Weekend Markets Edition – 11/24/19
Markets remained choppy in the 3rd week of November, and we think this was caused by a number of factors – 1) Conclusion of Q3’19 earnings season, 2) heightened risk of US-China trade risk 3) FOMC Minutes that dampened any expectations of a December rate cut.
While the risks are noteworthy, it’s worth noting that we don’t anticipate the same end-of-year correction that rolled markets over in 2018. Sentiment while somewhat muted isn’t nowhere near as bad as prior year given the absence of headline worthy indicators, i.e. yield curve inversion and softening corporate earnings. Increased deal-making activity due to lower interest rates, and diminished financial comps due to softness in 2019 financial results set-up a positive back-drop for FY’20 earnings comps.
When pertaining to fixed income, we remain bullish, as we anticipate a number of interest rate cuts in 2020, which will sustain the bond market rally when we rollover into 2020. However, in environments where interest rates drop – volatility tends to diminish, and absent of weak economic datapoints, it would be foolhardy at this point to be betting in favor of volatility. Instead, we think fixed income will continue to rally next year due to Fed Reserve policy, and equities will revert to the long-term trend.
Fear/inflation trade dissipating, Gold trending lower, and Bitcoin nose-diving
The markets are rotating out of a couple categories namely inflation hedges like Bitcoin, and fear-driven hedges like Gold and VIX, but not necessarily bonds. So, given this environment we’re going to highlight a couple key market trends worth noting.
Source: Volatility Index ETN (VXX) Google Charts
The Volatility Index or VXX continues to trend lower, not surprisingly. Investors aren’t pricing-in a whole lot in terms of volatility, and we don’t anticipate the fear-gauge to creep much higher in the near-term. It’s a persistent down trend, and some of this is driven by the drop-in brokerage trading volume, but also the lower interest rate environment.
Source: XAU/USD Trading View
The price of gold continues to consolidate and trend lower. We’ve noted that the recent surge in gold prices in August/September in prior research. However, the absence of volatility in more conventional assets diminished the need, or desire to hedge volatility with gold. Hence, the point at which Gold peaked, the Volatility Index also peaked at a similar point in the year. These two patterns are correlated, although the VIX tends to exaggerate to the downside in comparison to gold. We anticipate that the price of gold has further room to correct, with support likely strong at $1,400/oz. Keep in mind Gold is still up on the year with YTD performance of +19.61%. Investors should take this opportunity to rebalance some of their portfolio in favor of defensive equities, or long-dated treasuries to capture upside from lower market volatility.
Gold likely extends its trend next-year on some volatility triggering event, albeit we’re not certain what could trigger another episode of fear in markets, and so with rotations coming into focus we think defensive positioning in riskier assets or riding lower interest rates with longer-duration bonds will result in the most optimal capital growth.
Trading Economics Core-CPI 5-Year Chart
Inflation remains persistent, and continues to trend higher, we saw a couple quarterly blips in 2018, and 2019. So, there’s some logic to owning inflation hedges such as gold, and bitcoin. However, both gold and bitcoin seem a bit frothy, and a little overheated relative to the long-term trend with inflation. Also, the persistent core-CPI trend limits policy options for the Federal Reserve, and so the mandated inflation targets continue to be met with the latest CPI reading growing 1.8% vs. prior 1.7%, which means that core inflation is awfully close to the 2% target. We anticipate that if inflation were to exceed 2% the Fed will slow down on accommodative monetary policy, and so we’re only 20 bps away from that eventuality, and so we anticipate that a couple more interest rate cuts could trigger some inflation, albeit just enough to justify the inflation targets, and from there… the Fed could return to tightening, though that still seems like a 2020-2021 theme.
