Markets to remain under pressure this week

The dollar index may consolidate further this week, but a low has been formed that should lead to a multi-week rally. Bonds are still in a bear market.  Last week’s rally is probably over. The US 10-year should test the 3% level that we think is a soft limit for the move.  US equities should resume their downtrend, with the objective of breaking the February lows. Gold hit our buy target last week. It may base a while, but a large rally should follow.

To recap, our fundamental indicators show the economic cycle that began in 2009 approaching a peak. Economic tops are rarely abrupt—unless there is a catalyst, and this one has at least been dulled by the tax cuts. Dollar liquidity has been tightening for some time and the growth rate of Austrian money supply has been falling in a similar fashion to 2007. Unlike 2007, the financial system appears relatively robust. But this does not mean that financial markets will hold up. In fact, all asset classes will remain vulnerable.

Our goal here is to track the market dynamics that this economic scenario offers—and it is rich with opportunities. Tighter liquidity implies possibly dramatic price changes in both directions. In short, macro trading is back—and back to stay. Not only are financial markets going to be more volatile because of economic change, but the geopolitical environment is becoming ever more dangerous as the US-led global order frays under the challenge of dictatorships in Russia and China.  It is gratifying to see that the Western intelligencia now seems to recognize the dangers that it now confronts.

While the intellectuals are getting the message, the electorates are in a process of evolutionary change towards radicalism. This will only get more extreme as the economic cycle turns down. We will, therefore, see an interplay between domestic extremism and geopolitical instability. There is no personality or party in the West that seems ready, willing or able to deal with these challenges, so we can look forward to a period of relative chaos—with all the dangers that implies. This environment will deliver many investment opportunities, and it is the aim of these notes to identify them.

In the currency markets, the dollar will retain its “perfidious privilege” and remain a safe haven as both the Yen and Euro are likely to be in geopolitical hot spots and gold may end its long bear market. Commodities should outperform financial assets as equities and bonds enter long-term bear markets. In no case will the price action be smooth; volatility is back to stay.

In the coming week, equity markets should resume their declines. It is still our central case that the decline will be limited to about 15% from peak to trough, taking most to new lows for the correction. But  we must recognize, greater bearish potential exists.

At the same time, bond yields look set to resume their upward trend. For now, we see the 3% area as one of support for the US 10-year, against a background of falling equity prices. Gilt yields look set to test 1.8%, and Bund yields too are likely to rise a little.

As for crude, we remain bearish with a target of 55 for WTI. The CRB will also therefore be under pressure, but firming agricultural prices should hold the index to about 424—or a 1% decline.

Target support levels for equities are: DAX 11,869; FTSE 7,004; Nikkei 20,528; HIS 2,800; and the S&P 2,417.

In the currency markets, the Pound and the A$ could be the best performers, and both could test their recent highs despite negative fundamentals because they are very oversold. The Euro will not be as strong, since it looks increasingly likely that a weekly high is in place and the overall trend against a background of  political uncertainty is down.

Malcolm Tulloch

The writer is director of the firm Tulloch Research. The company provides bespoke advice to clients on macro-opportunities in financial markets.

“Intuition is a product of accumulated experience”

Tobias Truman