The Everything Bubble Rallies

The onset of November ushered in another fascinating week in financial markets. While the turn of the calendar means colderweather, the major US equity markets have caught fire. Each of the major US market indexes closed the week at new all-time highs. The rally in stocks has been indiscriminate. Large caps, small caps, industrials, tech, consumer discretionary, andconsumer staples all powered higher. On Friday, in addition to its new all-time high, the NASDAQ closed higher for the 10thconsecutive day, and the S&P 500 has rallied in 15 of the last 17 sessions. The S&P 500 also briefly stretched above $4,700 intraday on Friday, adding a new milestone to this bull markets uniquely distinguished resume.

Precious metals, bonds, and the dollar also advanced on the week. For good measure, even the VIX volatility index—which typically moves inverse to the broad market averages—managed a weekly gain and jumped nearly 7% higher on Friday despite the market-wide rally. It sure seems that this everything bubblehas now settled into the groove of a new everything rally. Only a few invitations to the party were lost. Several real estate sectors and certain commodities, most notably crude oil, closed lower on the week. Even in the case of oil, however, the price closed strong, gaining 3.12% on Friday.

So, after a brief misstep in September, the bubble dynamicsgears now appear to be cranking again in perfect upward harmony. The advance/decline line has continued to make new highs after months in which it was not confirming higher equity prices. Just this week, a new all-time high in the Dow Jones Transportation Average negated a Dow Theory non-confirmation warning signal that had existed relative to the DowIndustrials and other major indexes. Both represent significant technical developments for market internals that have now swung from bearish to bullish and point to a continuation of higher trending prices.

At the same time, there are also emerging signs of overheating.Every major index is now extremely technically overbought, and the subdued investor sentiment that was conducive for a rally at the start of October has now reached dangerously high levels.The Daily Sentiment Index (DSI) from trade-futures.com is a contrary indicator. When it records excessively bullish investor sentiment, it is a strong warning sign.

After reaching the lowest levels in a year this past October, the DSI has now sharply reversed course, reaching a 93% reading that represents the highest measure of bullish market sentimentsince the start of 2018. Looking back to that last high in the DSI sentiment reading in January of 2018, we see some similarities to the present moment. During the two years preceding that 2018 excessive sentiment level, the Dow Jones had rallied 72%.Within a matter of a few days of the high reading, the Dow began a yearlong 18% correction. Currently, the Dow has rallied nearly 100% in less than two years, and bullish sentiment has once again hit the danger zone.

Similarly, this last week saw retail and institutional call buying reach feverish levels. A total of over 100 million upside call options traded this week throughout US exchanges. According to Sentimentrader.com, that ranks in the top 2% of all weeks since the dot.com bubble era. In addition, a rising VIX volatility index alongside rallying equities may be another warning sign that recent extreme bond market volatility may be ready to bleed over into equity markets. Fascinating market dynamics indeed.

The big news of the week came courtesy of a US Federal Reserve FOMC meeting and the non-farm payrolls report for the month of October. Both events were highly anticipated. On Wednesday, the Federal Reserve finally announced that it willbegin trimming its monthly bond purchases in November, with plans to end the asset purchases in 2022. Most market participants saw the announcement as leaning dovish. Despite announcing a November rather than December start to the tapering process, the Fed did not directly signal when it mightbegin raising interest rates, arguably the most important phase of policy normalization.

The dovish tone was also perceived in Fed Chairman Powells comments on the inflation problem. Powell pointed to global supply chain issues as a primary cause of high inflation, and stated that, in the Feds view, the factors contributing to this inflation surge are expected to be transitory.The Fed acknowledged that it could take longer than they had anticipated for inflation to ease, but Powell asserted that, We dont think it is time yet to raise interest rates. There is still ground to cover to reach maximum employment.Powells preference to remain patient on interest rate increases ran counter to expectation within financial markets. Most investors thought that recent inflation data would trigger a more aggressive stance from Powell on Fed intentions to raise interest rates.

