Perspective Adds More Clarity

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Perspective adds more clarity to market action instead of looking at events in isolation. A very telling example this past week was US equity markets had their worst week since financial crisis and the quickest decline of more than 10% from their most recent high, in technical terms referred to as a correction, in the US market history.

Through to Friday, 5 trillion dollars in value was erased from global stocks. The MSCI Global Equity Index is down over 10%. One troubling indicator is that the similar fear trade concurrently taking place in sectors of the credit markets, sending treasury bond yields to records lows, indicate that we haven’t yet seen the worst of the selling action in stocks. This has prompted the debate of whether the US Federal Reserve and other central bankers will step up and cut interest rates as investors question whether a response from monetary policy officials can calm selling fears. Alternatively, some have raised the question that with central bankers limited firepower, whether markets would look instead for a response from public health officials that the virus is contained before showing signs of a bottom.

Where financial shocks based on liquidity issues or debt fears may be more simply reasoned and understood, the uncertainties around the extent of a virus are less clear, hence the wide-ranging opinions and outlooks.

It’s noteworthy that the US Federal Reserve, despite speaking engagements this past week, has remained tight lighted on their policy path. Even recently appointed European Central Bank President Christine Lagarde did an interview with the Financial Times this week on businesses needs to address climate change. However, policy direction has not been addressed and no guidance has been given to reassure markets.

As the financial markets are pricing in odds of four interest rate cuts from the US Fed by January of 2021, one analyst on Bloomberg Radio Friday morning warned that if the Fed fails to cut interest rates they are essentially tightening in this environment. He drew parallels (like the equity markets have) to the 2008 Financial Crisis where the US Fed was slow to react and consequently prompted further selling and lower prices in the stock market.

The merits of them not reacting is rooted in an academic approach on the efficacy of the Fed cutting rates in an economic slowdown that emanated from a supply shock. As supply chains backup and orders go on hold with factories being stalled, lower interest rates won’t transmit stimulus in that scenario. Still, the uncertainty is over the potential longevity of this economic slowdown. Easing of financial conditions for small businesses may provide a layer of relief for the time being, as many try to digest and determine the extent of the economic damage. Two points stand out.

First, since the financial crisis many have referred to a third or shadow mandate of the US Federal Reserve. The first and second mandates by congress task the Fed with targeting stable inflation and full employment. The third has been the Fed’s support for financial markets acting as a source of liquidity and creating a wealth affect through the economic recovery that benefitted those invested in the stock markets.

The second point speaks to the degree at which the most recent tightening policy, beginning with their taper program in trimming their balance sheet, followed by raising their policy interest rates. In some instances, they were anticipating the economic data and acting as proactive versus being reactive. If that were the case, instead of waiting for evidence of an economic slowdown in the US and global economy that might not be evident in the current data until mid-year, we might expect the fed to act sooner.

To recirculate to an earlier point, this raises the question when the Fed does ease, whether it gives equity markets and investors the necessary confidence. Without question supply chains have been disrupted, demand has been shocked, and markets seem to be pricing in a dire scenario. A question for the Fed that is yet to be tested, is whether anybody will listen.

The Week Ahead in Gold

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Stocks are set to open the new trading week Monday lower, sharply lower. The benchmark S&P 500 futures contract is down over 100 points, while the Dow Jones Industrial Average has declined by nearly 1000 points. It is going to be a rough open as stock trading gets going, and there is one primary area of concern for investors that may be behind today’s lower open: The coronavirus epidemic.

 

Over the weekend, the virus reportedly spread into Italy and South Korea. European stocks got hammered as worries over the spread of the disease increase. The Italian stock market, for example, declined by a whopping four percent. The equity losses were not limited to Italy, however, as German and French markets also felt the pinch of rising worries and fear.

 

Of course, the worry now is that the spread of the virus may put a major dent into global economic activity. The notion of a slowdown is not unrealistic, either, as the virus continues to spread rapidly. On Saturday, the International Monetary Fund (IMF) reportedly suggested that the virus could dent global economic growth by .1 percent and growth in China by .4 percent compared to estimates made just several weeks ago.

 

The effects of the virus are clearly being felt by manufacturing companies. Negative effects from the covid-19 outbreak are being seen in manufacturing indexes all over the globe, and many companies are now mentioning the potential impact from the virus when reporting earnings. With Chinese markets seeing major disruptions, the global supply chain is hampered, and those effects could continue if the virus spreads further.

 

U.S. stock markets remain firmly in uptrend mode, although that could change quickly with a few more days like today. Just how far equity markets may fall depends on several factors. The most important factor right now, however, may be how quickly or how slowly the virus spreads further. If the spread is slowed significantly, it may become easier for authorities to obtain a handle on it and control it. If it accelerates, however, the bottom could fall out from under global equity markets and a new downtrend could be seen.

