Stagflation Fear

It’s my 29th birthday today, and it seems like the perfect day to leave it to our investment team for commentary over the weekend. I’m glad it’s looking like a green day today, given the futures action this morning.

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Colin Symons, CIO Lloyd Financial Group

No doubt, the last two days of trading have been ugly. This is now the fifth week in a row where SPX has declined. Is there room for a bounce or do we keep going down? Of course, nobody knows, but here’s what I’m focusing on.

While obviously the core trouble is the situation in the Middle East, oil hasn’t come close to the spike high near $120 from near the beginning of the conflict. Nonetheless, SPX is down about -7% from there. Why? To me, the biggest pain point from the market is the pricing in of stagflation fears.

The stagflation fear is particularly clear looking at the bond market, and particularly the short-term interest rate (STIR) market. In a short time, we’ve gone from talk about two interest rate cuts this year to seriously contemplating and starting to price in a rate hike. As I’ve said before, I think that’s bananas but that’s what the market is saying.

So, what does the market do, from here? Of course, a lot of this is headline driven but I’m paying a lot of attention to the STIR market for direction. In that respect, I found Friday very encouraging, as the odds of a rate hike on the year started falling, again. One day doesn’t make a trend but it’s a nice start.

The market basically didn’t care about the STIR market on Friday, though. De-risking has been the name of the game, along with a continued positioning centered on stagflation. Admittedly, though, that selling was on pretty low volume. There’s been a reluctance to hold weekend risk, and it looks like we got that again, to end last week.

So, I’d look to see if we can continue the trend of pricing out rate cuts, next week. That would be a sign the stagflationary positioning is getting long in the tooth. What else? The dollar has also been on a tear, which is kind of a blessing and a curse. On the bright side, it’s an indication foreigners aren’t selling US assets but it’s also a sign that investors are seeking safe assets, like the US dollar. I’d like to see the dollar fade.

It’s no surprise I’d also like to see oil fade. Investors have been struggling with how long this conflict goes for, with the idea that closing the Strait of Hormuz for months could see $150 oil. If an off ramp can be negotiated, we should see relief in oil. That also could really help longer-term effects of higher oil causing a recessionary impulse.

Lastly, while the volatility index (VIX) still hasn’t topped highs from early in the conflict, it has been climbing since the middle of the month. That shows sustained fear and a lack of market liquidity, helping open up downside potential. Hopefully, VIX can relax soon.

These problems can potentially go away quickly, and it sounds like both sides are talking. It’s hard to know just when the market will start to get comfortable that the major problems are behind us, though. I, for one, am using the STIR market, the dollar, oil, and VIX as guideposts to see where we are. If those factors can ease, then great. If not, some amount of de-risking may make sense.

Iran is allowing 20 Pakistani ships to cross the Strait, at a pace of two a day.

Separately, Thailand made a deal to have their ships pass through the Strait.

The yen is on the rise, bouncing off old lows after the BoJ warned of taking action.

JPM and GS are raising the possibility that the Iran war will create recession.

Trump claims Iran gave into US demands, though oil is still up 2% and over $100. Similarly, VIX is only down marginally, and rates are off lows. Seems the market isn’t overly trusting of the claim and Iran has denied involvement.

The Treasury is meeting to talk about recent private credit market volatility.

SPX has now been down five weeks in a row.

What does it all mean? Some signs of progress on winding down conflict but the market is hesitant about trusting the news.

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