Divergence and Corrections

Financial markets showed some signs of divergence overnight, as an underwhelming US ADP Employment number rattled the confidence of the wall of fast money positioned in the buy everything trade. ADP Employment rose by 428,000 jobs, positive, but well short of the 950,000-gain forecast by markets.

US indices higher while yields slip

Although both the Nasdaq and S&P 500 finished higher, the rally was driven by a strong rotation into defensive sectors such as financials and utilities, at the expense of technology. Meanwhile, US 10 and 30-year yields both fell strongly as nerves increased that Friday’s Non-Farm Payrolls would disappoint. The US dollar corrected higher, with both gold and oil suffering substantial falls.

The divergence between the trajectory of US yields and equities versus the US dollar, energy and precious metals implies that the greenback is still the haven of choice. The price action also means that much of the recent FOMO buy everything price action recently is non-sticky tail-chasing fast money that heads for the exit door at the first sign of trouble.

We are likely to have more days like this ahead, with an acceptance that higher intra-day volatility is a side-effect of the democratisation of financial markets via online platforms. That money is noisy and is desperate to extract every tick out of every move.

Stepping out of the herd’s FOMO noise, the fundamentals for higher equities, a lower US dollar and higher precious metals remains firmly in place. Falling US real yields with a Federal Reserve and its quantitatively easing central bank coterie prepared to keep rates lower for much longer. The shocking state of the US government’s fiscal accounts that already had a trillion-dollar deficit before Covid-19 leading to fears of currency debasement. The hunt for yield anywhere, and signs that the rest of the world is, slowly but surely, modestly recovering from the pandemic.

Rather than looking for conspiracies everywhere, which is tiring on a daily basis, an acceptance of higher intra-day and probably weekly volatility should be the longer-term investor’s modus operandi. It’s either that or lots of Panadol. Like Douglas MacArthur, the buy everything trade shall return in all its glory.

That economic recovery was reinforced by China once again this morning, Caixin Services PMI printing at a still expansionary 54.0, for the 4th month in a row. That Asia will probably lead the world out of the pandemic recession should surprise precisely no-one, although the recovery will be uneven across the region. That has lifted spirits in Asia today with the region’s major equity markets mostly in the green.

More talk of fiscal stimulus from the South Korean government, and a BOJ official stating that the central bank must cut rates further and quantitatively ease more has also helped lift the mood. That has helped sweep any fallout from the lower than expected July Australian Trade Balance, (4.6 bio vs 5.4e), under the carpet, despite a worrying 17.70% fall in exports to China. Australian investors appear to be treating the latter number as a mere flesh wound, and despite China and Australia’s tense relations, core exports will stay intact.

German and French Services PMIs are released this afternoon, with both expected to show substantial increases. With the euro on the back foot overnight, after the ECB’s Chief Economist expressed disquiet about the high level of the currency and its deflationary effect on import prices, weak readings could be enough to tip the single currency into a deeper correction.

Tonight’s US Initial Jobless Claims will assume greater importance after yesterday’s disappointing ADP employment data. Initial Claims are expected to fall to 950,000, a slight improvement over last month. Continuing Claims are expected to fall to 14 million. With no sign of a follow-on fiscal stimulus package from Capitol Hill, an unexpected rise in Initial and Continuing Claims could see more haven inflows into the US dollar, deepening the correction, even as US bond yields would inevitably track lower. That could spill over into energy and precious metal markets, although only a brave man would stand before the FOMO-gnomes of Wall Street in equity markets. Bad employment means lower interest rates and more easing equals buy equities. Positive data indicates the economy is recovering equals buy equities. It’s that simple, even if I sound jaded saying it.