 

The news of the spread has pressured stocks lower while boosting some safe haven asset classes. Yields on the benchmark 10-year note have fallen by several basis points, while the price of gold has climbed by nearly $40 per ounce. The rise in gold puts prices at seven-year high, and previous all-time highs are well within reach. In a sign of strength, the yellow metal is sharply higher today even as the dollar index also catches a bid higher and crude oil prices sink. In fact, most raw commodity markets are under selling pressure and could see sharp declines as the day progresses.

 

The gold bulls next target is to take out the overnight highs at $1691.70 and to then close above the $1700 level. The bears will want to see a breakdown below the $1620 region before getting too excited.

The Week Ahead in Gold

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As the holiday-shortened trading week gets going Tuesday, investors will be on the lookout for any new developments in the ongoing spread of coronavirus. The weekend has brought few, if any, fresh headlines about the disease. An increase in the rate of infections could, however, be enough to fuel widespread risk aversion and selling in stocks and risk assets.

 

A further spread of the virus could potentially act as a black swan event that could have significant effects on the Chinese and global economies. The virus may impact key areas of the Chinese economy that could already be considered fragile. The property sector in the country, for example, could send shockwaves throughout the global economy. With very high debt levels and sales having already come to a halt, an ongoing lack of activity could start a wave of defaults. A large amount of defaults in China would not only affect China but could also cause a significant decline in demand for commodity producing countries such as Australia and Brazil. A wave of defaults could also fuel a general sense of risk aversion in the global marketplace that could send stocks and risk assets sharply lower.

 

The coronavirus epidemic could also drive central banks to ease at a more expeditious pace. This week, markets will pay close attention to the latest FOMC meeting minutes due for release on Wednesday afternoon. The latest meeting minutes come on the heels of testimony by Fed Chairman Jerome Powell to a Congressional committee last week. It no longer appears to be a given that the Fed will hold on rates for the year, and further action could potentially come in the weeks ahead at the central bank’s March meeting. The FedWatch tool, as of Friday afternoon, was estimating only about a 10 percent chance the Fed would lower rates at the March meeting. The chances of action from the central bank jump for September, however, as the tool is showing over a 40 percent chance of a rate cut from the Fed.

 

With interest rates in the U.S. already at low levels, the U.S. Fed could be forced to look at alternative methods of boosting the economy. These could include fresh QE or even fiscal spending by the government. Whatever the case may be, lower rates and/or QE or other easing measures should be another positive for the gold market and could send the metal back to previous all-time highs or better in a hurry.

 

The last several weeks have seen the gold market build a large triangle pattern. The recent trading range has been tight, and the market could be on the verge of a significant breakout up or down. The bulls are looking for a sustained breakout above the $1600 region. The bears are looking for a breakdown below the $1550 and $1500 levels.

 

A lack of any fresh bullish or bearish inputs could keep the gold market in its recent trading range for the next several weeks or longer. The next major market move will likely be driven by the coronavirus epidemic or changes in monetary policies.

Near Term Distractions

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The most noteworthy observation on the financial markets a month and a half into 2020 seems to be the resiliency of US stock markets. No market moving story, and there has been a few of them, can seem to change their trend and direction. To begin the year, we witnessed a US drone strike on an Iranian General that prompted escalation fears between the United States and Iran. For only the third time in history we saw the congressional impeachment of a US president. And of course, still playing out are the unknowns associated with the coronavirus through China and the impact to their domestic economy along with global growth.

Continuing with the coronavirus, it’s been a challenge for the medium to long term investor to make sense of headlines that often fail to put in perspective the extent of the health scare. The point of this blog is not to attempt to join the chorus of global health experts in conjecturing on the breadth of this scare, but instead echo the skepticism for how this pandemic will play out, and whether markets are mispricing the end result.

What has been interesting is assessing the potential economic impact and thus why it was the focus of officials from the Federal Reserve Chair Jay Powell before Congress this week and even Canadian Finance Minister Bill Morneau speaking before an audience in Calgary. As Minister Morneau stated, the Canadian economy will be impacted from tourism numbers to global supply chain, and even resource demand. Canada’s situation in a global economy linked to an increasingly important China is no different from the United States or Europe. Whether this creates a v-shaped decline or is anything negative sustained is the unknown, which speaks to assessing the depths or longevity of this crisis.

With regards to Powell and deviating from the short-term discussion above, it was another comment he made before Congress this week that is perhaps more interesting. In his twice annual two-day testimony Fed Chair Powell came close to questioning whether the Fed had the adequate tools to combat the next recession and called on Congress to play a bigger role in the fiscal side of the equation.

This message echoes and motivates the narrative from many commentators that the ability for the Fed to continue to spur economic growth from ultra-low interest rate policies is coming to an end. An insightful comment was made by Greg Ip in the Wall Street Journal a few weeks back when he mentioned how the US economy has transitioned to be made up of less interest rate sensitive sectors. An aging population has diminished the significance of a rate cut to prompt home purchase or take on auto loans as services and education and healthcare now account for a larger share of GDP.

Phillip Hildebrand, the former head of the Swiss National Bank, and former US Federal Reserve Vice-Chair Stanley Fischer suggested that “unprecedented policy coordination” could be the answer to the next economic slowdown. This speaks to the notion of central banks financing fiscal deficits.

