• Weekly comments for July 18, 2016

    Investors know that the US markets are at an all time high with earnings growth weakening. Only Nirp and liquidity justify current prices. Should we invest for the long-term, knowing that Nirp and liquidity will at the end force worldwide inflation, or should we be defensive?

    If we look at margin debt, we can see that US investors are clearly becoming more defensive by reducing margin. It is easy to say that today's pattern is very similar to the two previous patterns that occurred just before a big plunge, but in past occurrences, the markets were, relatively speaking, more unfettered by central banks.



    On the other hand, the US/Japan rate differential is pushing higher, which is attracting more Nirp Japanese money into US assets.



    We can see that the weak Yen is supporting higher US equities, although in the past two days, traders have been buying the Yen. Based on that pattern alone, we could expect weaker equities on Monday.



    We can also see that since the very bullish NFP report, the US10Y have been under pressure. (Higher rates imply that the Fed might have to act to cool down the economy.)



    Higher rate expectations are also negative for the PM sector.





    High-yield bonds look to be under pressure too.





    The S&P500 shows a weakening MF, but non-S&P500 stocks show an even weaker MF pattern. This indicates that investors are chasing the combination of yield and security in larger stocks.



    A negative MF does not bode well for the S&P500 itself... But it is not negative yet!



    On the other hand, Excess Reserves show a negative trend, indicating that money is being pulled from reserves and used somewhere else. This figure dates from 10 days ago. A new figure should be published in the next few hours. I am convinced that the expectation of higher US rates has pulled more money out of reserves.

    The movement in and out of reserves depends only on the differentials between the US 10Y rates and the 0.5% that excess reserves now offer. The higher the difference, the more money will chase after US equities... But if earnings turn out to be poor, then dividends and buybacks will weaken and money will revert back to reserves (and to Japan.)



    Conclusions:

    Expectations of higher US rates attract more money from Japan and from reserves. These forces are very strong, and they are a new development. In the past, no such strong pool of liquidity was parked at the Fed, nor did Japanese Nirp exist.

    These two forces are much stronger than the decrease of margin debt.

    As a consequence, even though as a general rule higher rates are negative for US equities, it probably will not be the case this time.

    However, the Money Flow on the S&P500 has obviously weakened in the past days. This probably tells us that the markets only need a small negative trigger to find a lower floor.

    After a small pullback early this week, I believe we will see rotation from expensive to cheaper sectors such as Biotech, which showed strength last Friday.