Bitcoin continues to struggle from the mid-point of the year. It’s fair to say at this point, investors are buckling-up for a joy ride lower or are rotating out of the more volatile asset class after what has been a historic run-up from the beginning of January/February up until the mid-point of the year. While, the year-to-date performance has been noteworthy for BTC/USD, there hasn’t been enough near-term catalysts to drive BTC pricing higher, or to sustain the rally, with participants exiting the markets in droves.
We wouldn’t be surprised if Bitcoin were to retest the low point of the multi-year range at $3,000 per coin. Also, it’s worth noting that the asset is very volatile, and requires patience and timing, so for investors who couldn’t get in from November 2018 – February 2019, there’s not much opportunity to buy, unless if you’re hoping to catch a dropping knife. While, Bitcoin pundits emphasize that mining difficulty will increase, which should rebalance expectations on supply, we’re also nervously skeptical of the recent mining-bust in 2018, and the 2019 rally. There wasn’t enough development or adoption of blockchain and given the recent hurdles with Libra, and the news-cycle tied to crypto assets being rather unremarkable with little in the way of noteworthy developments that are game-changing, we’re likely reverting to the low-point of the multi-year range.
Democratic Presidential Nomination still a three-horse race
Source: Real Clear Politics
Recent poll data shows Biden maintaining a 26-30 percentage point approval for Democratic Presidential Nomination when aggregating polling data. However, Elizabeth Warren has recently lost some ground in the month of October, mainly because of the out-sized criticism for her Medicare for All Proposal. Biden’s presidential bid has been a little more volatile due to the on-going rhetoric tied to Hunter Biden, and the questionable connection to Ukrainian politics. Trump’s on-going impeachment hearings have helped Biden look like a sacrificial lamb for the better good, however, which is why the political base has rallied in favor of Biden in recent weeks due to the political in-fighting that has also made Trump’s presidency questionable in the minds of the public.
When pertaining to Bernie Sanders, his base has started to rally, yet again, following the recent heart attack scare. Voters still question his health, though the headline risk has dissipated for his campaign, as he has taken a different approach to his campaign (slowing things down), but still saying meaningful points on the recent Atlanta debate stage.
However, Joe Biden at the 5th Democratic Debate (Atlanta) looked a little better on stage, with less crowd booing, and more reticent to say anything. Basically, leaning back, and dodging criticism from other candidates while emphasizing his track-record as former VP during the Obama administration (which has been an effective strategy).
When pertaining to Elizabeth Warren, she took up the most time among candidates showing slight media bias in favor of a Warren Presidency. She elaborated slightly more on her healthcare plan yet reiterated the same comments over the 2% wealth tax she has been pitching for the bulk of her campaign. Somehow, she lost some momentum in recent weeks, but maintained her composure while also dodging attacks on the 5th Democratic debate stage. We anticipate her polling figures to start recovering.
The rest of the Democratic field has weakened in polling figures or remained mostly unchanged. The inclusion of Michael Bloomberg (former NY mayor) and founder of Bloomberg also shaved off a couple percentage points. We anticipate Michael Bloomberg to eventually take the debate stage. The surge in Buttigieg support has been noteworthy, however his debate stage performance was the weakest among the group of candidates, as he couldn’t address some of the questions from moderators that effectively.
Notwithstanding, we anticipate that the polling data will lean-in favorably for Biden, Warren, and Bernie with the entrance of Michael Bloomberg deflating favorability for the rest of the field, and creating challenges for Julian Castro, Booker, Steyer, and Gabbard to stay in the race. We anticipate Yang to hold-on for a while longer, whereas Kamala Harris will also stick around for quite a while longer. We don’t anticipate Buttigieg to hold onto his surging polling figures.
Key economic data points for the week
U.S. Housing starts increased 3.8% m/m to 1.314M seasonally annually adjusted rates in October. This was in-line with consensus expectations of 1.32M. The data parses out to 2% gain in SFR (single family residential), whereas multifamily rebounded by 8.6%, which was driven by lower interest rates, and heightened financing activity. September data was also revised up to 1.266M from 1.256M.
