Along with my trades for 2018, there are some charts that I believe will be key for determining how the year unfolds.
First, wages are a key metric of the monthly NFP, perhaps as closely watched as the headline number. As I’ve mentioned before AHE is led by the Atlanta Fed’s Wage Growth Tracker. There’s been a slight pullback in the momentum of AHE, and my view is that the WGT will stay at or above its growth rate and that AHE will move upward toward it as it did in the previous cycle (the 90s play out this way as well, as is illustrated by a longer time series).
If this occurs the Fed will be forced to turn more hawkish and the front end will move up more quickly than what’s priced in.
What makes me think wages will move up? That takes us to our next chart:
Housing starts. As not-esteemed-enough professor Edward E. Leamer notes “Housing IS the Business Cycle”. Only two post-war recessions were not precipitated by a housing decline–the dotcom bust and the DOD recession in 1953. As long as starts keep on trucking, the music will keep playing.
The yield curve.
A fairly reliable recession predictor, though usually several years out, I think it’s likely the curve inverts this year. I’ll have follow-up posts on the two and the ten separately and suffice it to say that flattening will solidify the regime in which we find ourselves, and set up trades for next year. And although Yellen is out and Powell is in, I have a feeling her view that yield curve inversion isn’t a harbinger is consensus within the Fed, which means they’re not likely to fight it.
Above is the Caixin PMI. If this stays above 50 expect commodity currencies, copper, global DM equities to continue to rally. Expect the opposite if there’s a move below 50. Which way is it going to go? I have no idea. The size and complexity of China coupled with the dearth of quality data and opacity of their credit markets make it a trade for none but a few true experts, and none of them is writing this blog post.
2017 saw the dollar decline, vol nearly completely absent (i.e. equities grinding ever higher), yield curve flattening, and macro funds putting up positive single digits on average. Without further ado, here are trade ideas for 2018:
Short dollar via long EUR, JPY; commodity currencies if you don’t mind the tail risk. I expect a significant further move down in the dollar. Don’t pay attention to rates (a subject for a follow-up post), but rather the US twin deficits versus other DM twin surpluses, and then look at relative PPI changes over the past several years, both of which will continue to exert downward pressure. I prefer EUR, and will be buying dips. JPY is a bit tougher because it’s been so tethered to the Ten Year, but I expect the BOJ to lean more hawkish as inflation picks up a bit and for these to decouple. Still, I’m in wait-and-see mode in JPY. Longer term I’m targeting 1.35 in EUR, 11112 in JPY (I trade the futures), and similar moves in GBP in CAD, with smaller moves in AUD (waiting for a pullback), NZL, and CHF.
Short the US two year; put on a 2s/10s flattener if you want to hedge. My models suggest a move to as high as ~2.9% for the two year, but probably something in the mid 2s by the end of the year. Last week it sold off on the ADP number, which came in above expectations, and when NFP came out weaker than expectations, it still ended the day lower after the initial algo-driven rally. That is, it’s looking for any excuse to go lower. Sell every rally. If you want to hedge duration, buy the Ten. I expect the curve to invert by 2H.
Short Russel vs S&P: My initial thought was short Nasdaq vs S&P based on valuations but if we get a selloff I expect small caps to share the pain roughly equally with tech stocks, and if there’s a cyclical move lower in equities I expect the smarter small cap markets to lead, as they traditionally do. So, if Russel-S&P works it will work about as well as Nasdaq-S&P, and if it doesn’t work it won’t be as painful when Amazon goes to $2,000. This is my lowest conviction trade. I’m really torn on equities here because while I don’t see the business cycle precipitating a bear market this year it’s hard to ignore the ridiculous valuations. But as long as earnings are growing it’s difficult to see an end to the daily grinding higher.
Good luck this year. Happy hunting.