Risk Assets Extending Higher. Are Negative Rates Ahead?

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Rabbie Gill

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Risk Assets Extending Higher. Are Negative Rates Ahead?

The S&P500 and risk assets continue to extend higher as the daily MACD has registered such high levels only twice before.  The S&P 500 can continue to extend higher as it bounces against overhead resistance in the 2,800 to 2,880 level.

The improving sentiment and valuation multiples can be tied directly to the Federal Reserve’s capitulation on further policy rate hikes.  But TRI believes, the Federal Reserve does not control the business cycle, and the headwinds for slower growth into early 2020 cannot be undone merely by the Fed moving to the sidelines.

TRI senses the powers that be are beginning to float trial balloons of what is likely coming down the pipeline in North America…  while TRI is likely early on this call of negative policy rates… don’t be surprised when you pay banks to hold your deposits.

Market Trends

  • The S&P 500 continues to push higher, even after a bite size daily cycle low of Feb 8. Indications are for higher prices, but caution is warranted as the easy part is behind us.
  • If the daily cycle fails to make new highs above 2.05% and the daily cycle becomes left-translated, then probabilities increase of Can10yr rates will test the May 2017 1.40% rate level sooner rather than later.
  • Based on the right-translation of the previous weekly cycle, TRI expects the USDCAD to move higher to test, if not break through the previous weekly high of 1.3688 seen in Dec 2018.

TRI Cycle & Trend Signals*

The TRI Cycle and Trend Signals are shown below.  These signals are as of market close on March 1, 2019.  Please see the TRI Overview document for further information.

Source: Fieldhouse Capital Management

Equity – Risk Markets Still Extending Higher

The S&P500 and other risk assets continue to extend higher out of the December 2018 low.  The S&P 500’s bite size pullback into Feb 8 was sufficient to mark the most recent daily cycle low, and now is exhibiting overbought readings across several indicators. For example, the daily MACD has only registered such high levels twice before, in Jan 2019 and Mar 2000.  The S&P 500 can continue to extend higher here as it bounces against overhead resistance in the 2,800 to 2,880 level. Caution is warranted as the easy part is behind us.

The S&P 500 hit our initial target of 2,800, albeit much quicker and through a more direct route, that TRI had targeted in early January as evidence of the Daily, Weekly and Monthly cycle lows were completed.  The strength of the price increase has created an extremely right translated daily cycle which completed on Feb 8. The current daily cycle is also tilting towards being right translated as well given this week’s price action.  The Weekly cycle is now up 10 weeks in a row and likely to be right translated as well.

The importance of the right translation is that momentum continues to be positive and should support higher prices beyond the halfway mark of the cycle.  Once we see future Daily cycles, either fail to make new highs and/or become left translated we will then be on the watch for a Weekly cycle top.  The move out of the next Weekly cycle low, which TRI anticipates should be between late April and mid-June 2019 will be key assessing how much wind remains into the rising portion of the current monthly cycle. Based on price action across the 3-time degrees of cycles, TRI believes we the S&P 500 will move below the December 2018 low of 2,316 into late 2019 or early 2020 after this price spike exhausts.

Source: Tradingview.com

Investor Sentiment

The CNN Fear and Greed Index demonstrates the cyclical nature of investor sentiment.  The current reading of 72 put investor sentiment into the “Greed” zone, as the TRI is beginning to see signs of complacency rising.

Source: cnn.com

A year ago, in Feb 2018 investor fear was at a reading of 8, while Dec 2018 the index registered a reading of 3. Meanwhile the S&P 500 went from (in round numbers) from 2,800 in Jan 2018 down to 2,500 in Feb 2018 only to rise to new highs above 2,900 before falling to 2,300 and now snapping back to 2,800 level.

Business Cycle

The oscillation of investor sentiment can also be seen in the valuation multiples (P/E ratios) over the past year and a half.  In the chart below, the P/E ratio of the S&P 500 fell 4x from the beginning to the end of 2018, only to snap back by 3x in early 2019.

Source: Cornerstone Macro

The improving sentiment can be tied directly to the Federal Reserve’s capitulation on further policy rate hikes.  But as the TRI has stated before, the Federal Reserve does not control the business cycle, and the headwinds for slower growth into early 2020 cannot be undone by the Fed moving to the sidelines.  The chart below illustrates the economy has a short-term counter-trend bounce higher in early 2019, but then will again begin to fade lower. TRI believe economic growth, company revenues and cashflows will follow, also reducing valuation levels investors are willing to pay for risk assets.

