S&P 500 Charge’s ’Risk Appetite’ Lead, Covid, Brexit and Other Top Themes to Start 2021

S&P 500, VIX, Dollar, EURGBP and USDCAD Talking Points:

• We are transitioning into a new trading year with volatility still churning at exceptional levels – what are the most important themes for the start of 2021?
• My first concern is the systemic interest and bearing of ‘risk trends’ with market participants pushing into every more extreme exposures
• Aside from the extremes of fear and greed; I am watching matters of pandemic numbers, growth forecast, stimulus measures, Brexit discussions and trade wars

Risk Trends Are My Number One Concern…Along With Nearly Every Other Trader

As the end of the year draws relentlessly closer, the event horizon for liquidity increasingly distorts between headline-driven volatility and a supersaturated speculative exposure. While sudden shifts in underlying market direction and urgent moves in key assets are probable through the immediate future, the opportunity of trend is quickly dwindling as liquidity thins out. At this time of the year and hounded by an unrelenting speculative interest, I find it important to start tracking out the critical fundamental themes that are likely to take the reins for critical trends at the start of the new year.

Looking ahead to the overture of 2021 trade, there are a number of critical fundamental and thematic matters that are likely to push and pull markets to significant movement. At the very top of my list is the state of ‘risk appetite’ across the entire financial system. While certainly pushed and prodded by key fundamental matters, this disposition of the entire speculative landscape is more appropriately construed as market condition. There are a number of high-profile fundamental catalysts that can spur a further build up in risk exposure or otherwise trigger a cascade from an already-top heavy position. Yet, more important to me than the news item that the market seizes upon for justification one way or the others, I’m more concerned about how prone to seismic alignment we find these markets. Among the measures to watch the US indices are overindulgent but far from the peak of speculative indulgence. Nevertheless, the record highs from the likes of the S&P 500 and ratios like SPX to VEU (rest of world ETF) or even the Nasdaq 100 to S&P 500 concentration can reflect better the intensity.

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Chart of Relative Performance of S&P 500 and Other Risk Assets (Weekly)

Chart Created on Tradingview Platform

From the tech-laden measure (NDX) relative to the broader US indices (S&P 500 or Dow), we find justification of disruption, pandemic override and comfort in market capitalization; but I see a more rudimentary and indulgent motivation at work: appetite for momentum. Rather than looking for value, there seems to be greater premium paid to assets that have continued to charge regardless of their inherent fundamental limitations. And, taking that notion even further, we have seen particular favorites arise with FAANG giving way to Tesla in the past months. Further to the extremes of the surface of the bubble (which I believe we are seeing form, but that doesn’t mean it has to pop just for our recognition) are the assets pursued simply for their properties of amplification. Consider TQQQ, the Ultra Nasdaq ETF, which was number three for ETF volume this past session or the enormous demand for IPOs or SPACs particularly these past weeks.

Chart of S&P 500 and VIX Seasonal Performance by Month Back to 1980

Chart Created by John Kicklighter with Data from Bloomberg Terminal

Though this is not the most extreme measure now and it has been around as a critical charge in previous years, I am nevertheless keeping close measure of the speculative activities around hedging measures. The VIX volatility index is generally treated as a volatility reading and draws from its intended benign reflection of hedging around the S&P 500. That said, speculative engagement of this index has exploded over the years to the point of being a distilled trading outlet. While the likes of the VXX short-term volatility ETF are worth monitoring, I am particularly sensitivity to effort to push a short-volatility position via net speculative futures exposure for VIX or the few vehicles intended to play counter to activity readings like the SVXY.

