Price Action

After a blistering October for stocks, drunk on yet another month of record liquidity by the cental planners, November's first overnight trading session has been quiet so far, with the highlight being the release of both official and HSBC China PMI data. The official manufacturing PMI rose to 51.4 in October from 51.1 in September. It managed to beat expectations of 51.2 and was also the highest reading in 18 months - since April 2012. October’s PMIs are historically lower than those for September, so the MoM uptick is considered a bit more impressive. The uptrend in October was also confirmed by the final HSBC manufacturing PMI which printed at 50.9 which is higher than the preliminary reading of 50.7 and September’s reading of 50.9. The Chinese data has helped put a floor on Asian equities overnight and S&P 500 futures are nudging higher (+0.15%). The key laggard are Japanese equities where the TOPIX (-1.1%) is weaker pressured by a number of industrials, ahead of a three day weekend. Electronics-maker Sony is down 12% after surprising the market with a profit downgrade with this impacting sentiment in Japanese equities.

Just as it is easy being a weatherman in San Diego ("the weather will be... nice. Back to you"), so the same inductive analysis can be applied to another week of stocks in Bernanke's centrally planned market: "stocks will be... up." Sure enough, as we enter October's last week where the key events will be the conclusion of the S&P earnings season and the October FOMC announcement (not much prop bets on a surprise tapering announcement this time), overnight futures have experienced the latest off the gates, JPY momentum ignition driven melt up.

Of course, the "relentless" rise hasn't been for two months this time.......it's been for nearly five years. And I can tell you, reporting directly from the heart of the Silicon Valley, the zeitgeist around here is 1999 and 2007 compressed together and supercharged.

The last week has seen dramatic upwards price action in the bitcoin markets, driven by a series of macro and micro events across the globe. The fallout from Silk Road’s closure turned out to be but a blip in bitcoin’s price history, with significant gains since then. Turmoil in global financial markets and recent news of leading global websites accepting bitcoin may have bolstered enthusiasm for digital currency, but most interesting may be CNY’s definitive recent price leadership.

Overview of the price action in the fx market.

As markets twiddle their thumbs waiting on Washington to come up with a political solution to the Federal Debt Limit/budget debate, ConvergEx's Nick Colas decided it would be a good time to review the academic literature on how markets discount expectations in the first place. Behavioral finance posits that human nature skews perceptions of risk and return, causing everything from irrational risk aversion to asset price bubbles. Against this current backdrop of theoretical uncertainty, measures like the VIX are currently somnambulant.  So, using the modern vernacular, WTF?  The bottom line, Colas explains, is that Wall Street thinks it has the current "Crisis" all figured out: a last minute deal with no Treasury default.  And just as we haven’t sold off materially during this drama, don’t expect a huge (+5%) lift afterwards.

As we noted earlier, this is not what the White House was hoping for. Thanks to no T-Bill police being at work today and on the back fo JPY-carry trades, the S&P 500 has now joined the NASDAQ in the green for the day having risen non-stop since Europe closed. Treasury futures are selling off notably too (and were higher in yield long before equities went green) - with the 5Y (shortest maturity trading) the worst hit. It's unclear whether the Treasury weakness is just a reflection of equity exuberance or (given the short end weakness) reflects anxiety over the deadline.

Commodities are no longer on investors’ radar screens. Various signals, however, are pointing to a new rally within the commodities super cycle.

We now appear to be close to the day of reckoning that likely determines what the coming weeks/months hold.

• Do we step back from the brink, see our politicians reach an agreement and carry on? Although to be fair, in 2011 the break below supports that led to accelerated losses in the equity markets actually took place once an agreement was reached.
• Do we break lower thereby causing the negative feedback loop/concerns that feed back into the economy, kill any possibility of tapering and sees the Fed re-establish its dovish credentials (Like 1998 and 2011)
• Do bond yields push higher after an agreement thereby increasing concerns about a negative feedback loop into the economy, housing, emerging markets, Europe (Like 2011) and ultimately the equity market?

Time will tell us the answers to the above questions, but whatever happens, Citi notes it looks like the price action in the near future is at pivotal levels that need to be watched closely.

As we noted last night, yesterday's move in US equity markets showed signs of investor panic and capitulation. BofAML points out that the inversion of the VIX to levels that have coincided with market lows for much of this year, the significant underperformance of recent outperformers (the NASDAQ Comp fell 2% and the Russell 2000 fell 1.72% vs an S&P500 decline of 1.23%), and pop in the ARMS Index all point to signs of capitulation. While this is encouraging from a technical perspective, as it says we are one step closer to completing the multi-week correction, they warn - it does not mean the correction is finished.

During the European crisis, we saw sovereign debt yields rising way above their domestic banking sector's yields as investors feared systemic crisis and technical flows dominated the price action amid aggressive hedging. Now, with Washington looking increasingly likely to crash upon the shores of a US Treasury technical default, for the first time on record the yield on short-term Treasury-Bills is above the yield on US interbank loans. T-Bill yields (the US government's "risk") have surpassed short-term LIBOR (US Banks' "Risk")... must be a good reason to BTFATH...

Markets are so obsessed by developments with the US debt ceiling, that absolutely nobody noticed that the Japanese Current Account (JPY152Bn, Exp. JPY520bn), Industrial Outuput in Spain (-2.0%, Exp. -1.6%), Factory Orders in Germany (-0.3%, Exp. +1.2%), Trade Balance in Germany (€13.1bn, Exp. €15.0 bn) and that the Jan-Aug tax revenue in Greece below expectations by 5.7%, all missed horribly, and that for all the talk of a European recovery (which was merely driven by a brief surge in Chinese credit spending making its way into the European pipeline) is once again fully and entirely premature. But with Congress on everyone's mind, even increasingly China and Japan, who cares about fundamentals: after all there is a Federal Reserve to mask the fact that nothing but liquidity injections matters. Even if that means a complete collapse in the actual economy as those separated from the Fed by one or more layers of banks, crash and burn.

Overnight trading over the past week has been a bipolar affair based on algo sentiment about what is coming out of D.C. But which the last session was optimistic for some inexplicable reason that a deal on both the government shutdown and the debt ceiling out of DC was imminent, today any optimism is gone in the aftermath of the latest comments by Boehner on ABC, in which he implied that a US default is not unavoidable and that it would be used as more political capital, as it would be once again blamed on Obama for not resuming negotiations. As a result both global equities and US futures are down sharpy in overnight trading. And since the government shutdown, better known as a retroactively paid vacation, for everyone but the Pentagon (whose 400,000 workers have been recalled from furlough) continues it means zero government economic statistics in today's session with the only macro data being the Fed-sourced consumer credit report at 3 pm. This week also marks the unofficial start of the Q3 reporting season in the US with Alcoa doing the usual opening honous after the US closing bell tomorrow. JPMorgan’s and Wells Fargo’s results on Friday are the other main ones to watch to see just how much in reserves are released to pretend that banks are still making money.  As usual, expect disinformation leaks that send the market sharply higher throughout the day, which however will only make the final outcome that much more painful, because as during every US government crisis in the past, stocks have to plunge so they can soar again.

Technically, the dollar is looking a bit better.  Here is our assessment.

Looking at the equity market and some of the background dynamics Citi's FX Technical group cannot help but be reminded of 2011. They also warn, despite the constant hope-driven rallies this week, there are also some aspects of what we saw in 1998 and similarities with 2000 that are worth noting. The bottom line, we have had the view for some time that we would see a much deeper correction in the equity market (in excess of 20%). Recent price action and developments might (just might) be suggesting that it is time to revisit that theme.