Weekly Memorandum 8/17/2020

Equities continue to consolidate near their highs, which is bullish. The divergence between the major indices remains a concern in the short-term, as the Nasdaq has tagged all-time highs from this rally, while the S&P and Dow have not. The longer this goes on, the more of a concern it will become.


One notable observation in the last couple weeks has been the widening of credit spreads between investment grade corporate bonds and treasuries. This is a reliable indicator for liquidity in the market, and if it continues to widen, it means liquidity is decreasing. This comes off the back of the Fed's recent reduction of corporate bond purchases. Remember, the Fed began purchasing corporate bonds in response to credit spread blow outs during the corona-crash. This will be a good test to see if private-sector credit markets can operate without central bank support.


Interest rates have crept up a little bit in recent weeks, but the Fed continues their QE-Infinity program. There have been times in the past where interest rates rose during periods of QE, so maybe the Fed is trying to kick-start inflationary pressures. But more importantly, Dallas Fed president Robert Kaplan recently stated that the Fed may be tolerant to see inflation run above their 2% threshold. This would represent a major policy shift that could come with major repercussions for the economy.


But it doesn't stop there with respect to interest rate risk (a lot has happened in the last week). Last week, large swathes of Iowa and Illinois were absolutely devastated by a derecho, which is basically a land-based hurricane. The storm damaged roughly 10 million acres of crops, or about 1/3 of the state of Iowa. There doesn't seem to be much reporting on this.


We learned in Econ 101 that a reduction in supply can cause an increase in price. Higher prices mean higher inflationary pressures, which can translate to higher interest rates. So, we have interest rate risk coming from 3 directions: Reduction of corporate debt purchases, a Fed that may allow inflation to rise above 2%, and a potential crop shortage. Much of this was covered in the most recent issue of the Mercator Letter, which was published yesterday.


In other markets, all of the "big 3" cryptocurrencies (Bitcoin, Ethereum, Litecoin) tagged cyclical highs today, which is bullish. Gold and silver pulled back from their recent highs, but still appear constructive in the short-term. Crude Oil continues its multi-month consolidation, from which we anticipate a large price move to occur. The U.S. Dollar continues to take it on the chin, which has been a major driver behind many of the trends we've seen recently.


We also note that a significant bottom may have formed in agricultural commodities recently. This is something we will continue to monitor closely.

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