors, already witnessed this year in the British pound & more recently the Mexican peso, to become more frequent and stronger; the symbolism of BREXIT, a vote for regime change in the absence of recession, would force risk premia dramatically higher.

Bear Trades of the Unexpected:

  • Trading a hawkish Fed will depend on the reaction of yield curve: flatter yield curve = deflation trades = long defensives, short EM equities & resources; a hawkish Fed is US dollar positive and boosts long Main Street, short Wall Street trades, e.g. long KRX, short XBD.
  • Should the UK vote for BREXIT our European strategists expect GBPUSD to sell off to 1.25 and the FTSE index to fall 15%; in addition, long gold, short peripheral European debt/banks, would work as investors discount FX wars & euro breakup.

Nicely put though note that most of the bull trades and catalysts are actually bearish in terms of an accelerating Mining GFC so beyond short term market action the business cycle is still confronted with a life threatening problem.

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