Money Flows, Market Structure Project Major Turnings Points In SPX, NDX, 10Y Yield, Gold, U.S. Dollar, High Yield, And Bitcoin

Summary

For equities, the US dollar, high yield and Bitcoin, expect a small recovery within a week (a rebound within two weeks also possible) - a significant decline follows thereafter.

But we should see a cyclic low for these assets sometime in late April-early May, followed by a new upside phase of the bull market.

For bond yields and gold, expect small downticks within a week (allow within two-weeks), which could be followed by significant rallies in gold and the 10-year yield into May.

We will be on the lookout for a major top thereafter - significant declines for both assets should follow.

I recently explored market conditions in a recent article at Seeking Alpha to assess the outlook over the next 3-6 months (see it here). In that article, I used macro data and economic fundamentals to argue that the markets are probably friendly to asset prices (but unfavorable to gold and bonds) over the next 3-6 months. After providing the cautionary note that fiscal and monetary initiatives take from 5 to 6 quarters before the effects can be seen in asset prices, I summarized the situation, as thus (see graph below):

“Risk assets have few more months of support from positive macro, but global/US systemic liquidity is receding, and inflation risk is putting pressure on the Fed, which may again over-tighten.”

Nonetheless, macro data is not the last word in the forecasting of asset prices. The economy (GDP growth) is frequently a lagging indicator. Even so-called "first principles" relationships in Economics frequently flip-flop. In my experience, the most reliable correlations (relatively speaking) can be found between the causality from monetary flows (changes in systemic liquidity) and changes in asset prices (see graph below). Very often, it is the change rate in the nominal values (flows), not the absolute changes in nominal value (the stock), which makes the most impact. Note, however, that the response of asset prices to the impact of those flows is variable; some assets respond more quickly to the flows; for other assets, the impact of those flows come later. Apparently, the tenets of the Efficient Market Hypothesis (EMH) are suspended in those relationships.

(In the graph shown above, the bank reserves impounded at the Fed and the Reverse Repurchase Agreements being conducted by the Treasury have significant impacts on the high-frequency valuation of the US Dollar TWI. The lead time of the liquidity variables is very short, sometimes even practically non-existent. To use this information profitably, look for systemic liquidity conditions, macro data, or financial variables which can modify the bank reserves and the reverse repo agreements. For example, if you are convinced that the Fed will reduce the bank reserves to a significant degree over time, why would you be bearish on the US Dollar TWI long term?)

It should therefore come as no surprise that in very many cases, some market prices are best forecasters of other asset prices. And frequently, the variable co-movements of two asset prices (spreads) can frequently provide clues as to the future behavior of other assets, and in fact, as to the future state of the financial markets. The spreads of market rates are especially very useful in this regard (see graph below). This example (below) is simple and straightforward, but even at this state, the spread is already useful, as it could telegraph likely equity market moves several weeks in advance (if properly set up). Imagine how much more useful these tools can be with the application of statistical and numerical analysis (which we do at PAM) to refine expectations and define probability cones - important information when making investment or trading decisions.

Insofar as this theme is concerned, there is no doubt that interest rates and bond yields have huge impacts on other prices and, in fact, on whole economies. I cite an example: developments in global bond yields (which have been collectively rising) could soon be posing significant headwinds to global growth and financial assets. In a reply to a reader’s comments on the article mentioned above, I said:

“While I think that the inflection point of US growth may come in H2 2018, there is empirical evidence that Global GDP and MSCI World($) are very sensitive to, and are negatively correlated, to aggregate global bond yields. And that data has been rising for the past 4 quarters (that's when the negative impacts starts to kick-in).”

Another idea which was introduced in the article, but not sufficiently explained in detail, was the impact of global central banks’ (Fed, ECB, BoJ, PBoC, SNB) stimulus measures on the world’s financial assets. Due to their relatively large volume, the aggregate G5 central bank stimuli (in the form of bank reserves) have also become their de facto Monetary Base (MB).

In other words, due to the small percentage of the cash percentage (notes and coins) to the whole, banks reserves being held by central banks have become their MB. Copious amounts of ink have been spent in explaining the process by which the asset purchases of the central banks (essentially just an asset swap) positively impact a broad range of financial assets (specifically, the equity markets - see graph below), so there’s no need for a further long exposition on the matter.

Almost all analyses agree that the impact through the portfolio balance channel and the signaling channel can push up house and equity prices, and also lower the future path of short-term rates and reduce longer-term yields. However, those relationships only stayed in place from November 2008 (when the Fed started QE) until June 2014, when the relationship reversed.

As from that time, adding to the bank reserves drove long bond yields higher, and vice versa, reducing the bank reserves triggered a decline in yields (see the two graphs below).

Relationship of bank reserves and bond yields BEFORE June 2014:

Relationship of bank reserves and bond yields AFTER June 2014:

I am bringing this up now because there were plenty of questions in the comments section regarding the implications of the Fed’s self-imposed regimen of reducing its balance sheet by scheduled monthly reductions. We can explain away a putative fall in rates in the event of significant reduction of the Fed balance sheet via its link to the M2 money supply and the Money Multiplier, but the empirical evidence shown in the graphs above is easier to visualize.

Furthermore, the flip-flop in the co-movement of the variables MB and bond yield impacted a lot of the modeling work we do to project changes in money and liquidity flows to subsequent changes in asset prices. Seeing that so-called “first principles” relationships do not necessarily stay that way forever, I did an extensive review of our working models to make sure that we are not being blind-sided by these flip-flops. It was too much to expect that we would escape unscathed, and so, there went my long Easter holiday.