Powell also went on to add that he did not see the troubling increases in labor wages that might raise the risk of a wage-price spiral. Such a development could force the Fed into an aggressive policy direction intended to ease inflation. The relaxed stance was surprising. The Labor Department just released data on third quarter wages that showed pay increasesjumping sharply over the previous quarter, and at the highest-ever rate on data that goes back 20 years. The same release also showed the value of employee benefits doubling from the previous quarter. Businesses have more open positions than there are people to fill them. The consequence is a tight labor market where labor has the bargaining power to command higher pay and benefits for the first time in decades. As the wage data demonstrates, labor is starting to get that higher compensation. The conditions necessary to initiate an inflation-maximizing wage-price spiral are now in place.

Meanwhile this week, the release of the latest IHS Markit manufacturing survey also pointed towards more consumer inflation ahead. Chris Williamson, chief business economist at IHS Markit said that the data revealed a …survey record rise in manufacturers selling prices, suggesting that inflationary pressures continue to build and look unlikely to abate to any significant degree any time soon.

Also casting doubt on the wisdom of Powells relaxed inflation stance was a Thursday release from the Labor Department. The Department reported that US unit labor costs, the price of labor per single unit of output, spiked higher in the third quarter while productivity declined at its sharpest pace in 40 years. Unit labor costs surged at an 8.3% annualized rate in the third quarter after rising at only a 1.1% pace the previous quarter. The report offers yet another sign indicating that high inflation is likely to stickwith non-transitory persistence.

Meanwhile, the news on the jobs front this week was encouraging. US employment increased more than expected in October, indicating some increased economic momentum following a sharp GDP fall-off in the third quarter. According to the Labor Department, non-Farm Payrolls increased by 531,000 jobs in October. The jobs number beat estimates for 450,000 payroll additions from economists polled by Reuters. The unemployment rate fell to 4.6% from 4.8% in September.

The better-than-expected jobs number on Friday and other recent signs of stronger economic data would traditionally be thought to increase the chances of a future hawkish Fed pivot.Typically, events that raise expectations for such a pivot are assumed by the market to be negative for gold prices. Notably,however, on Friday, despite a significantly better than expected Payrolls number and a US Dollar Index that hit its highest level in more than a year, gold managed to close above all significant moving averages and at its highest level since early Septemberat over $1,816.

Gold is in an interesting situation at present that bears close watching. After nearly a year-and-a-half-long corrective consolidation following the August 2020 all-time highs, the yellow metal is caught in a wedge between converging levels of strong underlying support and strong overhead resistance. A volatile breakout in either direction is becoming increasingly likely with the passage of time. With gold rallying in the face of the positive economic data and the Fed tapering announcement that is now behind us, any shift in the market away from extremely overheated momentum stocks toward out-of-favor value offerings like gold could send gold prices above significant technical resistance between the $1,825 – $1,840 level and catalyze a more significant larger scale rally. While the Friday close for gold was extremely encouraging, a resumption of selling shy of the key technical breakout levels in the near-term could trigger the volatility breakout to the downside. At MWM, we will be watching closely.

As for weekly performance: The S&P 500 closed the week up 2.00%. Gold was higher by 1.84%, silver gained 0.88% on the week, platinum was up 1.48%, and palladium gained 2.39%.The HUI gold miners index had a nice week, up 4.02%. The IFRA iShares US Infrastructure ETF was also strong, up 3.71% for the week. Energy commodities were mixed but extremely volatile again. WTI crude oil lost 2.75% while natural gas was up 1.66% on the week. The CRB Commodity Index was down 1.13%, and copper dropped by 0.57%. The Dow Jones US Real Estate Index ended the week up 0.16%, while the Dow Jones Utility Average Index gained 0.30%. The US Dollar Index was higher this week by 0.21% to close the week at 94.32. The yield on the 10year Treasury lost 10 bps to close the week at 1.45%.

Have a great weekend!

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC