Positioning for a Long-Term Cycle of Increased Risks

President-elect Trump’s landslide election has certainly activated the animal spirits in many markets as traders have been busy pricing in the expected impact of his anticipated new policies.  Stocks continue to slowly grind higher, making new all-time highs, albeit in a very unconvincing fashion.  The dollar is making progressively higher multi-month highs against most major currencies, and the US treasury market remains under pressure.  Bitcoin poked its nose above 99,300, effectively hitting my next upside target, and gold and silver are trying to reassert their uptrends a bit prematurely after having nasty corrective declines.

Traders are expecting the new administration’s policies to be supportive of further growth in the US, but highly inflationary.  There are many markets that are now highly stretched out, so we need to prepare ourselves for a tremendous amount of volatility over the coming months and years.  This volatility won’t only play out in the US markets, but the impact will be global.  Let’s discuss.

First of all, we really need to congratulate the Fed for having called the bottom in 10-year bond rates perfectly with their hyper-aggressive rate cut in September.  I have never seen a more perfect trigger for a market move that exploded in exactly the opposite direction of what was intended.  This was a bit like the story of the emperor’s new clothes.  The market didn’t buy what the Fed was selling.

Although the markets are all excited about the anticipated inflationary impact of future Trump tax cuts and tariffs, the real impetus for higher interest rates has really been the cumulative impact of irresponsible fiscal and monetary policies carried out for decades.  Trump’s tariffs will simply help nudge along an ugly trend that was set in motion long before Trump even considered a career in politics.  It took the concerted effort of many people a very long time to create more than thirty-six trillion dollars of US debt.  Yes, this debt level used to be thirty-five trillion dollars, but our government is really, really good at spending money they don’t have. Let’s have a look at a little chart and seriously consider whether we will be laying the blame properly when we attack the new administration for creating a giant fiscal mess.

 I am certainly not condoning or endorsing future tariffs or other taking any sort of  political stance.  Rather, I am pointing out the cold hard truth that our government has been running amok for decades, borrowing and spending money in astonishingly irresponsible ways.  

$36,019,972,384,9744 – That is a REALLY BIG NUMBER!!

It has taken a long time to get our debt to this level, and it will take even longer to make it go away.   Some sort of negotiated default will be far more likely over time.  The Fed has played a key role in this process, but remember that both political parties have been complicit in this utterly deplorable process.  

Ok, enough of my ranting about our country’s fiscal mess.  Let’s figure out some ways to make some trading profits. 

First, we have had another 11%+ rally in Bitcoin since I recommended a fresh long position last week.  I recommended that we take profits on this new position when it gets close to $100,000.  We touched $99,334 today, which for me was sufficient for this leg of the move, so I took profits and flattened my Bitcoin exposure for the time being.  If you want to hang on to your exposure and you haven’t grabbed your profits yet, then I would suggest you hold on to perhaps 10% to 20% of your recent long position.  Leave the original stop from last week in place and ride this wild train with a small position in case it wants to keep on going. I am in the process of re-examining my overall views on Bitcoin, and cryptocurrencies in general, as I am starting to anticipate more upside in these funny assets over time.  I will have more to say about that in the coming weeks.

Second, I think we are very, very close to a significant downside correction in the equity markets.  Equities are extremely overvalued right now by nearly any measure.  I can see potentially two and a half percent further short-term upside in the S&P500 (SPX) from the current levels, with at least eight percent to ten percent downside.  I don’t like those odds very much, so I am strongly encouraging a highly defensive posture for the time being.  The downside risk in the Nasdaq is far greater since the volatility of that index is far greater than the volatility of the SPX.  Playing the downside in stocks is very tricky for a variety of reasons. The volatility skew in the options market makes downside bets particularly expensive.  There are ways to structure clever option bets to play for the downside in stocks, but I am not going to delve into these strategies here.

Third, I stick with my primary bet on the currencies, anticipating yen strengthening against most major currencies.  In a way, this might be the best hedge against chaos and turmoil in the markets as the yen is still the preferred safe haven currency, excluding the US dollar, which is typically a strong safe haven currency except when the turmoil is specifically dollar-related.  Over time, the dollar will lose more and more of its safe-haven status, but that will take time.  In fact, the dollar will remain king for a while – at least until investors decide that US debt is no longer a safe place to park their money.  

Europe is a mess right now.  The economy in the eurozone is weak, and the hostilities in Ukraine have recently intensified.  The US decision to authorize the usage of their missiles by Ukrainian forces for attacks inside of Russia took the risk level of the war up more than a few notches.  Accordingly, I don’t see any near-term relief for the euro.  The pound is likewise under heavy pressure for the time being, as is the Swiss franc.  These currencies will all remain weak for a while, although I think their weakness against the yen will eventually be bigger than their weakness against the dollar.  

I am starting to see some signs that broad-based yen strengthening has started, but it is still very early in the move.  As noted, the European currencies – euro, Swiss Franc, and British pound are all showing serious signs of weakness – against both the dollar and the yen. The New Zealand dollar is also under very heavy selling pressure.  The New Zealand economy is struggling, and the RBNZ is set aggressively cut rates.  The Canadian dollar and Australian dollar haven’t really broken down in a meaningful way yet, but they should still weaken over time against the yen.  We need to be patient here, but the market action is getting encouraging.   

Gold has been on a wild ride, but we need to be careful here.  While it is possible that the sharp correction down to $2540 was sufficient to correct the rally from $2280 to $2790, I am not convinced that the whole correction is done.  Yes, geopolitical tensions are rising, and inflationary pressures are not dissipating as much as the authorities would like us to believe, but usually a correction of a move of that magnitude takes more time.  This is exactly the type of scenario that I had in mind when I noted that we should only partially liquidate our long gold positions.  

The recovery from the $2540 low has been sufficiently fierce to re-set the uptrend, but we really should be patient here before we plow back into our full positions.  I would rather purchase more gold on a pullback from new highs than chase the recent rally.  We only liquidated a portion of our longs, so we can afford to be patient.  The overall trend in gold is up, and Inflation is not going away so quickly, but time is on our side.  Trump’s intended policies will almost ensure that inflation remains with us for a long time.  The long-term disinflationary cycle that began in the 1980’s is done.  The rapidly expanding globalization brought many benefits to us in terms of attractive pricing is under siege.  Gold will go higher over time, but let’s wait and watch the markets further before we increase our exposures. Overall, we need to remember that BRICS wants to directly and aggressively challenge the supremacy of the United States, and this will lead to rising pressures and increased geopolitical military risks.  Gold will be a star for a long time.  

My overall message is that we need to position ourselves for a long-term cycle of increased risks at many levels coupled with increased volatility.  Governments will be forced to stretch themselves fiscally and central banks will be severely challenged.  In the big picture, as noted, gold will go higher.  Bitcoin will likely go higher as well, although it will be a much more volatile trade.  European currencies should weaken substantially against the yen, perhaps to shockingly weak levels over time. Aussie and Kiwi will likewise weaken against the yen.  The dollar will reign supreme for a while, but eventually it will come under tremendous pressure when people realize that the Fed is stuck in a double-bind, forced to choose between fighting inflation and supporting growth.  The Fed’s dual mandate will become increasingly hard to achieve.  

Next week I will write about a few stocks that have been particularly fun to trade recently. Until then, I wish you all the very best of luck.