Chart of VIX Volatility Index and Net Speculative Futures Positioning

Chart Created by John Kicklighter with Data from Bloomberg Terminal

Know Your Safe Haven of Preference

After more than a decade of recovery evolving into outright speculative stockpiling backed by temporary amplifiers like stimulus – and particularly with the suspect recovery of the post-pandemic market just this year – I am increasingly of the mind that there is an extreme skew in the probability/potential spectrum for markets. While I believe the probability is still favoring ‘risk on’ in the opening weeks of 2021, the projection of this path is likely to be more choppy and ultimately reserved. Alternatively, if a less likely risk aversion set in, it threatens to spread across the entire financial system and cause a full avalanche. With that in mind, it is important to consider your preferred vehicles ahead of time. I would eschew specialty vehicles or a ‘short’ position on stretched assets which don’t align to the same tempo in their advance for the assets that stand to benefit for an outright demand for liquidity. At the top of that list and materially off its own highs is the US Dollar.

Chart of Relative Risk Standing

Chart Created by John Kicklighter

While there are a number of safe havens that we can look to for a ‘long’ view against the speculative downshift, there are shortcomings that I suspect for many of the assets. From Gold, we are already pushing record highs and it is traditionally priced in what is the more stable liquidity provider: the Dollar. From the Euro or Japanese Yen, the desperation to keep exchange rates from ballooning has been stated outright by policy officials. On extreme risk aversion, I would look to the Dollar to start its lift higher.

Chart of DXY Dollar Index (Monthly)

Chart Created on Tradingview Platform

The Pandemic is Still A Critical Uncertainty

While most roads may inevitably lead to a trend in sentiment, it is nevertheless to monitor these themes for their catalyzing properties as well perhaps as their ability to stir relative market movements. The coronavirus pandemic is due to be just such a critical matter in the transition to 2021. While major Western economies – the United States, United Kingdom, European Union – have already begun the distribution of approved vaccines to the Covid-19 virus, it will take months to fully inoculate these populations and alleviate the risk such that governments are confident in fully opening up their economies. In the meantime a rise in cases, deaths and ICU occupancy will reasonably lead decisions to curb the contagion in the interim. Recognition of this could tip broad sentiment trends but they could also spur relative perspectives like trends in EURUSD.

Chart of Worldwide Covid-19 Deaths (Daily)

Chart Created by Google.com with Data from Wikipedia

GDP Forecasts are More Fluid than Investors May Appreciate

While the human toll of the pandemic is painful in itself, the amoral market will evaluate the damage in economic terms. The outlook for continued recovery still seems to be abstract between different economies and skewed between timely readings and rosy forecasts. Below, we can seem some of the divergence at play between the S&P 500 as a speculative measure of enthusiasm and a more grounded reading like the Conference Board’s consumer confidence survey.

Chart of US Conference Board Consumer Confidence Data and S&P 500 (Monthly)

Chart Created by John Kicklighter with Data from Bloomberg Terminal

Brexit Will Carry Through into the Open of 2021 Despite the Official Transition

Another, more localized issue that is likely to spur market movement at the very beginning of the new year is the state of play in the United Kingdom’s trade relationship with the European Union. As of today, it is still unclear whether the two sides can see a way forward; but approving a deal today would not absolve the issue through the start of 2021. There will still be significant uncertainties to work through and likely market movement from the Sterling and relative European assets.

Chart of the EURGBP (Daily)

Chart Created on Tradingview Platform

Trade Wars – 2018’s Top Fundamental Risk – Is Still A Systemic Threat

While there are many other issues that will be on ready display to star the new year – and perhaps matters that are more pressing in headlines to close out 2020 – I will be watching the state of trade wars as we transition. That is in part owing to the swap in administrations in the United States from a Trump Presidency that ushered in an extraordinary disconnect in global trade. In fact, before the Pandemic; trade wars was the most prominent and effective global market moving theme in 2018-2019. Against the backdrop of a general economic struggle, the thawing or maintenance of these pressures will carry a lot of weight for the likes of USDCNH, USDCAD, USDMXN but likely also risk trends in general.

Chart of USDCAD with 50-Weeky Moving Average (Weekly)

Chart Created on Tradingview Platform

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