“You either die a hero or you live long enough to see yourself become the villain.”
Harvey Dent: The Dark Knight
**Any market or trading views are purely my own thoughts and views and in no way are to be considered investment advice.**
Macro
It has been a tough environment to be bearish equity markets, as they continue to climb the wall of worry. At the same time broader commodity markets are following the lead from crude oil, with copper, corn, soybeans and wheat all coming under pressure. Softs have been holding up well under supply disruption fears. The strength in equity markets has been driven by a few factors:
Mega-cap tech on the back of the “AI Revolution”
A belief that rates will be lower in 2H 2023 (despite markets heading to ATH)
A commodity price sell off that takes the pressure off inflation in the medium term
Unemployment remains relatively low. (but is that about to turn?)
For those that believe in efficient market hypothesis, these are interesting times. Gold [was] trading over $2k, front end rates at >5% in the US and the NASDAQ is now only 17.5% 14.5% from its ATH.
As Stanley Druckenmiller mentioned at the SOHN conference, this is one of the hardest periods of macro he has experienced. I think this is due there being several scenarios that you can argue for that all have a reasonable probability of playing out. The other issue is you may be “right” with the eventual outcome but if you get the sequencing wrong, you’re likely to drawdown quite significantly (ask Harvey Dent above).
So what are the probable scenarios? In my view they are:
Commodity head fake (30%)
Commodity prices continue to sell off, reducing cyclical inflationary pressures
Fed reduces rates to 3-3.5%
Housing markets stabilise
USD lower / Gold higher for balance of 2023
Growth over Value persists for balance of H2 2023
Commodities rear their heads in Q4 2023 or Q1 2024 and the inflationary pressures come back harder and faster.
Rates go higher faster (30%)
The services inflation stickiness persist
Commodities bounce before Q3 2023 due weather or a geopolitical event
Growth equity tumbles
Real economy goes down with the equity market
Commodities bounce hard, causing an abrupt lowering of demand (think EU energy in 2022) and the global recession is severe
USD stronger / Gold lower
Main St. Vs Wall St (40%)
Services are sticky and wage inflation persists due to collective bargaining and increased power of unions
Commodities trade in a band (e.g. oil in a $68-88 range base WTI)
House prices flat in nominal terms, lower in in real terms in the US. Housing in more rate sensitive markets in Australia, Canada and UK remain under pressure in nominal and real terms
Slower rotation back into value from growth
EM outperforms DM
USD weaker generally but more idiosyncratic depending on relative balance sheets
Fed holds firm for balance of 2023, eases a little in H1 2024. Real rates stay negative but nominal rates come lower.
The more time goes on, the more I think number 3 happens eventually but the market bounces ferociously between almost starting scenario 1 or 2. Given government support is more likely to take the form of fiscal policy than monetary policy, this tends to lead to generally worse equity performance on relative basis. Its not the melt up scenario or the melt down scenario that most talking heads want to see. The main problem with number 3 as the final outcomes, is that the likelihood of left tail events happening is higher than the past 30-years, due to poor foreign policy the geopolitical tensions on the international stage, and the populist environment western governments face at home. That makes stupid poor, woke reactionary decisions a higher probability than normal.
Neutral stance
The commodity bulls have been stubbornly wrong for nearly 12 months now. Apart from soft commodities, just about every sector is flat or lower on a YoY basis except precious metals.
I have no problem with being wrong, I am wrong fairly often (just ask my wife!), but some of the rationalising saying “price is wrong” or “the market is still tight” or “it’s the macro speculators” are in denial. They have been wrong.
As commodity markets sit today, I have a neutral stance generally for the next 6 weeks or so. Maybe the long awaited demand turns up over the summer and the wealth affect of tech ripping higher boosts the wider economy. I don’t think so but happy to hit pause on the bearishness until it becomes more clear over the holiday period in the northern hemisphere. Since the low earlier this month, the WTI Crude curve has rallied and the spreads have become firmer. This does bode well for the bulls and I have to respect the recent price action at the lows. Maybe Joe is filling his SPR after all? So it would not surprise me to see a re-rest of $80 on crude oil, but I am not convinced it can conbincingly break through yet.
Weekly Chart - WTI Rolling 2nd Month Chart
Grains & oilseeds have also been a lot weaker than expectation with many ignoring huge supplies in Brazil of corn and beans whilst focusing on losses elsewhere. Now that old crop sales from the US into China have been cancelled the tepid nearby demand removes the old crop story. However, with some uncertainty creeping into US production thanks to weather and the speculators mostly short new crop, you could see the prices rally but spreads weaken (which has been the opposite of what has happened for most of Q2).
Daily CME Corn - July 2023 / December 2023 Spread
Softs commodities are more interesting and will send out a separate focus piece on those markets later this week. Good luck out there.
**Any market or trading views are purely my own thoughts and views and in no way are to be considered investment advice.**