Why the risk-off tone? Isn’t divided government bullish?

Mid-week market update: Why have the markets gone risk-off? Isn’t divided government supposed to be equity bullish?

While the exact results of the mid-term elections aren’t known just yet, polling models and PredictIt odds, which represent consensus expectations, show a narrow Republican majority in the House and a probable Democrat control of the Senate.



This result should be equity positive for several reasons:
  • A tighter fiscal policy which makes the Fed’s job easier and raises the odds of a more dovish path for monetary policy.
  • A narrow Republican majority reduces the tail risk of a disorderly debt ceiling impasse. The recent UK experience showed that the market has little patience for fiscal uncertainty.
While the political overtones of the election are mildly bullish, I can think of some other reasons for the risk-off tone in the markets.



Crypto implosion

The FTX crypto implosion dragged down the most extreme forms of risk appetite. Crypto prices are correlated with the performance of speculative growth, as measured by the relative performance of ARKK. The recent problems with FTX likely had some contagion effects on the speculative growth factor.




Risk divergence

An unusual condition occurred yesterday to flash a tactical sell signal. The 5-day correlation between the S&P 500 and VVIX, which is the volatility of the VIX Index, spiked when the NYSE McClellan Oscillator was not oversold. There were 25 such signals in the last five years. 18 of them resolved bearishly and 7 bullishly. I interpret the heightened correlation as a divergence between stock prices, or risk appetite, and risk measures such as VVIX. History shows that the risk indicator is usually correct in these cases.



As well, investors have to be aware that the Cleveland Fed’s inflation nowcast is slightly above consensus expectations for tomorrow’s CPI print. Here are the market expectations.



Here is the Cleveland Fed’s inflation nowcast. A hot CPI would be bearish for risk appetite.



Subscribers received an email alert this morning that my trading account was initiating a short position in the S&P 500. If I am right on the short-term outlook, the 14-day RSI of the S&P 500 Intermediate-Term Breadth Momentum Oscillator should recycle from an overbought condition to neutral. In the past, this has been a reliable tactical sell signal for the market.



Stay tuned.



Disclosure: Long SPXU


11 thoughts on “Why the risk-off tone? Isn’t divided government bullish?

    1. Crypto will go down as the tulip mania of our time. Life’s way of saying don’t think it can’t happen again. It’s happening right in front of us. And everyone’s dismissing the kid(s) who point out that the Emperor has no clothes. That’s just my opinion.

  1. Cam, you have said in the past that the Cleveland Fed’s inflation nowcast is not reliable. Why do you trust it now?

    Also, the last CPI reading exceeded the expectations but the market rallied 10% after that reading.

  2. This crypto collapse is a very big deal to the point of being the Lehman moment to send the market down violently.

    1. Most of crypto’s leverage is offshore, so central bankers won’t feel compelled to ride to the rescue as systemic risk is limited.

  3. As the crypto market implodes, over $1.5trn in funny money has disappeared.

    Does Powell breathe a sigh of relief? Does it make his task easier along with trillions lost in the stock and bond markets so far?

  4. Someone commented:
    Apparently Cleveland Fed has forgotten Keynes:

    “It is better to be roughly right than precisely wrong.”

    1. One inflation-equities model with monthly inflation data of 7.7% and SPX monthly Zscore is issuing a buy signal here. The model is spot on in April of 2020 but was early by 1 to 3 months in other periods for example 2008.


  5. DXY and the 10 year TSY yield. These 2 indices will tell us if this rally will continue. Getting caught offsides here with with SPXU as a hedge.

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