Weekend thoughts on the market (July 24th 2020)

Posted on 24th Jul 2020

I make it a habit to study both the micro structure and the macro structure of the market. What I mean by that is that I may spend a lot of time looking through correlation matrices, studying market structure and broader patterns over longer term data, but despite not really being much of a day trader I also find myself glued to Bloomberg screens daily to watch the minute and second ticks of a large number of asset classes. The reason I do that is that I believe often the micro charts provide information about market changes that are going to go on to become longer term trends.

One of my favorite Bloomberg screens is a combination of a few dozen charts covering every currency, commodity, stock market and interest rate you can probably think off at the top of your head, and seeing those move in tandem or in different directions at different moments provides a lot of information about correlations and potentially changing patterns.

So what stood out to me over the last few weeks in terms of market dynamics? First of all, as you will be aware and as I have written about myself, there is a correlation between crypto and stocks that tends to act up during times of broader market stress (both selling off simultaneously). Every crypto analyst on the face of the earth is currently telling you that once the S&P500 drops, crypto will go along with it too and that is having a lot of people on edge.

But interestingly, on the intraday charts today we had the S&P500 futures dropping like a rock, with crypto initially moving along on almost tick for tick basis, and then suddenly snapping back up in V-shaped fashion while the S&P500 was not showing any signs of budging yet in its downward trend. Earlier this year we have seen crypto-stocks correlation move from negative (BTC behaving like a risk-off asset in the first weeks of the year during the US-Iran tension), to highly positive, to just about neutral right now. I just wonder if we may be witnessing a third trend break that will catch everybody off guard. As long as there is not an obvious catalyst for stocks strongly dropping again (but remember - the market never does what you think is most obvious) crypto may for now be able to shake off the relationship with traditional markets, and we may be ready for some range-bound stock trading and eventually skyrocketing crypto. Try and trade this new "hot take" narrative too much and you could get burned.

Secondly, the US dollar has been a difficult beast to tame over the last few months. From absurd strength in March when it whipsawed every asset on the face of the earth, to now showing persistent weakness (albeit soon running into critical support levels for the longer term upward trend). Where earlier in the year we actually had assets like the Japanese yen and even gold *weakening* in those moments of severe risk aversion, it seems like the Fed actions of Q1 have put markets back to their old tricks. Both yen and gold are behaving like true safe haven assets again and are likely moving upwards / have strong upward potential (we are a resounding LONG on both of them here at LSS). I do worry about what will happen to both in the next bout of market stress and a potentially even more severe USD funding squeeze. Assuming that Q1 2020 was like Q4 2008, and knowing that after the GFC it took until mid 2010 before the market experienced any stress again, it may be late 2021 before we have to worry about that.

Thirdly and lastly, what's absolutely fascinating to me is that despite the S&P500 bouncing back to 3200 after dropping 3400 to 2200, the US yield curve has stayed at its all-time lows. We all know fixed income traders tend to get the economy better than stock traders and so this is a pretty good reason to be cautious on the market as a whole. Having said that, while at macro level this signals a reason for worry, at micro level we actually see that rates do bounce back up in tandem with stocks. This may indicate a "new normal" base level for developed market interest rates as we slowly head to zero, therefore not necessarily signalling impending doom on the near-term horizon.

Happy weekend everyone.

The LSS Team.