Mid-Week Update
Markets are currently in the mode of taking money off pretty much everyone. As I noted a few weeks back, something in overall market conditions has changed and is alerting me. Bonds are trading as if we are on the cusp of a recession, which is possible but not very likely in the near term. Stocks have been trading poorly, finally reacting to bad news being bad news. Metals, aside from Gold, have also been resuming their downward trend, while Oil has been caught in the midst of a declining global demand picture led by China’s continued slump. Credit, however, is still trading well, which is at odds with all other market moves so far. All this feels very much like we are on the brink of something much larger brewing, and my senses and antennas are tuned to the max.
A financial market induced recession is something that has occupied my mind for a few months now. Markets lead economic data. How much of an equity drawdown would be sufficient to manifest recessionary conditions? My guess is 15% or wiping out this year’s gains. This would most likely accelerate job cuts and turn the taps off the consumer-led recovery rather rapidly. That’s where the vulnerability lies. But playing this is still a daunting task. That’s why bonds have outperformed, as it’s seen as the safer hedge now we are facing rate cuts, and the correlations with risk assets have “normalised” back to negative.
A friend of mine asked me recently what probabilities I would attach to the recession scenario. I thought about it, and I would say it’s 25%. While clearly not base case, the implications for financial markets would still be profound in that the calculated expected return would still be much lower for equities and higher for bonds. Markets don’t spit out expected returns however, but realised outcomes. For now, the road of travel is pretty clear as the market-implied probability of the dreaded R-word is increasing. As also previously opined, I don’t think this is equivalent to what we experienced earlier this year, which was a fade. I will lay out a scenario analysis and potential game plan in a separate post, but for now, stay the course, be nimble and don’t do stupid things. Most importantly, don’t give in to sensationalist takes. Everything is possible, but that’s always the case.
Let’s now hear from Macro D and his latest thoughts, before I’m updating a few charts and setups.
Let’s go!