Sound And Fury

Sound And Fury

US equities were worried about a burgeoning humanitarian crisis in India on Monday and Tuesday. Then stocks forgot about it.

US equities were worried about higher capital gains taxes on Thursday. Then stocks forgot about it.

That was basically the week, in a nutshell.

Thursday’s tax angst morphed into an outsized Friday rally. In the end, the S&P went nowhere. Sound and fury, signifying nothing. Or, actually, sound and fury signifying i) untold despair in the world’s second-most important emerging market, ii) what some insist will be untold financial despair for a tiny fraction of US taxpayers at some indeterminate point in the future and iii) a predisposition on the part of market participants to buy dips, irrespective of what caused them (figure below).

This week “certainly evidenced the post-monthly Op-Ex ‘gamma unclenching,’ which gave us greater ability to move thereafter, particularly following the ‘higher taxes’ headlines,” Nomura’s Charlie McElligott said Friday, adding that “this ‘greater ability to move’ dynamic has been abetted by an uptick in demand for downside ‘left tail’ hedging this week.”

In the end, small-caps were the winner. Headed into the closing bell on Wall Street, the Russell was on track for a second weekly advance (figure below), while the S&P was hugging the flatline and big-cap tech was lower, even after gaining into the weekend.

The juxtaposition between the proximate cause of market angst early in the week and the rationale for Thursday’s jitters could scarcely have been more stark.

India is spiraling into a pestilent nightmare with hundreds of thousands of lives at stake, a scenario that understandably unnerved market participants. On Friday, the Biden administration said it’s discussing what, if anything, the US can do to help. Markets were forgiven for casting a wary eye at the situation. By contrast, this week’s other concern (how much a relative handful of US citizens will need to pay on investment gains) seemed wholly trivial.

Some of you will suggest that’s unfair — that people prospering in advanced economies can’t possibly be expected to spend their days fretting about people they don’t know in far-flung locales. And it’s all relative anyway. Someone who gets COVID in India and survives is infinitely better off than a starving family in Yemen. Obviously, we worry about ourselves first, those closest to us second and strangers last, if at all. But 2020 was a reminder: When it all falls apart overnight, things like capital gains taxes become irrelevant. Keep some perspective.

The data continued to come in hot in the US. Flash PMIs on Friday registered records, new home sales rebounded more than expected and jobless claims hit a pandemic-era low. The world’s largest economy is “firing on all cylinders.”

And yet, bonds are unimpressed. Yields ended the week lower. “Taking a step back, even another attempt to breach 1.77% in 10s is still well within the confines of the seasonal patterns and with the May refunding a more traditional inflection point for Treasury yields, we’ll exercise caution against assuming 1.50% is immediately vulnerable,” BMO’s Ian Lyngen and Ben Jeffery wrote Friday.

“That said, if it does break there is little from a technical perspective before the 74-day moving-average at 1.402%,” they added, noting that “for context, the 50-day at 1.547% has already been breached on a closing basis, even as yields are currently drifting back above this indicator that hasn’t been challenged since November.”

SocGen’s Subadra Rajappa called this is “a temporary pause” that should be followed by “the resumption of the reflation trade.”

“A variety of factors contributed to the rally in bonds in April,” she said, flagging “demand from foreign central banks, a sharp increase in corporate issuance, especially from financials, and swapping of corporate issuance and demand for the long-end from pension and insurance companies.”

The idea, generally speaking, is that the fundamentals still point to higher yields eventually. A corollary is that the same fundamentals will reignite the reflation trade in equities. JPMorgan’s Marko Kolanovic reiterated the bank’s preference for reflation and pro-cyclical expressions this week, for example.

“Despite the pullback seen in reflation-, cyclical value- and economically-sensitives on a spot price level so far [in] April, we do continue to see options evidence high Call Skew in many of these sectors, industries and themes looking further out as folks keep ‘reflation crash-UP’ hedges on,” Nomura’s McElligott said, in the same note cited above.

Meanwhile, the dollar is mired in its worst weekly losing streak since November. “One driver of the greenback’s recent decline is falling real yields,” Bloomberg’s Ye Xie wrote Friday, in a short piece, noting that “the Fed’s insistence that it will be patient in withdrawing stimulus is starting to sink in with traders [and while] one could argue there’s limited room for US real yields to fall further given the improvement in the economy, the rate differential is moving against the US as other central banks, including Canada, start to take their feet off the pedal.”

Maybe higher taxes can help. After all, the fiscally responsible thing to do is “pay for” stimulus with tax dollars, right? If we offset the cost, then some of the bearish pressure on the currency from fiscal largesse will abate. If you’re wealthy, try to think about it that way. The dollars you have left after paying higher taxes will be worth more when you secure your COVID passport and fly to New Zealand to inspect your bunker.

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