One change we have to modify is the conclusion published on March 28 by my partner Tim Kiser in his first Seeking Alpha article, SPY Will Increase For 2 Weeks”. He summarized the article by suggesting that the S&P 500 will recover from this correction, and the direction of the market is up for the next two weeks. Recalibrating the models suggests that the uptick Tim K. has forecast may be delayed a week and could last for just a week. While we may indeed still see a two-week uptick from a bottom soon, our new optimization process stripped away the safety margin for a two-week bounce, and we can only now feel confident of a shorter rebound from here. All other conclusions written by Tim K. remain valid, in my opinion.

I have been writing articles at Seeking Alpha which have money flows as theme, but those have been mainly published at my blog at Seeking Alpha. This is my first general article on the subject in the Market Outlook section, as I am now seeing plenty of new interest on that subject, especially as it applies to the forecasting of asset prices and macro data (e.g., inflation, growth). Monetary aggregates undoubtedly impact, and in fact, lead the trajectory of growth, depending on how you configure your tools. Using the change rate of Money Velocity (GDP/M2) often shows some advance indications of what to expect regarding GDP and its subsequent effect on asset prices.

Much of that new interest has been generated by the work and comments of Salmo trutta, the doyen of money flows proponents at Seeking Alpha. I have been using money flows or liquidity models for more than 20 years and reach my conclusions via a process slightly different from Salmo's (assuming I properly understood his procedure). Salmo deserves a lot of credit for being a proponent of money flows (which the central banks have basically ignored since the early 1980s) and for creating a strong buzz about the subject of money and liquidity flows at SA discussion forums and elsewhere, which benefits many readers and investors. His work is highly recommended, although the reader should first acquire basic familiarity with monetary economics before piling in.

We are now completing the creation of a new investment advisory platform at Seeking Alpha, called Predictive Analytic Models, so the members of the team (myself, Tim Kiser, Seeking Trends) decided on a graphics-rich presentation to introduce our systemic liquidity models.

These are the general descriptions of expected market action over the next few weeks:

  • For equities, the US dollar, high yield and Bitcoin, expect a small recovery for a week (a two-week rebound is also possible) - a significant decline follows thereafter. But we should see a cyclic low sometime in late April-early May, followed by a new upside phase of the bull market.
  • For bond yields and gold, expect small downticks over the next few days, but this should be followed by significant rallies in gold and in the 10-year yield into early May. Significant declines in the price of both assets follow thereafter.

The illustration of expected relevant market structure over the next few weeks for each individual financial asset is self-explanatory. But nonetheless, you can ask me for more details (if you wish) in the comments section.

SYSTEMIC LIQUIDITY MODELS vs. S&P 500 Index

Expect a small recovery for a week (a two-week rebound is also possible) - a significant decline follows thereafter. But we should see a cyclic low sometime in late April-early May, followed by a new upside phase of the bull market.

RELEVANT PRICE STRUCTURE MODEL vs. S&P 500 Index

SYSTEMIC LIQUIDITY MODELS vs. Nasdaq 100 Index

Expect a small recovery for a week (a two-week rebound is also possible) - a significant decline follows thereafter. But we should see a cyclic low sometime in late April-early May, followed by a new upside phase of the bull market.

RELEVANT PRICE STRUCTURE MODEL vs. Nasdaq 100 Index

SYSTEMIC LIQUIDITY MODELS vs. High Yield Index

Expect a small recovery for a week (a two-week rebound is also possible) - a significant decline follows thereafter. But we should see a cyclic low sometime in late April-early May, followed by a new upside phase of the bull market.

RELEVANT PRICE STRUCTURE MODEL vs. High Yield Index

SYSTEMIC LIQUIDITY MODELS vs. US Dollar TWI

Expect a small recovery for a week (a two-week rebound is also possible) - a significant decline follows thereafter. But we should see a cyclic low sometime in late April-early May, followed by a new upside phase of the bull market.

RELEVANT PRICE STRUCTURE MODEL vs. US Dollar TWI

SYSTEMIC LIQUIDITY MODELS vs. Bitcoin (Various)

Expect a small recovery for a week (a two-week rebound is also possible) - a significant decline follows thereafter. But we should see a cyclic low sometime in late April-early May, followed by a new upside phase of the bull market.

There are strong linkages between, and among, global systemic liquidity, the global stock markets, and Bitcoin and other crypto-currencies (see the graph above). But the subject needs a longer exposition than the space here allows. I will write about those linkages in my next Seeking Alpha article.

RELEVANT PRICE STRUCTURE MODEL vs. Bitcoin (Various)

SYSTEMIC LIQUIDITY MODELS vs. 10-Year Yield

Expect small downticks over the next few days, but this should be followed by significant rallies in the 10-year yield into early May. A significant decline for bond yields follows thereafter.

RELEVANT PRICE STRUCTURE MODEL vs. 10-Year Bond Yield

SYSTEMIC LIQUIDITY MODELS vs. Gold Bullion

Expect small downticks over the next few days, but this should be followed by significant rallies in gold prices into early May. A significant decline for gold follows thereafter.

RELEVANT PRICE STRUCTURE MODEL vs. Gold Bullion

Post Notes:

The concepts shown the relevant price structure models were derived from Elliott Wave Principles. In the late 1980s, I wrote a book titled “Elliott Wave Principle - Applied To The Foreign Exchange Markets.” It was hailed by the London Society of Technical Analysts as “the best book ever written on the subject”. Ten years ago, the book was already out of print, but I was still getting queries for sources of the book. So I put it out in the public domain, and the book can now be downloaded from the internet, free of charge. Just make sure you download it from a reputable web site, so as not to download viruses. Scribd seems a safe site to download the pdf file of the book, but you have to deal with a free trial offer. Scan the file for viruses, just to be safe.

Disclosure: I am/we are long U:EOG, U:XOM, U:CLR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.