The last six weeks have been an interesting start for the markets in 2020. Geopolitical events to date have failed to unnerve investors from their evermore advancing trade in US equity markets. Events that have been so monumental that they’ve even masked potentially more consequential headlines.

The Week Ahead in Gold

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The gold market is under moderate selling pressure as stock markets move higher and risk appetite is on the rise. Fed Chairman Jerome Powell told a House of Representatives Financial Services Committee today that the U.S. economy is in a good place, even as he discussed the coronavirus and the long-term health of the economic outlook.

 

The current U.S. economic expansion is the longest on record and is now in its 11th year. Powell repeated the central bank’s view that current interest rates, between 1.50 and 1.75%, are appropriate to maintain growth. The outbreak of the coronavirus, however, will impact economic activity in China as well as that of its trading partners. The U.S. will almost certainly feel the effects of the virus as well and it is difficult to tell how much the spread of the virus may affect GDP. Powell suggested that the Fed will have to consider whether the effects will be persistent enough to warrant a material reassessment of the economic outlook. He reportedly stated that it is simply too early to know at this point.

 

Powell also discussed labor market conditions and suggested that the labor market has remained strong. He also suggested that companies are increasingly willing to hire workers with less skills and to train them, which could be indicative of labor market gains spreading to more groups. Powell did, however, also cite some concerns over the labor market. He discussed disparities being seen across racial and ethnic groups and suggested that individuals in their prime working years are not being seen in the same force as in other countries.

 

Of note is the fact that Powell reportedly warned about the increasing and massive fiscal deficit. He reportedly suggested that putting the nation on a path towards a balanced budget when the economy is strong would allow for flexibility to fight the next economic downturn.

 

Although the gold market may remain vulnerable to changes in risk appetite as well as headline risk, the bigger picture for the market remains solid. Ongoing geopolitical uncertainties, rising sovereign debt levels and an aging expansion and equity bull market are all issues that could keep gold on the offensive in the months and years ahead. Household debt is also becoming an issue. It was reported today that U.S. household debt reached a record $14 trillion. Of concern is the fact that credit card borrowers have continued to go into delinquency in rising numbers, a trend that has been in place since 2016. The increase in credit card delinquencies could be due to student loans, as more and more borrowers are unable to service their college debt or are forced to do so at the expense of other debt types. The gold market could potentially spend more time trading sideways as it prepares for a large upside breakout. The bulls are targeting a breakout above the $1600 region on a closing basis, while the bears are looking for a breakdown below $1550 and then $1500 to attract further selling momentum.

The Week Ahead in Gold

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The stock market is sharply higher Monday as the new trading week gets underway. As stocks rise, global risk aversion is on the decline and perceived safe haven assets such as gold and silver are under selling pressure.

 

Despite gold’s lack of upside today, however, its long-term prospects remain quite bullish. The yellow metal has possibly built a major long-term bottom at this point as prices have remained range bound from $1500 to $1600 for the last few months. The bears have been unable to push prices lower and willing bargain hunters have stepped into the market to buy any major dips. An additional upside breakout could potentially take some time to develop, but for now, the bulls appear to be content with prices maintaining their recent range. The next logical upside push could possibly target previous all-time highs near $2000 per ounce and could take place rapidly.

 

The spread of the coronavirus remains a major area of concern for global markets. Chinese markets, which opened for the first time in over a week due to the Lunar New Year Holiday, declined by almost eight percent for the largest drop in over four years. European markets, which have been open for business, were mostly higher Monday. The virus has been on the move, and both domestic as well as global business in China is being disrupted. The ongoing business slowdown, in addition to travel restrictions, could have a significant impact on Chinese GDP. Markets may have already priced in a drag on GDP, however, as both U.S. and European markets are higher today.

 

In bearish news for gold on Monday, crude oil is lower, trading for less than $51 per barrel. It has been reported that Saudi Arabia is considering a drastic production cut and OPEC officials may even get together this week to discuss the market. The U.S. Dollar is also seeing a bounce back from declines seen on Friday, and the stronger greenback is also likely weighing heavily on gold and other metals.

 

After the gold market hot a three-week high overnight, prices have calmed down and the market has made a bearish outside day on the daily bar chart. The multi-month uptrend does remain intact on the daily chart, however, and the bulls may need to target the January highs near $1620 to attract further buying interest. The $1550 region on the downside could hold the keys for the bears. The market bears must produce a solid close or series of closings below this level to gain momentum.

 

In other gold news, gold-backed ETFs saw record level inflows in 2019 in what may be construed as a bullish factor for the market. The inflows could also suggest that the market is seeing more interest from both institutional as well as retail investors amid much of the global uncertainty seen over the past year. The rising global uncertainty trend is likely to continue, as the global trade war continues and as the global economy remains a bit softer. This increasing demand for gold could pave the way for the next bullish run higher and increasing demand for bullion could set the stage for a new all-time high in the yellow metal sometime this year.