Philly Fed Survey also showed some signs of improvement, with the survey reading up to 10.4 in November from 5.6 in November, which was above consensus expectations of 6.0 Philly Fed Survey. Hence, the diminished expectations for further interest rate cuts. The new orders index declined to 8.4 in November from 26.2 (likely due to diminished expectations on US-China trade), and some seasonal impact where build-up of orders/inventory tends to be heavy in October, and tends to dissipate in November and December due to sell-in.
The interest rate curve showing some patterns of flattening with the 30-year trending up to 2.43%, and then reverting lower to 2.22%. The 1-month remains flat in a 1.56%-1.59% range, whereas the 20-year has also gyrated, but trended lower from 2.27% to 2.08%. We think buyers are flooding to the long-end of the curve causing some compression at the long-end. We’re still optimistic on long-term bonds.
Remain long equities and long-duration bonds. Avoid hyper-volatile assets like Bitcoin. Rotate out of gold a little, i.e. rebalance with some defensive equities. We anticipate that volatility will continue to decline in a lower-interest rate environment, and with some positive data on the economics front investors have to anticipate a pause on the Fed policy front. However, this doesn’t change the high likelihood of another interest rate cut in 2020.
When pertaining to politics the race has narrowed, but a new entrant in the form of Michael Bloomberg could stir-up some chaos for the field. We thought the debate stage performance was mostly strong among the three-lead Democratic candidates, whereas the laggards got stifled even further.
Economic data points mostly positive this week, and the spottiness in economic fundamentals ties more into US Tariffs near-term than anything else. We don’t anticipate interest rates to further flatten across the curve, and so we encourage some risk-taking given the heightened likelihood of diminishing market volatility for the foreseeable 12-month timeframe. Political risk will remain a key theme in an election year over the next 12-months, which is why long-duration bonds seem like an adequate hedge, and limited gold exposure. Avoid crypto assets until the dust settles.
Disclosure: Cho Research was not compensated to publish “Weekend Markets Edition: 5th Democratic Debate, Remain Long Equities, Alternative Assets Get More Volatile, and Strong Economic Data.” Though Cho Research does use the research dollars it
generates from other clients of our research service to fund market research
reports such as this. This document is not produced in conjunction with a
security offering and is not an offering to purchase securities. This report
does not consider individual circumstances and does not take into consideration
individual investor preferences. Recipients of this report should consult
professionals around their personal situation, including taxation. Statements
within this report may constitute forward-looking statements, these statements
involve many risk factors and general uncertainties around the business,
industry, and macroeconomic environment. Investors need to be aware of the high
degree of risk in micro capitalization equities, cryptocurrencies, crypto assets.
Independent equity research isn’t regulated by the SECand operates separately from more conventional sell-side equity research. Thepublication of independent equity research is unregulated and rules pertainingto published independent equity research are covered under “freedom of thepress” with legal case precedent taken all the way to theN.Y. Supreme Court to guard against libel based claims or claims of lossrelating to the publication of a report on a company. Any copyright claimrelating to infringement is covered under fair use of copyrighted materials. Sincethe use of material was derived into a separate form of analysis without anysubstantial content derived from any third-party no copyright claim can bepursued under common law. To discuss investment risk or to consider the riskspertaining to any securities it is recommended to consult a registeredfinancial advisor. To understand independent research it’s encouraged to readthis published article on independent equityresearch to become more familiar with industry standard practices and therelative value of independent equity research versus brokerage research andnews media.Cho Research, its subsidiaries, and employees may open along/short equity position at future date from the data of publication of thereport. The price per share and trading volume of subject company and companiesreferenced in this report may fluctuate and Cho Research is not liable forthese inherent market fluctuations. The past performance of this investment isnot indicative of the future performance, no returns are guaranteed, and a lossof capital may occur. Certain transactions, such as those involving futures,options, and other derivatives, can result in substantial risk and are notsuitable for all investors.