Slippery Slope

As I said two weeks ago (What's Love Got To Do With It?) financial markets don't like to be told what to do. But, being outright manipulated - that's an entirely new level of risk. There is an entire division of the SEC devoted to policing such financial fraud. You can go to jail if caught trying to influence prices by nefarious means.

It's a slippery slope you have just headed down, Sleepy Joe.

As the frozen Thanksgiving turkeys were being thawed out across America this week, Biden was busy shoring up his failing popularity. He took a speech-filled victory lap, touting the BBB Act that just passed Congress. He recklessly drove a Hummer EV at a government-subsidized GM plant. Now, he is attempting to manipulate the gasoline market through his release of oil from the Strategic Petroleum Reserve. If you or I did that, we'd quickly be in front of a judge.

And speaking of turkeys, what President Erdogan is doing to the Turkish economy is equally criminal. Turks are experiencing a full-blown currency crisis, spiraling beyond control. Taking a page from the Argentinian playbook, his central bank ordered interest rates to be lowered to artificial levels. That type of financial populism is rampant among the lesser developed economies of the World. I had hoped for better from to so-called 'Leader of the Free World'. Unfortunately, President Biden is showing himself to be no different than Erdogan, looking like a tin-pot dictator when it comes to policymaking.

The reason d'etre of the SPR is to provide emergency supplies in case of supply disruptions. The first proposal to create such a reserve goes back to the later stages of World War II. The current SPR was created in1975 by the Ford administration during a period of high dependency on the Gulf States for supplies during a period of strategic instability. It was never intended to influence prices in a grasping, transparently political move to shore up the popularity of an elected official of the nation. Unfortunately, Joltin' Joe has struck out. Such a policy is doomed to failure by definition. A one-time, 50mm bbl spit into a 100mm bbl a day ocean isn't likely to do much to lower prices sustainably. A few 'spec longs' got scared off last week, but they seem likely to come back this morning, sensing a head-fake buying opportunity.

Is this what we now should expect policy-making to look like going forward in Washington - management by polls and popularity surveys? How pathetic. America isn't looking so exceptional now, is it?

Yesterday, we saw the re-appointment of Jerome Powell to the position of Fed Chair. Lael Brainard, the more dovish choice for sure, was given the backup role of Vice-Chair in an attempt to appease the left-wing of the Democratic party. Markets, relieved by Biden's status-quo choice, initially took this to portend a more hawkish path for interest rates, while the removal of uncertainty initially provided a temporary bounce to equities.

But there are still three openings on the Fed Board, and those may be dovish bargaining chips within future Democratic Party horse-trading sessions. The mere fact that Powell's reappointment was even questioned is shocking, given his initially deft stewardship of Covid crisis monetary policy. We'll see just how hawkish the Fed gets if the economy suddenly starts to wobble next year. Given his recent moves on oil, I have my doubts that Biden can keep his hands off the Fed now. We may not have heard the last of Elizbeth Warren yet. She has famously called Powell 'exceptionally dangerous'. Takes one to know one.

Nevertheless, recent markets have been choppily higher as the easy money liquidity continues to wash ashore like an oil spill that won't stop flowing. But it looks like this market is having trouble getting to the 2021 finish line. Big Tech has a seriously exhausted feel to it. Breadth readings are falling to two-month lows (chart below). The last hour of trading is often more telling than the first, and yesterday's last hour was a complete debacle. The leading equity horses are tired. As the cowboys of old used to say, "they've been rode hard, and put up wet".

NYSE: Advances-Declines

As the unresolved debates about the path forward continue to swirl, all investors have left to do is window-dress and tax-loss sell. Fresh thinking can wait til next year and its market-moving data. This year has been better than anyone could have imagined, but as I stated last week, 2022 is as clear as mud. Now adding to the uncertainty, expectations are being buffeted by non-economic forces driven by political expediency.

Equity volatility is coming off a significant period of quiescence. Like with gold, I think volatility management deserves a place in my portfolio for more than just tactical reasons. The path forward as we enter a mid-cycle environment of endemic Covid, increased Geopolitical tensions, and accelerating climate change disasters, looks less smooth than the bounce-back year we have just experienced. The proliferation of craven political manipulation of markets now threatens to exacerbate this choppiness. I expect structurally higher realized volatility is coming to the U.S. equity market.

I'm going to restate my thesis from earlier this year that Delta postponed: The economy will do better than the markets over the next 12 months.

And it looks like a slippery upward slope.

3 Month Volatility Index: 2008-Present

Risk Model: 3/5 - Risk On

The market is flipping on and off like a light switch. Two-week rotations seem normal now. The RSI overbought signal has reversed and the Copper/Gold ratio bounced off support. All this, without any serious damage to the broad averages over the past three weeks. Correction players - you can go home now, there's nothing to see here. The juggling act is looking a bit wobbly though. Watch the 1.45 -1.70% trading range levels on U.S. Ten Yrs for a confirming definitive break - and I'm not sayin' which way just yet.

Implied volatility measures are now ratcheting higher as a result of the increasingly divergent narratives about inflation and interest rates. I expect that debate continues into year-end, reflecting the recent economic cross-currents. It is interesting that realized volatility in equities is significantly less than expected measures. The same cannot be said of bonds commodities or currencies. I take that to mean that investors are nervous but liquidity but financial conditions are supportive (TINA, FOMO effects). It's no wonder equity protection is getting more expensive, given the nose bleed index levels and speculative pockets of excess periodically showing up in the headlines. I don't know anyone who paid $170 for RVIN, but somebody did.

The Cu/Au ratio depicted below mirrors the choppy nature of expectations about the economy. After the initial euphoric rise based on successful stimulus and effective Covid vaccine development. Since those expectations were 'priced in' by May of this year, the market has undergone a series of back-and-forth moves as the Delta variant was juxtaposed against a still-growing global economy. This needs to be resolved, one way or another, to generate a sustainable change in market leadership. Like the rates market, the jury remains out for now.

Copper/Gold Ratio