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Volatility is high as we enter 2019 – a look at the year ahead.
This images is licenced under a Creative Commons Attribution-ShareAlike 4.0 International License.
This week’s Weekly might run a little longer than usual as I wanted to set up my thoughts on a few important things that will drive markets in the first quarter and potentially the next year.
Before I do that though it’s worth noting the acute volatility we have seen in stocks and other markets in the period since I last wrote my weekly. We have had the worst Christmas Eve for decades, we’ve seen the Nikkei in Japan then fall 5%, bonds rally, and a forex flash crash. And now we’ve seen the Fed guinely blink. It’s not quite the Bank of England back in the early 1990’s but it’s a clear sign of the primacy of markets – stocks in particular.
Before I begin here’s the moves over the past couple of weeks.
Key Themes driving markets as we kick off 2019
Volatility, headlines, and volatility expanders like algos and robot traders
The picture above is from what’s known as the “Mandlebrot Set”. I’ve been fascinated by it and its creator benoit Mandlebrot since I first heard of the great professor back in the early to mid-1990’s (not exactly sure when). What’s remarkable about the Mandlebrot Set – and the fractal geometry that go with it – is that whether you scale in or out you get repetition of and refinement of detail at the higher and lower magnifications.
Those of you who have been reading my notes for a long time will know that this helped influence the way I set up my charts and the system I trade which is the same for 1 minute as it is for 1 month charts.
Anyway, I introduce this to reinforce something I shared with my Platinum subscribers this week about volatility and this volatility cluster we are seeing in markets right now and why it may persist for a time.
I want to explain the increase in volatility lately in terms of a Minsky/Mandelbrotian take with a behavioural overlay I’ve had for years.
We know via these two great professors Hyman Minsky and Benoit Mandelbrot that both stability breeds instability and that volatility clusters. We also know that we transition through these two regimes.
Behaviourally, when it is human traders, investors, and fund managers doing to transactions these periods of acute volatility usually lead to position size reduction, volatility matching, and players moving to the sidelines. That makes things more unstable for a time (volatility clusters) but ultimately as these traders make the rational move to sit things out we see the seeds in the reduction of volatility that eventually follows the volatility expansion.
BUT when the robots and automated trading systems keep pushing, don’t get turned off, and – as I tweeted after the Nikkei’s big Christmas day fall – continue hunting, then the necessary and natural circuit breaker doesn’t occur. It’s why at the end of last year I wrote that 2018’s years volatility hadn’t been unusual by my measures (yearly range divided by previous years closing price) but the last 6 weeks or so was.
Volatility rising in the bear market
That said though the Fed and the data flow has introduced its own volatility into the equation recently. And, as you can see the chart above volatility picks up – materially so – in down markets.
Volatility feeds on volatility, or as Mandlebrot say, volatility clusters.
What’s important here in January 2019 after a couple of months of acute dips and surges, surges and dips in stocks and thus most other asset associated classes too, is that the press are volatility amplifiers, they spruik it up and down – they just want eyeballs. And it is a reality that talking heads – of which you could call me sometimes as i go on telly too – love this too as they get to flog themselves to a wider audience.
And of course as central bankers, react to the market moves, reacting to the headlines we get humans moving to the sidelines and algos and automated systems feeding on themselves and the price action. Then the price action becomes the driver of the narrative and we start again – rinse, repeat.
As this tweet from Glushkin Sheff’s David Rosenberg highlights.
In a nutshell 2019 feels like it is going to be a volatile year. There is much uncertainty in the macro economic environment with the global growth slowdown, with QT at the Fed and an end to QE in Europe, China’s slowdown too seems to be taking hold. through in Brexit, the Trade War, the market price action itself, worries over recession.
Transition periods are always like this – we’ll see lots of ups and downs in the months ahead.
The Fed has just written the Powell Put, but is it really needed
The volatility that traders experience in stocks, bonds, and in foreign exchange markets over the past couple of holiday interrupted weeks ha caught the Fed’s attention. Never mind that this very price action was as much a function of lack of traders and algos’ chasing prices as it was about any fundamental drivers. The Fed was watching and its become a little scared.
On Thursday Dallas fed president Robert Kaplan pre-empted Chair Powell’s comments Friday saying a pause in rates for a couple of quarters and possible change to the automatic pilot of the balance sheet – quantitative tightening – operations was possible.
Then Friday Powell read from prepared remarks rather than his usual free wheeling, off the cuff style of communication. And it was his prepared remarks which really got risk assets bid – even thought US bonds sold off heavily on the back of non-farms.
He didn’t say anything particulalry stunning to anyone who actually knows what central bankers do and how pragmatic they have become. But he did say what the media and mavens were saying he needed to to sooth the nerves of traders and give the press fresh headlines to crow about.
Those key comms were that he said, “with the muted inflation readings that we’ve seen coming in, we will be patient as we watch to see how the economy evolves” and also added that if needed “We are always prepared to shift the stance of policy and to shift it significantly”.
“Patient” and “muted inflation” was the key here.
