Shiny Coin Trick
The magician's job is to create a illusion that seems to defy logic. They try to trick people into believing in something that is impossible. But successful conjurors have one advantage. They have a willing audience that wants the magic to be real. Audiences collectively suspend their disbelief and go along with the trick. The shiny coin trick fools them every time.
The U.S. dollar, today's shiniest coin, is currently generating a belief that the economic policies currently in place are working. But the greenback's strength, that earlier this year took many observers by surprise, is now exposing the weak links in the global economy. More importantly it is confounding policy makers' efforts to generate coordinated global growth.
Federal Reserve policy has aided and abetted the dollar bull market by its singular focus on domestic employment and inflation metrics. No mention has been made in any recent Fed communications of the deteriorating global economic backdrop.
Trade policy is similarly fuelling the dollar advance. In all of Trump's xenophobic MAGA rhetoric, there is a common narrative. 'The world is against us and even our allies are taking advantage of America'. A rising "King Dollar" (coined by Tump's advisor Larry Kudlow) is viewed as the litmus test of the effectiveness of the current policy mix.
But be careful what you wish for.
By exposing the failings of weak link nations like Venezuela, South Africa and now Turkey, contagion fear is generating risk-off bid to the U.S. 10 year bond. The knock-on effects of that will soon be obvious to Fed officials. They will have to stop raising rates earlier than the market expects. A static 10 year won't allow them to normalize rates as fast as they desire.
The flight to quality effects of the global economic deterioration are just starting. Continued demand for safety assets is offsetting the normal market response to economic strength. At this stage of the cycle bond yields should be rising. But the ten year bond is not acting normally. After sharply rising late last year it has flattened out completely in 2018.This further strengthens the case (see last week's "Squeeze Play") for an imminent policy reversal.
The Lira crisis in Turkey isn't over yet despite this morning's Tuesday at 11 type bounce. Profit taking and short covering is the likely motivation. I'm actually worried more about another Lira - the Italian one.
The unresolved Eurozone financial rot is a car crash in slow motion. The Turkish death spiral (that is sure to worsen) has exposed the balance sheets of the Eurozone banks to elevated credit risk. Italian politicians, once they return from holiday at the Amalfi coast, are likely to generated a few risk-off headlines of their own shortly. Molti problemi!
Gold is now looking very interesting as a hedge. The most recent decline in response to the dollar strength is creating a crowded trade on the short side. The GLD ETF last quarter experienced its first outflow in years. The COT (Commitment of Traders) report is at a three year low. The Fed policy reversal I am expecting will generate a quick reversal in that oversold chart. Gold charts of the past are full of such "V" shape reversals.
Trailing data such as employment stats and Q2 earnings are masking the deteriorating growth path of the global economy. But investors in the U.S. have suspended their disbelief in many ways. They are eagerly awaiting the market's shiny coin tricks such as the next iPhone, the next Netflixs series, even the ephemeral Tesla short-squeezing LBO.
They are being fooled into believing in this ever riskier market because they want to. They want the U.S. economic magic to be real. I've got a shiny coin trick for you.
Sell.
Risk Model: 3/5 - Risk On
The 'risk on' signal is stuck in the same mode as most of the past month. The markets are gently coasting higher on light volume, unchallenged by volatility spikes and immune to the risk-off behaviour in the currency markets. But as the AAII sentiment shows, new money is not entering the market. The recent growth-value rotation move that briefly flared up three weeks ago has failed yet again.
As Apple, Amazon and Netflix do all the heavy lifting, the broad market is meandering aimlessly. This looks suspiciously like the quiet before the storm to me.