Let's kick things off in the risky side of the financial universe. For this analysis I look to the S&P500 and Crude oil as increases in their prices tends to signal an increased appetite for risk assets. Equities for example, reflect improving expectations for the economic outlook while Oil reflects improving expectations for economic activity. When the price of risky assets increase, financial markets are awash with optimism while the opposite is true when prices are falling. The S&P started its slide in right out of the gate in January 2022, while oil didn’t turn lower until later that year in June. Stocks eventually bounced off of a bottom made in October 2022 while oil prices began trading sideways between about $93/bl on the upper-side and $70/bl on the lower-side.
Safe-haven assets were also trending very consistently for most of 2022 as well, the dollar was the only instrument an investor could have bought that appreciated for much of last year, until October when it too pivoted. Tied to the move in the dollar was a commensurate move in US10YR Treasuries as the bonds sold off to reflect the rising interest rates that were fueling the steady move higher in the dollar. Gold was an interesting vehicle to watch last year, despite a $440 swing in price from as high as $2,065 to as low as $1,625 gold began 2023 at roughly the same price as it began 2022, though it also experienced a sharp pivot in October.
So now let’s link market expectations to macro-economic implications. The S&P500 found support around the 3500 level in October, and risk sentiment improved as news of China reopening and ending the zero COVID policy they’ve had in place since to start of the pandemic. Interestingly enough, the oil market hasn’t reflected the enthusiasm. With escalating risk of interruptions of Russian oil as NATO ramps up military support for Ukraine, and OPEC all but promising more production cuts, oil should be trending higher. The lack of positive impulse in the energy market suggests some underlying deterioration of demand outside of southeast Asia as the China re-open is surely putting upward pressure on prices. Relative weakness in economic activity outside of Asia probably means relative equity underperformance as well.
Last October into November, safe-haven assets made a U-turn as well, which roughly corresponded to what can be considered “peak Fed hawkishness”. The falling dollar is signaling investors expecting the Fed to pivot policy and stimulate before inflation falls to their 2% target, which was reflected in rising gold prices. The rally in the US10YR corroborates that idea, as a Fed pivot to rate cuts would mean investors demand for bonds at current rates increases. These market trends can continue, and indeed accelerate if when faced with a slowing or shrinking economy and rising unemployment, the Fed decides to change its narrative. If the Fed however, decides to stay the course and focus on bringing inflation back to it’s target, market dynamics could reverse quickly.
The direction of the dollar and the direction of oil could be the most telling indicators of both economic sentiment and activity. Equity markets are discounting mechanisms and so, try to look through the near-term and price for the medium-term, which doesn’t paint a very accurate picture in a rapidly changing economic environment. Demand for dollars is a little more immediate, as it measures liquidity needs, which are much harder to look through. So when demand for dollars increases, if sentiment turns negative from a drop in activity reflected in oil prices, investors will sell their stocks and even their gold to get their hands on more dollars. As a sidenote, this is the type of environment needed to force stocks and bonds back to an inverse relationship, undoing the last of the residual effects of the response to the Great Financial Crisis of 2008. Investors will buy bonds as the elevated nominal...