Market Journal: EOD Update
Little bullish about today’s advance. Break-evens key to monitor.
Discussion
I have no interest in fighting even a multi-day rally, let alone a move back to new rally highs. This is an incredibly dynamic environment that requires dodging and weaving around liquidity windows and key events to get into appropriate multi-week/month position. As discussed as nauseam on these pages, I believe the September/October historical danger zone is going to be particularly dangerous this year given the lack of confirmation from the 3y/10y UST curve and 50dma thrust signal that the rally off the October 2022 is a durable bull market advance, the lags of monetary policy entering the fabled 12-18 month window of variable impact (for reference, that June to September 2022 time frame when UST 2s rose from circa 250 to 450 is what will really start to be felt here in the coming months), and the high and bullish levels of valuation, positioning, and sentiment. As such, the month of August is about getting ready for that zone and I don’t want to be dogmatic about any position, long or short, in this preparation period.
All that to say, if today’s market action contained the signals of a likely continuation tomorrow and beyond, I would say so. But those signals were almost entirely absent, with the exception of a deeply red VOL complex:
Given the seemingly bullish advance, breadth was anemic at less than 2:1 advancers on NYSE and negative on NAZ
HY CDX tends to track RSP, so when RSP is up 50-100 bps on the day HY CDX will often be down circa -10 bps, but especially coming out of a bit of an oversold condition HY CDX could easily be down -10 to -20 on a day like today with RSP up 85 bps. Today it was down less than 7 bps. Very weak bullish confirmation.
Defensive sectors were solid through the day, with the exception of XLU which sold off with bonds (a continuation of its behavior the last few weeks). And under the hood, Healthcare skewed very defensive. If the market was kicking off a new run to rally highs, defensive sectors would have melted today. Not bullish.
It’d be interesting to look back through history at the number of times the UST curve has bull and bear steepened in a single day as it did today. Bizarre. A literal reading of the price action is pure stagflation - short end yield weakness on an impending economic downturn, and long-end yield strength on sustained deficit spending underwriting long-term elevated inflation. The Fed continues to claim inflation expectations are well anchored, but the 5y5y and 10y tenors of the TIPS break-evens curve are starting to beg to differ. Need to watch closely.
I don’t like to ignore the VOL market, but given the sharp move higher in VOL into the close on Friday I think today was more of a reversal than anything. Need to monitor closely, but given the lack of bullish confirmation discussed above, I think you fade today’s red VOL.
Lastly, I don’t know what to make of Thursday’s CPI report. If financial markets were trading in a clean “soft landing” manner, I would say CPI likely underpins a continuation of that rally. Now with this stagflation price action in bonds, I don’t know what to think. If Core CPI is soft, perhaps 2s fall on 1H24 rate cut pricing optimism; but given how 5y5y and 10y TIPS BEs are trading, rate cut optimism could fuel a continuation of long-end steepening. If CPI comes in hot and 2s rally, the long end may re-invert on a hawkish FED, underpinning at least a temporary equity rally. Still noodling.
Exhibits
Weak breadth.
Middling fall in HY CDX.
Deep red VOL complex.
But strong defensive sector performance.
Long end of the TIPS break-evens curve saying something is afoot.