Weekly Hard Assets Insights
By David McAlvany

King volatility ruled markets again this week. In many ways, this week’s market movements were almost the mirror-opposite of last week. The S&P 500 rallied to new all-time highs and closed above 4500 for the first time ever. Commodities made a very strong comeback from last week’s drubbing, the dollar fell, Treasury yields rallied, and economically sensitive risk-on trades broadly outperformed defensive sectors. This week-to-week two-faced contradictory market behavior may seem strange and confounding, but it’s consistent with a brewing heavyweight battle between conflicting major market narratives wrestling for clarity and dominance.

Since the government’s monetary and fiscal fire hose was unleashed at full blast in the wake of the Covid crisis, the crucial macro factors have lined up overwhelmingly bullish for markets and asset prices. Liquidity flooded the system, the vaccine rollout and reopening went far better than many feared, and the resulting resumption of economic activity translated, along with pent-up demand, to strong economic growth stewarded and supported by ongoing and unprecedented ultra-accommodative Fed policy. That is a very favorable environment for stocks and higher prices. Over the course of the last year, a trend of higher prices and upward momentum has been firmly established.

As has been pointed out in recent issues of HAI, however, over the summer months, the factors and data driving markets have become much more complicated. Volatility and whipsawing prices can be expected as, over time, new data challenges the widely held bullish consensus. In fact, this is exactly why, historically, periods of heightened market volatility are associated with, and provide a clue about, major market trend changes.

Another historical indicator of major market trend changes comes from changes in margin debt. The amount of leverage employed by investors is tracked by the Financial Industry Regulatory Authority (FINRA). The aggressive use of leverage to boost returns has skyrocketed to record levels since the COVID lows of 2020. According to Bank of America’s Stephen Suttmeier, major trend changes in rising markets correlate to periods when leverage is unwound. This week, in a note, Suttmeier flagged what could be a “potentially…bearish peak for margin debt in June 2021.” Suttmeier said, “Rising leverage tends to confirm US equity rallies. It is not new record highs for margin debt that we worry about. We get concerned when margin debt stops rising to suggest that investors have begun to reduce leverage….” 

FINRA reported that in July margin debt declined by 4.3%. That represents the first monthly decline since the March 2020 market lows. BofA’s Suttmeier said he is “concerned” about this development, and says the S&P 500 “tends to be much weaker” following a peak in margin debt. 

In addition to the first monthly decline since March 2020—particularly given that it was a significant one—the 12-month rate of change on margin debt has also turned negative. At its peak in March 2021, the 12-month rate of change had reached 71.6%. That is the second highest reading in the history of the measure, short only to the 2000 tech bubble peak at 78%. Since the margin debt rate of change peaked in March, the reading has fallen aggressively to this week’s low reading of 37.55%. The negative dive in rate of change from such excessive levels likely confirms the significance of July’s negative 4.3% absolute decline in margin debt. While markets could certainly continue their momentum moves higher, the margin debt data adds yet another variable suggesting that we may be in the midst of a significant and volatile market trend change.

Expectations built on Fed stimulus as far as the eye can see have transitioned toward speculations on the timing of Fed tapering. Positive economic surprises and blowout growth expectations have morphed into signs of slowing growth. As of Thursday, the Citigroup Economic Surprise Index plummeted to a reading of almost negative 50, indicating that economic data is rapidly surprising to the downside. Inflation dismissed as transitory is now being increasingly recognized as stronger and more persistent than expected. And so goes the ongoing saga of an ever-changing economy and fluid financial markets. In light of this storm, volatility is expected, and we are certainly seeing that in spades.

The big event of this week was the Jackson Hole Economic Policy Symposium, with Fed Chairman Powell’s much anticipated speech on Friday. The Chairman’s remarks were widely viewed as leaning dovish. Cliff Hodge, chief investment officer of Cornerstone Wealth, described the speech as “An uber-dovish speech…[that] has equity markets setting new all-time highs.” While Powell indicated that the Fed could begin tapering asset purchases by the end of the year, he seemed to hedge his position both on tapering and interest rate normalization.

Improvement in the area of the Fed’s dual mandate of inflation and employment are the measuring stick for the “substantial further progress” Mr. Powell has cited as the benchmark for tapering asset purchases. In his speech, the Fed Chairman said, “My view is that the ‘substantial further progress’ test has been met for inflation. There has also been clear progress toward maximum employment,” but he also said “…the delta variant presents a near-term risk…,” and the Fed will be “carefully assessing incoming data and the evolving risks.” The dovish interpretation is likely the result of Mr. Powell leaving the door just open enough to provide cover for any future backtracking on an imminent taper program. 

Perhaps the bigger contributor to the dovish flavor of the speech, however, came from his remarks on interest rates. Mr. Powell stated that, “The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test….” Again, rather than a bold and confidant Fed that’s firmly committed to policy normalization, the Chairman seemed to throw the door wide open to the possibility of lower interest rates for longer. Referring to present interest rates, he said the current policy will remain until the economy shows more stability, including lowering the rate of unemployment, while adding that there is “much ground to cover” before reaching sustainable unemployment levels.

So, Mr. Powell offered enough hedging, caution, and lack of any firm commitments to swing markets into rally mode. In reaction to the speech, Goldman Sachs released a note saying, “Powell’s speech…was in line with our expectation that he would acknowledge both the strong employment gains in recent months and the downside risks posed by the Delta variant. We continue to believe that the FOMC’s intention is to provide advance notice in September and formally announce the start of tapering in November, assuming all goes reasonably well by then….” And there you have it. Rather than a firm commitment, the Fed made tentative plans based on a premise that assumes “all goes reasonably well by then….” 

The markets are at an interesting juncture here. Asset prices can continue to follow the Fed’s balance sheet, which is moving higher, or start to align with GDP forecasts and the Citi Economic Surprise Index, which are both moving decidedly lower. In the wake of Mr. Powell’s speech, at least for now, markets are choosing to value assets based on the Fed’s balance sheet and the “QE multiple” rather than on any other metric. All eyes next week will turn toward August’s US employment report due out on Friday. 

As for weekly performance: The S&P 500 closed the week up 1.52%. Gold was up by 1.99%, silver rallied 4.12% on the week, platinum gained 1.24%, and palladium was up 5.78%. The HUI gold miners index rallied 6.05%. The IFRA iShares US Infrastructure ETF was up 1.92%. Energy commodities had a big week. WTI crude oil rebounded by 10.62%. Natural gas was also in on the rally, gaining 13.50% on the week. The CRB Commodity Index also had a big week, up 5.90%, while copper gained 4.71%. The Dow Jones US Real Estate Index ended the week up 0.40%, while the Dow Jones Utility Average Index lost 1.95%. The US Dollar Index dropped 0.88% to close the week at 92.69. The yield on the 10-year Treasury gained 5 bps to close the week at 1.31% in another volatile week.

Have a great weekend!

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC