Weekly Hard Assets Insights
By David McAlvany

Are We Moving from Risk Appetite to Risk Aversion?

After both the Dow Jones Industrial Average and the S&P 500 registered new all-time highs on Monday, all three main U.S. stock indexes (the Dow, S&P, and NASDAQ) closed with losses for the week. Market breadth was notably weak again as the number of declining stocks vastly outnumbered gainers. In fact, the NYSE Advance-Decline Issues Index has not made a new high since before fireworks and 4th of July celebrations. 

Despite a rally in stocks on Friday, a closer look at this week’s market moves reveals a risk-off signature and, in particular, may be suggestive of economic growth concerns. There was a clear performance divide this week between the more and less economically sensitive stocks and assets. Looking at equity market sectors, consumer staples outperformed consumer discretionary, oil and energy stocks were crushed, and both materials and industrials got hit. Meanwhile, the defensive sectors of health care and utilities were higher.

Outside of equities, the story was the same. The safe-haven assets of bonds, gold, and particularly the dollar all caught bids. With that said, gold deserves special mention here. While gold is certainly a safe haven asset, it’s also heavily affected by the rest of the commodity space. It’s also affected by the dollar in a typically inverse relationship. This week, however, despite an absolutely slammed commodity space and a surging dollar that finally established a technically significant new high in the rally that started at the beginning of the year, gold demonstrated amazing resilience and actually ended the week higher. Gold’s decoupling from these typical relationships may be another tell that economic growth concerns are taking hold. 

Looking at the demand-sensitive commodities sector outside of gold, this week was a bloodbath. The broad CRB commodity index was down 4.61%, with its largest weekly decline since Covid. Dr. Copper was down 5.78%, and broke below the $4 level intraweek for the first time since breaking above it last spring. And WTI crude oil plunged 9.21%, giving up the last of its gains since February.

The nature of this week’s market behavior fits with a potential thematic phase change from the booming recovery and high-powered growth narrative that has dominated markets since the rally out of Covid lows to a new narrative that’s concerned about fading growth, inflation, a coronavirus resurgence, and a Fed moving closer to withdrawing stimulus and raising interest rates. In that context, this week’s gold price resilience is also interesting in what it may be signaling about that new narrative and possible stagflation. Perhaps the (unusual in context) strength in physical gold is an indication of the asset’s particular merit in a stagflationary environment with weakening growth but continued high inflation.

Commensurate with the possibility of a thematic change, market pricing behavior may now be starting to demonstrate some of the concerns highlighted in recent issues of HAI. These include last week’s grisly University of Michigan Consumer Sentiment Survey, continual GDP downward revisions, weak PMI manufacturing data, Chinese growth and credit concerns, and looming Covid Delta variant jitters. Add in this week’s big retail sales miss, and the emergence of a new risk-averse, cautious, and concerned market narrative would seem entirely reasonable.

Meanwhile, Fed officials have recently been beating the drum of policy normalization at an increasing rate. With a view of the economy that seems much more consistent with the booming recovery and growth narrative than a more cautious alternative, Fed officials are increasingly claiming that we are right on the verge of fulfilling Chairman Powell’s “substantial further progress” benchmark for policy normalization. On Monday, Boston Federal Reserve Bank President Eric Rosengren said, “If we get another strong labor market report, I think that I would be supportive of announcing in September that we are ready to start the taper program.”

As a free-market advocate and a supporter of sound, responsible, and sustainable government policy, I’m philosophically sympathetic to the taper talk. With that said, from a market perspective, if the taper is especially ill timed, it would likely have significant negative implications for near-term asset prices. In that scenario, it’s certainly possible that the unprecedented extreme risk appetite that has defined this recent era in financial markets could quickly and dramatically be replaced by significant risk aversion. Perhaps the market is just now digesting that potentiality.

Interestingly, on the topic of risk appetite, it’s worth circling back to the notably cautious Federal Reserve semi-annual Financial Stability Report released last May. The FSR stated that, “…should risk appetite decline from elevated levels, a broad range of asset prices could be vulnerable to large and sudden declines, which can lead to broader stress to the financial system.” In the report, Fed Governor Lael Brainard added the following:

The latest Financial Stability Report provides valuable analysis to track increases in financial system vulnerabilities. I would highlight a few areas…. Vulnerabilities associated with elevated risk appetite are rising. Valuations across a range of asset classes have continued to rise from levels that were already elevated late last year. Equity indices are setting new highs, equity prices relative to forecasts of earnings are near the top of their historical distribution, and the appetite for risk has increased broadly, as the “meme stock” episode demonstrated. Corporate bond markets are also seeing elevated risk appetite, and the spreads of lower quality speculative-grade bonds relative to Treasury yields are among the tightest we have seen historically. The combination of stretched valuations with very high levels of corporate indebtedness bear watching because of the potential to amplify the effects of a re-pricing event.

Well, credit to the Fed here. On the comment that “…should risk appetite decline from elevated levels, a broad range of asset prices could be vulnerable to large and sudden declines…,” we at MWM wholeheartedly agree. Given the confluence of factors mentioned above alongside a Fed taper program, risk aversion may well be upon us. Jackson Hole in August is a spectacular place to be, but I have a tough time imagining that Fed chairman Powell is looking forward to this year’s retreat in the fresh maintain air, or to the position he may find himself in as we get further into the fall.

As for weekly performance: The S&P 500 closed the week down 0.59%. Gold held impressively firm this week, closing higher by 0.33%. Silver lost 2.82%, platinum lost 3.10%, and palladium collapsed by 14.3%. The HUI gold miners index lost 5.86%. The IFRA iShares US Infrastructure ETF was down 2.25%. Energy commodities were lower again this week. WTI Crude Oil was hammered, losing 9.21%. Natural gas, on the other hand, was little changed, down only 0.23%. The CRB Commodity Index was down big this week by 4.61%, while copper losses were 5.78%. The Dow Jones US Real Estate Index ended the week unchanged, while the Dow Jones Utility Average Index added 1.33%. The US Dollar Index gained 1.08% to close the week at 93.51. The yield on the 10-year Treasury lost 2 bps to close the week at 1.26%.

Have a great weekend!

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC