PAM's Tools Suggest An Equity Market Upside Correction Ends This Week; The Long Bond Yield Rally Also Peaking Just Slightly Ahead

Summary

• Even as 10Yr Yields surged higher, Primary Dealers, Institutionals, and Central Banks accelerated purchases of long-term bonds attracted by the high yields (which are unlikely to stay high for long).
• Our model for the buying behavior of central banks re US long-term Treasuries, suggests that the 10yr yield peaks this week and will be lower until the middle of April.
• The liquidity models suggest that ongoing upside (sideways) corrections from peaks made on February 15 (in the NDX 100 and S&P 500 ends this week, followed by declines until mid-April.
• All the current market action in rising yield was based on what INFLATION EXPECTATIONS have done so far. Commodity inflation is also a factor, but this type of inflation is about a year ahead of actual inflation. Bond yields are "mapped" into Core PCE and/or Core CPI. If Core PCE/Core CPI fails to take off for February (after a market expectations miss for January 2021), yields have to deflate.
• It appears that bond yields and equities are supposed to top out during the same time frame (equities probably lagging by a day or so) this week -- within this March 8 to March 12 trading week. And the positive covariance returns thereafter.

MARCH 7, 2021

robert.p.balanModeratorLeaderOwnerMar 7, 2021 12:34 PM

The bond yields were stable to lower on Friday, March 5, 2021, as Primary Dealers, Institutionals, and Central Banks accelerated their purchases of long-term bond, attracted by the high yields (which are unlikely to stay high for long), see chart below.

Even as 10Yr Yields surged higher, Primary Dealers, Institutionals, and Central Banks accelerated purchases of long-term bonds.

The Primary Dealers (Masters of the Universe, MOTUs) have been accumulating long dated Treasuries, as central banks grab long-duration paper.

The MOTUs have been increasing long bond positions, even as long-term yields surged higher, see chart below.

Our model for the buying behavior of central banks re US long-term Treasuries seems correct (see chart above), and the model is still providing advance information about the short-term course of the 10Yr bond yield.

The model suggests that the 10yr yield peaks this week and will be lower (not in a straight line) until the middle of April, 2020.

Why is this so? The global central banks have been a very large influence in the course of the 10yr yield. A combination of US Dollar and 10yr yield moves determine to a larger extend whether global central banks are going to buy or going to sell US Treasuries.

In fact, in the final analysis, global central banks buying behaviors of US long term treasuries determine to a large extent what the 10yr yield will do in the medium-term.

The current behavior of central banks as shown in the earlier chart above is consistent with the recent developments in the US Dollar and long term yields.

Foreign official institutions (central banks) were also doing the same thing, (see chart below), normally take advantage of a (previously weak) US Dollar (DXY as proxy), and rising long bond yields (see chart below).

The primary influence of the US Dollar to foreign central bank purchases of Treasuries

Foreign official institutions (central banks) buy more Treasuries when the US Dollar is weakening, and vice versa

Foreign official inst'ns (central banks) also buy more US Treasuries when yields are rising, and vice versa

It was equities strangely having a tantrum due to SLR issues which are remit of the bond market; yields were rock steady, and even ended lower.

We said that this equity tantrum will pass quickly, and it did. PAM reset long equity trades after the equity tantrum calmed down, looking for test of previous equity peaks, by early next week, week of March 8 to March 12.

TimK123Mar 7, 2021 7:30 PM

Not sure if all the money sloshing around means this time is different for yields, but found this interesting - "rising rates are not a foregone conclusion" (after a recession). I assume the reason inflation has receded in the past a while after a post-recession rise in inflation is that there is a lag between increased demand from companies and for them to invest in staff and equipment to expand capacity to meet the new demand:

TimK123Mar 7, 2021 7:30 PM

TimK123Mar 7, 2021 8:09 PM

Kashkari Stunner: If Real Rates Spike "That May Warrant" More Easing

"...[a rise in real rates] would give me concern ... and that might warrant us considering a policy response...

timothy.r.kiserMar 7, 2021 9:44 PM

If they were to zoom out to 18 months, then rates have not really risen much. It is all relative. Zerohedge loves fear. I have ridden through many disasters predicted by them.

robert.p.balanMar 7, 2021 10:39 PM

Fear-mongering gets the eyeballs.

Triple.F.FredMar 8, 2021 12:20 AM

robert.p.balan timothy.r.kiser A very interesting thoughts guys. As we used to say in the fire services decades ago... "blow the smoke out of the way and look at the fire." Of course that was a figurative statement...the real meaning was Look to the old hands, they are the ones who have likely seen this scenario before and know what is "Likely To Happen."

Knowing what the fire is likely doing or more to the point "Likely to do going forward" will tell you what you need to do to combat it's growth... Many thanks for the leadership guys!

TimK123Mar 8, 2021 12:38 AM

LOL good point Tim, Robert, yes they do tend to have a pretty doomsday view in most cases one way or the other, at least 80% bearish in the last year I guess. I like to play devil's advocate and explore counter arguments that's my nature alas - I posted both in favor and against rising yields earlier so it's just exploring both sides for me.

My main takeaway is that in case rates spike more there might be a backstop from the fed. That is looking less likely now given Robert's thoughts on the matter, and also some data I came across I posted above, earlier, but something I will bear in mind anyway.

Yes zooming out is always a good strategy. Golden rule number one in many cases!

robert.p.balanModeratorLeaderMar 7, 2021 10:41 PM

"It is all relative" - according to Mr. TK.

Nothing special so far about the recent rise in yields . . .

The 10yr yield rarely stays very long above its regression line, unless the Fed is hiking the FFR

. . . and the Fed never hikes the Fed Funds Rate during a recession

The fear about *surging yields" is merely "recency bias* . . .

ikswo123Mar 7, 2021 11:05 PM

Inflation thoughts...[looking for the scarcity that will drive inflation]. 1. PPI may have localized pressures due to various global supply chain disruptions. Offsetting that is the 5 years of small business destruction done last year, reducing aggregate demand. 2. Even if PPI is trending upward, it would likely take a few months to flow through to CPI >> i.e. consumer inflation is more of a second half of 2021 possibility. Best guess for next couple months from where I sit is a spring lull as things begin to reopen.

robert.p.balanModeratorLeaderOwnerMar 7, 2021 8:05 PM

I showed these EWP schemata of SPX sometime in early February. These illustrations show the likely pattern of the S&P 500 index going forward, over the next to or three months ahead.

No. 1

No. 2

No. 3

This is the EWP schemata (No. 3) that we favor in illustrating the current equity market correction, which may last until mid-April.

Compare those charts above to the chart of SPX today.

robert.p.balanModeratorLeaderOwnerMar 7, 2021 8:44 PM

Here are the background facts that we have to consider in choosing which EWP schemata to favor:

1. Even after the stock market has been routed by the sharp surge in yields, investors are still pouring in billions of funds into equities.

2. The stimulus bill clears the House of Reps by Wednesday, but it is a foregone conclusion -- the checks will be going to be mailed by middle of March. Note however, that this is the last stimmy bill for some time -- unless we have COVID-19 Wave III by autumn.

3. The FOMC will very likely do something to address the surging long bond yield on March 17 -- that's two weeks away, but expect the MOTUs to get information way ahead of time -- watch what they do. There will be plenty of front-running whatever the Fed may do.

4, The surge in inflation breakevens, which has been the basis of the market to conclude that actual inflation is about to take-off, has actually gone sharply higher, because the Fed has been a large BUYER of TIPS -- hence widening the breakeven spread aggressively. That has caused long-term bond yields to rise aggressively as well. If the Fed stops buying TIPS, the breakeven will deflate. And the long bonds will correspondingly deflate as well. 

5. Core CPI for January 2021 was sharply lower vs. expectations., In three days, March 10, we will have the February CPI data. Another CPI surprise to the downside will deflate bond yields. I believe the Fed (Mr. J Powell) already have an idea about the CPI data, and so did not feel any urgency to act.

6. All the current market action in rising yield was based on what INFLATION EXPECTATIONS have done so far. Commodity inflation is also a factor, but this type of inflation is about a year ahead of actual inflation. Bond yields are "mapped" into Core PCE and/or Core CPI. If Core PCE/Core CPI fails to take off for February (after a market expectations miss for January 2021), yields have to deflate.

7. Taking all of these into consideration, we believe that a moderate downside correction (alternative No. 3) is what may happen, which may run for another 6 weeks, until the middle of April.

robert.p.balanModeratorLeaderOwnerMar 7, 2021 8:57 PM

Our task is how to translate these stuff into market into a market forecast. Another issue -- will the negative covariance between equities and bond yields continue? Or will the covariance shift back to negative if/once yields start to deflate significantly? For me. this is the biggest conundrum. At this time, I have no idea if that will happen, and if so, when.

Nonetheless, and I agree with Mr. TK in this, we should start with the minimum outlook, which is the last illustration -- the one with the least decline.

That EWP schemata posits that we are seeing a Wave 4 and Wave 5 resumes after a decent correction (which does not have to be as deep as illustrated.) Remember, corrections can also go sideways (or even do an irregular).

robert.p.balanModeratorLeaderOwnerMar 7, 2021 9:09 PM

Where are we in that correction? john.der was very perceptive about the irregular Wave 2 that we are likely having, and I expect to complete within two or three days.

*ESH1*

With that as timeline, maybe the CPI/PCE inflation data on May 10 makes a lot of difference -- but frankly, I am groping for what transmission mechanisms inflation data may have to impact equities negatively.

If we get another low Core CPI reading, I expect yields to deflate, but will that be positive or negative to equities? Will there be a shift back to positive covariance in an environment of lower than expected inflation? I have no idea at this time.

nanobrainMar 7, 2021 9:36 PM

why guessing about equities response, when we could go long bonds and be done with it? considering the fact that we can get more leverage for bonds and higher probability of profit I don`t see why we struggle

robert.p.balanMar 7, 2021 9:38 PM

Of course, nanobrain that is clear -- bonds will be the market leader -- but a lot of equity investors still want to know what to expect. I can't just leave them in the dark.

*YMH1*

*NQH1*

Unless a miracle happens, NQ will severely underperform ES and YM-

*RTYH1*

Same outlook for RTY -- it will likely underperform.

robert.p.balanModeratorLeaderOwnerMar 7, 2021 9:31 PM

iDoc08 was just showing me the performance of XBI and LABU vs the liquidity models (see chart below).

Seasonality of the US Financial System Liquidity Flows vs. XBI and LABU

So Biotech may also rise for a few days, and then resume the correction phase -- and it will be down, hard. Biotech is so HighTech in that regard. These two asset classes are prime moved by the state of the High Yield and Junk assets. Biotech is echoing the deleverage that is on-going in the HighTech sector -- and both will likely be the underperformers over the course of the next few weeks.

How long will the downside correction take place? First let us make sure that we see Wave 2 ends (in a few days), before we can make a projection lower. But our liquidity models illustrate what is likely to happen in the equity markets (see charts below):

The liquidity models suggest that ongoing upside (sideways) corrections from peaks made on February 15 (in the NDX 100 and S&P 500 ends this week, followed by declines over 6 weeks, until mid-April.

Decomposition of Systemic Liquidity Flows (Fed's Balance Sheet) and 2020-2021 SPX (Jan 1, 2020 to Apr 30, 2021)

An equity market decline may not follow a straight line, but it may take 6 weeks before the market is again primed to resume a credible bull phase.

Using the same decomposition of systemic liquidity flows (Fed's Balance Sheet) framework, we see the 10yr yield topping out within a day or so (see chart below). The yield is likewise expected to fall over the next 6 weeks, basically the middle of April.

This tool dovetails nicely with the modeled behavior of central banks in buying long-term US government paper, as shown and described at the start of this report. That model also shows the middle of April 2021, as period when the global central are likely to stop buying US govies.

Decomposition of Liquidity Flows (Fed's Balance Sheet) and 2020-2021 10Yr Yield (Jan 1, 2021 to Apr 30, 2021)

It appears that bond yields and equities are supposed to top out during the same time frame (equities probably lagging by a day or so) this week -- within this March 8 to March 12 trading week. And the positive covariance returns thereafter.

