"Trading A Market That’s Both Beautiful And Damned"

From Garfield Reynolds, Bloomberg FX, bonds and commodities macro commentator

Trading a Market That’s Both Beautiful and Damned

The past month shows the current market should only be traded by people with first-class minds: those, as F. Scott Fitzgerald posited, who can hold two opposed ideas at once while remaining functional. Equity indexes hitting record highs would seem to indicate a world where everything is fine, yet the tendency of markets to reverse sharply on relatively minor provocations threatens to keep me awake day and night

That unease may look reasonable, but calling a straightforward pullback in risk is far from straightforward. Given the way markets have been moving, it’s another reminder that having the right timing is often more important than having the right view.

Just look at Friday’s merciless outbreak of dollar and risk aversion, with traders apparently terrified that Hurricane Irma and North Korea would set off real-world destruction and blow the floor out from under Treasury yields, equities and the greenback.

That felt like a panic too far, for the moment at least. Even so, the scale of Monday’s manic risk-on reversal also came as a shock -- what has really changed for the better to warrant the S&P 500 rising to a level it’s never seen before?

Whether the current global rally is sustainable or not depends on what you think the drivers are, so lets take a look at some of the usual suspects:

  • QE, QE, QE. The massive injections of cash from the Fed, ECB, BOJ, SNB, BOE and other central banks have created serial asset bubbles, including stocks and bonds.
  • China’s recent pickup in inflation data signals a successful transition from export-oriented powerhouse to a more stable, consumer-led model, and that’s driving an explosion in metals prices that signals global growth momentum.
  • The Federal Reserve is right to be tightening because the world’s biggest economy is strong enough to move away from emergency accommodation and that’s also good news for world demand.

If QE is the key, then last week’s tantrum is merely a dress rehearsal, and the coming tapers from the Fed and then the ECB will make for some very interesting times.

But if stronger growth signs are behind it all, then Monday’s surge makes some sense, even if there are far more risks to the outlook than gauges like the VIX and MOVE index indicate.

The recent selloffs, though, show just how much fear there really is out there, signaling that the nightmares lurking behind them are all too likely to become real.