That’s because on the day non-farms doubled estimates with a 312,000 increase in jobs, when wages accelerated to a 3.2% annual rate, and when more people entered the workforce increasing the participation rate you could easily make the argument that the Fed is right about the economy and the market has no idea.
Now there are plenty of folks who say that the jobs market was strong just before the global financial crisis, that a rampant consumer confidence means that a recession is just around the corner. But seriously with Fed Funds essential flat to inflation is this really the case that recession looms large over the horizon.
But does it really or are we going to see the US economy ease back toward potential growth at 2% in the year and years ahead rather than collapse in a heap.
My sense is the US economy with this very pragmatic Powell led Fed will pause on rates, maybe pause on QT – because let’s face it it is and will impact markets and liquidity – and will thus deliver something like we’ve seen in Australian growth for many decades now. Sometimes spectacular but more recently around potential.
We’ll see across the year if me or the recessionistas are right. IT has important implications for asset returns – so watch this space.
Recession calls seem preemptive in the US but global growth is struggling
Global growth is weaker in early 2019 than it was as we entered 2018. That much is clear in the manufacturing and services PMI’s released for December. The JP Morgan global composite PMI which is calculated by aggregating the IHS Markit manufacturing and services PMI’s shows that global economic growth has slowed to a 27-month low in December.
Indeed it is worth noting that global PMI is not going backwards but leading indicators like new orders and backlogs are actually below 50 – in contraction territory. So the outlook has certainly and materially shifted.
You can see that, and why the market went into a complet funk recently about growth, China, Apple in China and more recently about US growth by looking at the Citibank economic surprise indexes.
So it is up to the data to disabuse traders and investors of their worries. It’s also up to President’s trump and Xi to end their trade war. That’s likely to happen sometime this year. The question though is whether it will be by the March deadline the US has imposed.
A long term look at the USD and forex markets more broadly
So we have volatility, we have the Fed, we have US growth, and we have global growth all complicating the outlook. No wonder investors headed for the sideline over the holiday season and the robots and algos were free to roam the landscape unfettered by real money bids and offers.
But one of the other areas of uncertainty is the US dollar.
As the other side of almost 90% of all foreign exchange transactions and as the denominator of the vast majority of global commodity trade the level of and changes in the US dollar influence asset prices all across the globe.
To thin slice a little a stronger dollar pressures commodity prices and emerging markets – all other things equal, which I know is never the case. But you get what I mean. The level of the USD adjust trade flows by impacting exchange rates between it and across other pairs. And in doing so it impacts growth in the US and abroad.
At present the dollar’s rally has stalled below significant resistance in the 97.70/98.20 region – in USD Index terms and it’s stuck in a 1.12/1.15 range against the Euro. but even a cursory glance of the above USD index chart can see how the USD is struggling to break higher.
Technically at present the take is that price again constrained by the overhead resistance at 97.70 and trend line. 3rd down week in a row though indecisive has combined with a close below MT trendline which opens up the downside. Support at the 30 week ema at 95.45 is now pivotal along with recent low at 95.60/65. Overall the MACD pointing lower.
So, given that outlook and that the most recent BAML fund manager survey showed investors see the USD as the most crowded trade the near term outlook for the greenback may be for weakness before the overall economic and central bank policy outlooks come back to the fore and the USD finds a bid once more.
The S&P 500 as the bellwether for global stocks
The last 20 days has seen the correlations between markets disrupted by the holidays and a potential short term change in risk appetite as the switch to buy the dip has occurred across a number of markets. How this plays out is difficult to know but we enter 2019 almost diametrically opposite to the positivity we saw from traders and investors as we entered 2018.
That’s seen sentiment collapse and begs the question I posed on twitter and in my newsletter Friday, ‘Could we all be too bearish on
#stocks, and growth, too bullish on #bonds #rates and the non- #USD currecnies? Of course This chart, by @JackAblin via @SoberLook‘s excellent WSJ blog suggests we should be getting ready to buy risk assets….on a 12 month horizon anyway”
But catching a falling knife is never easy.
Though it’s clear that some traders – even if they are robots – have been doing that in the S&P and other stocks markets. Indeed short term the outlook may have changed in a tactical sense. Loooking at the weekly chart of the S&P, as the bellwether for global stocks, it is worth noting a price appreciation back toward the break down level/s is in train. The overall medium term downtrend remains intact though based on my JimmyR indicator.
My synopsis is that after the JimmyR indicator (15 and 30 ema crossover) turned bearish for the first time since April 2016 (when the S&P was around 2,000/2,010 by the way) in December the overall trend remains lower on this weekly time frame.
Price then exceeded my Dec 22 targets of 2,500/2,523 and the subsequent further target 125 point below with the Christmas eve collapse. Subsequent recovery looks to have legs toward 2600 previous support and perhaps the 15 ema at 2,650.
We’ll see I guess, but if the S&P recovers expect risk to go bid,. Equally its failure will be the failure of so many markets should that occur. Except bonds of course 🙂
Have a great week
@gregorymckenna on Twitter
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