With that as timeline, maybe the CPI/PCE inflation data on May 10 makes a lot of difference -- but frankly, I am groping for what transmission mechanisms inflation data may have to impact equities negatively.

If we get another low Core CPI reading, I expect yields to deflate, but will that be positive or negative to equities? Will there be a shift back to positive covariance in an environment of lower than expected inflation? I have no idea at this time.

robert.p.balanModeratorLeaderOwnerMar 7, 2021 9:53 PM

I have other forward looking indicators which also suggest that breaven inflation will deflate soon.

US Inflation Swap Forward and TIPs 5yr/5yr compensation, Headline and Core CPI, 10yr yield

Market-based measures of future inflation (5-year outlook) already rolled over in February 2021, in line with Core CPI

Be prepared for a sharp rolling over of the 10yr yield very soon

If Core CPI (bright pink line) continues to fall, then the rest of the instruments in the chart below will follow lower.

If Headline CPI (green line) falls as well, then there is no inflation surge -- for now at least.

robert.p.balanModeratorLeaderOwnerMar 7, 2021 10:01 PM

I can almost see inflation expectations being disappointed with the Consumer Price Inflation report due on Wednesday, March 10. PAM expects Core CPI to fall again, following the weak January 2021 data.

Why?

All the major components of Core CPI are still doing swan-dives (see chart below).

There is no way that Core CPI will be able to support the Inflation Meme that has causing this surge in long bond yields, and causing the equity markets to consolidate. A correction is due in equities, and so a rising long bond yield was/is a convenient excuse to pull down stock valuations, for a good reversion to mean.

TimK123Mar 8, 2021 12:51 AM

Very revealing, thanks.

robert.p.balanModeratorLeaderOwnerMar 8, 2021 12:21 AM

AT 31,302.10 BOUGHT 288 SCALPER CONTRACTS YMM1 FOR ALL FUNDS, INCL TRACKER, EIGER

*We put a trail stop at breakeven for this trade.*

all PAM EXITS 288 LONG SCALPERS AT DOWNWARD BREACH OF 31,303 (BREAKEVEN), GTC -- ALL FUNDS

AT 3825.50 BOUGHT 288 SCALPER CONTRACTS YMM1 FOR ALL FUNDS, INCL TRACKER, EIGER,

*We put a trail stop for this trade.*

all PAM EXITS 288 LONG SCALPERS AT DOWNWARD BREACH OF 3800, GTC -- ALL FUNDS

centexlifeMar 7, 2021 10:11 PM

Robert is it too early to pre-plan now rolling over NQH strandees at 13499 to NQM given current under performance?

robert.p.balanModeratorLeaderOwnerMar 7, 2021 10:28 PM

Too soon Tex -- who knows? We might see a miracle. We will have enough time -- best way to do is double up NQ bets to pad the results.

On the other hand, it is always best to go with the highest MoMo, as gains are fungible anyway -- does not matter if you made if off ES. It is still a profit.

centexlifeMar 7, 2021 10:34 PM

Yes. Thanks to your guidance I am flush in ES and MY and will short MNQM against my MNQH longs if given that opportunity.

robert.p.balanModeratorLeaderOwnerMar 7, 2021 10:38 PM

I will see you gals/guys in late Asia tomorrow, Monday, March 8.

------------------------------------------------------------------------------------

This is the latest performance of PAM's One-Contract Portfolio, with a margin capital of $100,000, making the same trades as the flagship Swing Fund, but doing consistent, one contract-trades.

----------------------------------------------------------------------------------------

Here is the current status of the PAM flagship Swing Fund, which includes open and closed trades.

During the twelve months of 2020, PAM delivered phenomenal real-dollar Hedge Fund trading performance, the best at Seeking Alpha:

PAM's flagship Swing Portfolio, year-to-date (December 31, 2020) delivered $100, 181,522.77 net profit on $11,172,813 margin capital.

Year-to-date performance: 860.27%, on 888-98 win-loss trades.

January 2021 spreadsheet here:

Year to date 2020 spreadsheet here.

----------------------------------------------------------------