Is The Inverted Yield Curve Coming Back?
Oil prices continue to
march higher on the back of a reaccelerating Chinese economy and
Saudi concerns. The dollar continues to correct following the breakout we noted
weeks ago, and with it gold is strong. But gold is not just strong in dollars.
As we also noted weeks ago, gold in Euros broke out — it soared for a while and
has now successfully tested the breakout point and is now rallying off of it
nicely. Gold in Yen also broke out and continues strong, though the Yen has been
playing catch-up this week. Commodity indexes are testing their highs mostly led
by oil. Yet economic statistics continue strong in the US and appear to be
strengthening abroad in Asia and even Europe once again.
Amidst the strength economically, bonds have retreated to intermediate-term
trend-line support levels and bounced this week. Unless the 90-91.5 support
level gives way on TLT’s
(
TLT |
Quote |
Chart |
News |
PowerRating) we suspect bonds will be in a trading range
and can bounce a bit off of this support.
A key question is whether the dollar has peaked and will revert to a long-term
bear trend from here. We suspect that the Euro will rally into the 50%-62%
retracement zone and then have trouble, despite short-term bullish patterns
being displayed widely across currencies versus the dollar. It is rare for the
dollar to decline materially and consistently when the Fed is raising rates and
those rate hikes are coming at a time when most other countries are not raising
rates. Few variables match up to correlations with currency movements better
than yield spreads and yield spread trends. But that doesn’t mean the dollar
can’t get weaker for a spell as it retraces the rally since January — and as
long as it does gold is the primary beneficiary. We like gold versus the Euro
especially, for we suspect dollar strength or weakness will not be critical to
gains here.
Asian and European indexes are particularly strong here. FXI
(
FXI |
Quote |
Chart |
News |
PowerRating) broke out
and is in nearly runaway action. However US internals are not as impressive as
they were just a few weeks ago. The US market may be the first to have troubles
with higher oil prices in combination with tightening yield spreads. The Fed
looks determined to continue hiking for some time, and eventually the markets
will have to reckon with a flat or even inverted yield curve. A blow-off in
non-US, emerging markets, Asia, and Europe here would likely mean that the
reckoning will occur globally and not too far in the distance in terms of time,
though price moves could be exaggerated during the blow-off. We suggest
investors and traders play some of these top trends but with less than normal
allocation, as a face-off between fed tightening and market moves looms ahead at
some point. High risk and high reward.
Our model portfolio followed in TradingMarkets.com with specific entry/exit/ops
levels from 1999 through May of 2003 was up 41% in 1999, 82% in 2000, 16.5% in
2001, 7.58% in 2002, and we stopped specific recommendations up around 5% in May
2003 (strict following of our US only methodologies should have had portfolios
up 17% for the year 2003) — all on worst drawdown of under 7%. This did not
include our foreign stock recommendations that had spectacular performance in
2003.
This week in our Top RS/EPS New Highs list published on TradingMarkets.com, we
had readings of 56, 20, 47, 43, and 87 with 12 breakouts of 4+ week ranges, no
valid trades and no close calls. This week, our bottom RS/EPS New Lows recorded
readings of 8, 14, 18, 14, and 13 with 15 breakdowns of 4+ week ranges, no valid
trades and close calls in PIR and PTV. One valid signal remains in place in VLO
on the long side and in UIS on the short side. We’re still not getting a lot of
trading signals in valid breakouts, though the environment is improving slightly
on the short side.
For those not familiar with our long/short
strategies, we suggest you review my book The Hedge Fund Edge, my course
"The Science of Trading," my video seminar, where I discuss many new techniques,
and my latest educational product, the interactive training module. Basically,
we have rigorous criteria for potential long stocks that we call "up-fuel," as
well as rigorous criteria for potential short stocks that we call "down-fuel."
Each day we review the list of new highs on our "Top RS and EPS New High List"
published on TradingMarkets.com for breakouts of four-week or longer flags, or
of valid cup-and-handles of more than four weeks. Buy trades are taken only on
valid breakouts of stocks that also meet our up-fuel criteria. Shorts are
similarly taken only in stocks meeting our down-fuel criteria that have valid
breakdowns of four-plus-week flags or cup and handles on the downside. In the
U.S. market, continue to only buy or short stocks in leading or lagging
industries according to our group and sub-group new high and low lists. We
continue to buy new long signals and sell short new short signals until our
portfolio is 100% long and 100% short (less aggressive investors stop at 50%
long and 50% short). In early March of 2000, we took half-profits on nearly all
positions and lightened up considerably as a sea of change in the
new-economy/old-economy theme appeared to be upon us. We’ve been effectively
defensive ever since, and did not get to a fully allocated long exposure even
during the 2003 rally.
Asian and European equity markets have broken out
and are continuing to run. Bonds have tested an important trend-line support
level and appear to be holding up. The dollar is declining into support. Gold
has broken out versus multiple currencies. Commodities are testing highs, led by
oil. It is not clear when oil prices will start to weigh on equities, but at
some point, they will. Investors should be aware of the global environment and
watch macro trends carefully, and be aware that though rewards are good now,
risks are also high.
Mark Boucher