Source: Bloomberg

Fixed Income – Diverging CAD & US Long Rates

Government of Canada 10-year rates appear to have peaked in early Jan 2019 for the year.  It appears the most recent daily low in rates was on Feb 25 (still waiting confirmation). Ironically, Can10yr rates are struggling to move higher, even as US long rates are moving higher and oil trading higher into the $56 US per barrel range.

If the daily cycle fails to make new highs above 2.05% and the daily cycle becomes left-translated, then the probabilities increase of Can10yr rates will test the May 2017 1.40% rate level sooner rather than later.

Cyclically, the Can10yr yield weekly cycle remains positive as price is consolidating in this 0.2% range just below / around the 2% level.  Technically, it appears that a bear flag is forming with this price consolidation, which aligns nicely with the cyclical perspective of interest rates moving lower from here.

Source: Tradingview.com

TRI’s view Can10yr yields in the 2% range to be very attractive from a value and risk perspective, as mentioned in our previous commentary.   With Feb 2019 price action, TRI is becoming more cautious on the outlook, and do not think Can10yr rates will raise materially higher from here and hence this might be the best opportunity to buy long dated Government of Canada bonds for the remainder of this cycle.  TRI notes the difference between equity markets which have moved upwards of 15% from the lows compared to a mere 0.2% move higher in interest rates.  Interest rates are hinting at a less robust economic outlook than equity markets are.

Central Banks – Negative rates coming?

TRI’s investment process uses a combination of business cycle analysis and Cycles and Trend’s assessment to understand where the best relative value is amongst risk assets. As seen below, TRI believes the markets move ahead of the business cycle and different assets and asset classes provide value during the various stages.

Source: Stockcharts.com

TRI monitors economic policies and central bank communications to understand tone and potential future direction and that may impact cyclical price action for equity, fixed income, currency and commodity markets.  In February, the Federal Reserve Bank of San Francisco published an economic letter “How Could Have Negative Rates Have Helped the Recovery?”.  While Canada and US did not get to negative policy interest rates, we did see negative rates in Europe during the Great Financial Crisis of 2008/9.

TRI senses the powers that be are beginning to float trial balloons of what is likely coming down the pipeline in North America…  while TRI is likely early on this call of negative policy rates… don’t be surprised when you pay banks to hold your deposits.

Currencies – USDCAD Moving Higher Again

USDCAD had a massive move higher on Friday with weak Canadian GDP print, as it appears the last Daily cycle low bottomed on Feb 25.  TRI had been expecting another daily cycle move down into the 1.28 to 1.30 range to coincide with an extended Weekly cycle low as well. The overall US Dollar Index has been consolidating, oil and commodity prices moved higher along with equity markets appeared to have enough juice to support a short-term lower USDCAD (stronger Canadian dollar).   However, if the Feb 25 daily cycle low holds and prices move higher, the USDCAD is likely on its way to higher levels and test the 1.37 to 1.38 level sooner rather than later.

This would result in the last Weekly cycle low bottoming on the week of Jan 28, with the first Daily cycle holding above the Jan 28 low.  Based on the right-translation of the previous weekly cycle, TRI expects the USDCAD to move higher to test, if not break through the previous weekly high of 1.3688 seen in Dec 2018.

Source: Tradingview.com

Diverging interest rate differentials between the US and Canada also support the view of a higher USDCAD exchange rate. In the event, the current daily cycle fails, or we have one more push lower, this will serve to extend the current daily and weekly cycle low out to that low from Feb 25 and Jan 28, respectively.

 

 

* TRI Cycle and Trend Signals are dynamic and may change on a daily, weekly and monthly basis, without notice. The indicators are at a point in time and do not imply that the current trend will persist and should not be considered investment advice.

Disclaimer: This material has been provided solely for information purposes for the use of the recipient and Fieldhouse Capital Management Inc. (FCMI). This material does not constitute an offer or an invitation by or on behalf of FCMI to any person to buy or sell any security. It should not be assumed that the methods, techniques, or indicators presented in these pages will be profitable or that they will not result in losses.  Any reference to past performance is not necessarily a guide to the future and the value of investments may fall as well as rise.  FCMI accepts no liability for any direct or consequential loss arising from investments made in accordance with the attached material. The research and analysis contained in the attached material has been procured from sources which are believed to be reliable and accurate.

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