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March 2021 Commentary

Source: Fred St. Louis

Source: Fred St. Louis

List of Inflation Performance

Economic recovery will depend a lot on the affected numbers and vaccination rates. Looking at the US, with vaccination beginning to be rolled out and a decline in the number of COVID cases, the end of recovery might be near as consumer confidence in the economy just hit a 1-year high.

United States COVID cases over time 2-week trend

Source: Statsnews, Applied XL

Current and predicted vaccination rate

Source: Centers for Disease Control and Prevention

Source: Conference Board

In terms of our view on the US economy, we see both GDP growth and inflation increasing. Given the past correlation with the ISM NMI to GDP growth, the ISM is also signalling continued YoY GDP growth ahead.

Source: Fred St. Louis

Similarly, the ISM Manufacturing Prices paid and Kansas City Fed Raw Materials Prices, which are both seen as a leading indicator of inflation, signalling further inflation ahead.

Source: Fred St. Louis

Source: Kansas City Fed, Fred St. Louis

The past month’s sector performance saw signs of a transitory phase between a late-cycle to a recession cycle with XLE being the top performer for the first half of the month, a characteristic we normally see in the late cycle of the economy.

Utilities and consumer staples outperformed towards the end something very recession-like. However, signs of early rebounds in an economy were seen as well with the industrials, materials and real estate sectors starting to pick up their pace. Going forward we look to overweight on early cycle sectors while trimming our positions in late-cycle performers.

US Sector Performance 26th Feb – 30th March

Source: Koyfin

We should also see the gap between value and growth start to trim as recovery continues.

Source: TradingView

Traditionally, Central Banks have raised rates to fight against inflation however we feel that the current “bubble” is too big to fail and we respect the possibility of an environment with inflation and low rates going forward. This is because of the current debt level and a rise in rates could lead to higher defaults causing a financial collapse in the worst-case scenario.

From a technical perspective, the US10Y is at overbought levels last seen in the 1990s and as the month comes to an end, the TD monthly countdown 9 is about to form with confluence on the weekly countdown 13. We might see a short correction in yields in the weeks ahead.

US10Y Weekly RSI

Source: TradingView

US10Y Monthly TD Countdown

Source: TradingView

US10Y Weekly TD Countdown

Source: TradingView

As higher yields attract more inflow of money the DXY also hits its high since November as it catches up to rising yields on the back of strong economic data and strong technical supports. However, historically this would usually mean we are in a risk-off and deflationary environment which clearly isn’t the case with current market performance and we believe that this rising dollar trend will not be here to stay even though we are starting to see a rise in non-commercial CoT numbers.

DXY Daily Chart

Source: TradingView

Dxy Monthly Chart

Source: TradingView

Source: CFTC Commitments of Traders

If the dollar continues to trend, EM and commodities will be affected. We are already starting to see a slowdown in the S&P GSCI. Given current inflationary tailwinds, we believe the issue is with the current dollar strength.


Source: TradingView

Source: Nasdaq, Fred St. Louis

Having said that, we have been seeing back-to-back all-time highs in the S&P 500 due to reflation and we feel that a correction is due.

The Shiller PE ratio has been on the rise with increasing momentum to the upside meaning that company valuations are rising rapidly, a peak in the Shiller PE ratio has had a history with markets correction like Black Tuesday and during the tech boom.

Source: Robert J Shiller

Our proxy for the Buffet Indicator; the Wilshire 5000 to GDP ratio is also stating that the stock market is insanely overvalued compared to historical average.

Source: Fred St. Louis

A divergence has been forming on the S&P 500 vs the Nasdaq 100 which had a high historical correlation and we believe that something’s got to give. The last time an obvious gap between the two was seen the S&P was the one who played catch up and we believe that to be the case this time too.

S&P 500 (yellow) vs Nasdaq 100 (white)

Source: TradingView

Taking a look at the S&P 500 breadth (S5TH) as well, the number of stocks in the S&P 500 above their 200 moving-average is approaching an all-time high. Peaks in the breadth have had a trend of a correction following it.

S5TH Index (white) vs S&P 500 (orange)

Source: TradingView

The 12-month forward looking EPS doesn’t justify current price as well…

Source: FactSet

And it seems that the number of short-sellers is way too little according to Goldman, a squeeze happening now would be a big one.

Source: Goldman Sachs Global Investment Research

Given the above points, we feel that a correction is due, not to mention the VIX is looking like its ready for some action technically.

VIX Daily Chart

Source: TradingView

Traditional workings of the markets that have been prevalent in markets don’t seem as useful in our current economic environment as fears of rising inflation and debt looms. We saw investors rotating into assets which tends to better during inflationary periods and saw bonds yields rising to match it, although we believe a correction for the S&P 500 is due, we believe that the current “bubble” is too big to fail and we expect inflation with low rates going forward given current market dynamics.


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